Thoughts on this 12 unit?

Question

I'm considering making an offer on a 12 unit (would be my first RE purchase)with the following characteristics:

Asking price: $585,000
GOI: 95,940
NOI: 50,910
12 2bd 1ba units with rents ranging from 425-595, two of the units are corporate rentals all utilities included and rent at 1,010 and 1,320.
Built in 1985
New roof in 2005
Low maintenance exterior
No common areas
100% occupied
Nice quiet small village area.
Washer dryer hookups in units, not sure how many have them installed
Off street outdoor parking lot
Tenants pay own utilities

Comparable nearby apartment complex with very similar layouts, size and finishes (but with covered garage parking for one car for each unit - snow belt area) rents for $750+.  Also, the the target building has electric heat which is more expensive than gas and could also account for rent difference.  But it still seems rents are below market.  I also think expenses could be trimmed.

Building could use some cosmetic updates.

Thoughts on a good offer price?  At asking it is about an 8.7% cap rate based on the pro forma.

I'm thinking the corporate rentals should be discounted somewhat as they are way above market even after factoring in the included utilities so if the building loses those leases those units will be back at market rate.

Thanks in advance for any help.

David Beard · Answer

I've not seen one of these "types" of buildings (small commercial-class of this age) yet that has a TRUE expense ratio (vacancy+expense+capital exp) less than 55% or so, if you truly allow an adequate maintenance allowance and age out the roof, mechanicals, and systems.  But if you have modest property taxes there, it might be possible to hit 50%.

Make sure you look up the actual property tax rate, and apply that to your purchase price, as it will update to that (either automatically or on appeal).  Is water separately metered for each unit? Or some methodology used to charge it back?  Call the utility company to get 12-mth trailing averages for the electric bills for the units, and do the same for some of the competition.

Are you sure you can get bank financing?  Zero experience and starting with a 12-unit is a big negative.  An experienced prop mgr helps persuade the bank, but make sure it's a big company, as little guys drop like flies and banks know it.  Plus, you live some distance away, sounds like, so also a negative from bank's perspective.  You need to compensate for that with a very solid business plan and professional materials.  An experienced partner would help.

Brian was saying that "owner" financing will typically generate a premium price for a seller in this tough credit environment, perhaps 10% above a cash buyer.  If you're using a bank, you should talk to them first and obtain a written commitment to lend (a pre-qualification letter, if you will), then you're almost as good as a cash buyer to the seller.

Using a 10% cap rate sounds reasonable.  I wouldn't go any lower, and you should base it on current "adjusted" performance, not "hope for" performance that will require effort on YOUR part to achieve.  "Adjusted" NOI would have your reasonable/conservative assumptions for maint. and capital expenditures.  (For cap exp, I'd use no less than $400/unit/yr or 7% of gross potential rent, with appropriate additional amounts for any systems/mechanicals that are older).  You should cost out what it will take to put on a new roof, replace the mechanicals, etc, and schedule it out over the remaining life.  The seller's NOI is only a starting point.

Joel Owens · Answer

"You claim the NOI is $50,910 (which needs to be THOROUGHLY verified based on ACTUAL numbers today)"

I agree with this.I have seen investors go so far as to source the deposits into the account for the apartment complex.

I have seen a seller use their HELOC for a house to subsidize rent payments on their apartment building.The buyer looked at deposits and thought the tenants were fully paying only to find out they were half paying after purchasing and had side agreements with the seller.

My point is some sellers will do anything legal or not to unload a property they don't want for whatever reason.I look at everything with a microscope.If the seller pushes back and can't verify or give you what you want they are hiding something.

That's fine you just can't pay them on what you can't 100% validate to be true and accurate and your offer will reflect those circumstances.If the property has been sitting for 6 months likely it is hiding  some secrets or the seller has gotten to the point where they are ready to sell at a realistic price.

Bryan Hancock · Answer

If they were they were wrong!  I don't really ever see posts claiming this though.  The financing structure does not impact the capitalization rate, but it SHOULD definitely impact what you pay for the property.

It is really quite easy to get close provided you can do all of the due diligence needed to get an accurate NOI.  You don't want to use a blanket 50% rule to evaluate the asset.  You'll need to go through each expense and do the best you can to verify the validity of it.  One of the key expenses is the economic vacancy.  A good property manager should be able to help you with this.  If this is your first building I would also rely heavily on the expense estimates from a local competent property manager familiar with the market.  Given what you have described I would guess your expense ratio is going to be north of 50%.

