12-Plex Purchase Formula

[Spencer Hoogveld]

Hello BP Community:

I have a question about a 12-plex apartment complex that I’m interested in -

The sellers are an older couple who are looking to get out of the rental business after 40 years. In total there are 12 units that are each 1 bed and 1 bath. Water, sewage, and electric are all separate. They have 6 of the units rented at only $300/each. These units are WAY under-rented! I ran a report on rentometer and the median rent for the area is around $500. The other 6 units are vacant, but could easily be rented with some cleaning and minor updates.

The sellers are asking $455,000. This number seems extremely high when the building only generates $1,800/year in current rental income. While the units are functional, they all need to be updated to be able to generate $450-$500 in rent per month. I’m estimating about $75,000 in updates to renovate all units and modernize the exterior.

My question is: What formula can I use to show the sellers what the building is worth based on their current income?

I don’t want to be disrespectful by offering a low number, but also want to be fair so the numbers work for me.

[Account Closed]

How is it possible for the water and sewer to be separate for 12 units in an apartment building?

You need to get closer numbers before considering an offer. 

It is always better if you can get exact numbers and ask to see the books before making an offer. But, a standard is to make an offer based on a written statement indicating income and expenses given to you by the seller. This written statement is suppose to be accurate and give you enough information to crunch your numbers. Then, you make an offer, lock in the sale with an Earnest Money deposit and then you request the actual copies of the seller's books. You go over the books and if you find a discrepancy you request an adjustment on the price. A real smart investor has the building inspected and gets a ton of money back for repairs. The sellers don't like this, but they have no choice other than to do their best to compromise with you because you have their building tied up and they usually don't want to have to look for another qualified buyer and start all over.

Post some better numbers. Don't go by the seller's numbers because you will be paying more for the building than they paid and many of your taxes and insurance costs will be based on the price you pay.

If you put $120k down and your interest rate is 5% your mortgage will be about $1800 per month.
Property taxes at 1.25% (don't know your rate) will be $473 per month.
Insurance will probably be at leas $3600 per year = $300 per month.

Those 3 items = $2,573 per month. You will probably be paying $30 per unit per month for water = $360 per month. 

Do you have to pay for trash removal
In some cities you get a sewer use bill with the water bill and some come separate, but tenants do not usually pay for sewer use nor trash removal.
Does property have outside lights that run on an owner's meter.
What about gardening.

To clean up 12 units and the property for a thrashed building (as you stated) cannot be done for $75,000. I am a contractor and I just replaced only a bathtub in a apartment. By the time I was done, my cost for replacing the tub, installing a new faucet, replacing the bathroom sink and faucet because we had to take the bathroom sink cabinet out to replace the tile floor, to tile, install imitation granite, plaster and paind cost my $5,000. When I rehab 1 apartment unit it costs me about $20,000 to $25,000 to do a really nice job so you don't have to keep spending thousands of dollars every time a tenant moves out.

From what I can see, even if you rent the apartments for $500 per month I would probably not be interested in looking at this building because every time a tenant moves out it costs too much to clean, paint and replace carpets. Suppose, you are collecting $500 per month and you need to replace a furnace that costs you $3,000. After paying your mortgages and other expenses you won't see a penny of profit from that apartment for a few years. Suppose, the tenant moves out and you need to clean, paint and replace the carpets. You may not see a penny of profit for two or three years. When you apartment for $1,000+ per month and you have a positive cash flow of $400 to $500 the sting is not so bad when you have to make repairs. You lose a little on the apartment you repair and the other units make up for the difference.

Get all the numbers, post them and I will give you a projection showing how the property will look if you can raise the rents to $500+ and then raise the rents by 5%+ every year. It is more critical to know what your ROI is in the future than what it is the day you close escrow. In a few years, you could be making bank if you can increase the rents because when you increase the rents you make hundreds of thousands of dollars in equity because rent increases automatically increases the value of the property.

One way to get a rule of thumb value is to ask a real estate investor what the Gross Multiplier is for apartment buildings in the area. If the Gross Multiplier is 10 then you multiply 10 times the annual gross income. This is only for a rule of thumb value, but very presentable to the seller for a valid benchmark. Then, you have to get deductions from that value to make the property marketable for the Gross Multiplier times the Annual Gross Income. 

For example. Suppose, there is an identical 12-unit building next door. The building is grossing the same annual income, but the building does not need repairs. Then, the value for that building would be 10 times the Annual Income. That comes out to the same sale value as the building you want but that building does not need any repairs. So, you show the seller the math, tell him the value of both buildings is exactly the same, but he has to either rehab the building he is selling to make both buildings equal, or he has to discount the building and you will do the repairs.

There are many apartment buildings in places like Memphis and Arizona where you can get units for $40k and get rents from $850 to $1,000.

Whatever you do, don't invest a penny until you understand the math and if you want help I will show you how to do it the right way.

[Bryan Mitchell]

@Jack Orthman,

Excellent response to his question. I recently ran the numbers on a 8 unit apartment. The asking price was $499k. It seemed like a good price until I saw the fixed expenses and low rents. Once you plug in the numbers, the true value comes out. Over $64k per unit for $700 rent on a 2/1 even in good condition fully rented isn’t good enough.

[Bryan Mitchell]

@Spencer Hoogveld, Jake provides a great response. I had a similar experience on an 8 unit apartment complex with an asking price of $499K. I was speaking with the investor/owner and we developed good rapport. I really wanted this to work because I saw the value and loved the location which would have good rental demand in a good neighborhood. There were little to no apartments in the immediate area. Unfortunately, his fixed expenses seemed high. After running the numbers even though he couldn’t produce a P&L, it wouldn’t cash flow. I simply told him I’m having trouble seeing the cash flow and said that maybe I was missing something and asked for clarification. I even showed him my BiggerPockets PDF showing the lack of CF based on what I had. He said he had other interested individuals so he was going to work with them. In the end, I really wish I had the exact numbers. I’ve bought previous investments through an agent and they helped immensely in getting all my responses (expenses). This was an individually managed property sold by owner.

[Spencer Hoogveld]

@Jack Orthman

Thank you for the response, Jack. This was really helpful. I will gather some more detailed numbers. Would love to run them by you if you have time!

[Spencer Hoogveld]

@Bryan Mitchell

Thanks for the feedback, Bryan. The numbers seemed appealing at first, however after all of these new-found expenses it’s cutting into my cash flow. Really would like to make this work but they’