The two components needed to calculate YOUR capitalization rate are:

1.  The loan constant - You'll need to get a quote from lenders to see what rate and amortization period they'll loan on or IF they'll loan on the project.  If you intend to use a seller carryback for the 2nd you'll need to blend this rate into your loan constant and verify your lender will allow the seller to carry subordinate paper

2.  Your required ROE - I don't know what yield you are seeking, but 20%+ is quite common.  For grins you can use 20% to start with and adjust this north to be more conservative to allow for a lower starting offer

YOUR capitalization rate will be based on weighting the two components above based on the terms driven by the lender.  So if the lender will lend 75% on a 20-year amortization at 6.5% your loan constant will be 8.947%.  You can then use a 20% required return on your equity to arrive at YOUR overall cap rate:

(.75 * 0.08947) + (.25 * .20) = 11.71

You claim the NOI is $50,910 (which needs to be THOROUGHLY verified based on ACTUAL numbers today), so the seller would need to accept something around:

NOI / Cap Rate = Good Indicator Of Value
=> Good Indicator Of Value = $434,756

I would start under that number and work your way up.  The number above will be your MAO if you desire to keep a 20% ROE.  If you can adjust your ROE expectations you can adjust your offer price too.

Note that the procedure above is inexact.  There are some calculators derived from my original model here:

V7 Of Small Apartment Complex Pro Forma

that place the time value on cash flows and allow one to fine-tune things.  The procedure above is generally pretty accurate though provided you feed good data into it.  If you feed garbage in you'll get garbage out.

Michael Power · Answer

Bill / I am only just learning multi-family deals, and there is a lot to learn.  These deals seem to circle the drain on a couple of fronts.  Class of building, class of neighborhood and cap rates.  1985 sounds like a 'C' class building, (25-years old). and most likely sits in a 'C'-neighborhood.  For that combination, in Buffalo NY, in Q4-2011, the going Cap Rate is 9.6%, (REIS Reports).

Stay with me now....let's look at market rents as that is where you will be when the corporates leave.  $750/month/unit gives GOI @ $108k.  Assume the costs inferred include vacancy and maintenance, then your NOI is $57,090.  With a cap rate of 9.6%, the back of my envelope gives a fair price of....$588,500.

So, fair building & fair price based on potential market rents.  Now go look for the hidden gems and the mis-stated expenses and determine the real price.  Look at the rent roll and maintenance for the last 3-years.  If this is a 'Value-Add' play, and market rents sought are $750, determine how you are going to do that.  My going in price would be more in line with the current rents received....@ 9.6%, = $469,000.

If this is your first RE play, I would suggest taking it slow.  There are lots of multi's available, and Buffalo is as good a location as any other.  Just be cautious...there is no such thing as a low maintenance exterior in Buffalo, NY.

Mike P.

Joel Owens · Answer

Are you buying

1.all cash
2.bank finance with some down
3.taking over or assuming the existing note
4.bank finance with some down and a seller held second
5.all seller financed note

Big difference in debt service and price based on structure.

Johnny Holmes · Answer

Deal looks as though it would be good

David Beard · Answer

I would definitely try to finance on the front end:

* Property is highly stabilized and at full occupancy.
* It does not need any significant work.
* Larger LTV may be available for a purchase transaction, versus when you go in for a cash out refi later.

So it's an ideal candidate for front-end financing at 75-80% LTV, except for experience and distance factors.  You should interview PM's.  Look for a smaller bank, < 1-2bn in size ideally for a very small commercial project like this.

Bill E. · Answer

Brian - thx for the response.  If I have the ability should I always offer all cash assuming I can hold it through any seasoning period?  I'm thinking yes in order to get the lowest purchase price.

David - thx very much for your input.  To answer some of your questions:
Water and all utilities is sperately metered except for the corporate units.

Bill E. · Answer

Thanks Michael -  Lots of good points to consider.

As I'm guessing you saw from my previous response, the property is not in Buffalo.  So, I wonder how that affects CAP rate averages?  Can I search by area code?

At the same time I can tell you that the neighborhood is not "c" .  It's in a great area.  I grew up there and know it well.

Bill E. · Answer

Brian - thank you for the response.  And, for reference the property is not in Buffalo.  it's in a much smaller, nearby western new york county.

So, to clarify for a newbie - why would a seller accept a lower all cash offer? is it only because you don't need a financing contingency?  Or are there other reasons? In other words, say I could offer to buy with no financing contingency, is that the same as an all cash offer?  Assuming I have the ability to buy all cash, should I base my offer on that and say "all cash" and do so and then seek financing afterward?

To answer your other questions:

1.  A nearby 12 unit sold for $628,000 recently.
2.  Building has been on market for atleast 6 mos, probably more.
3.  Taxes are $14,539.
4.  Rental demand is moderate.  It's a small village.  Not a metro area, but nice little village in western new york.

Thoughts on this 12 unit?

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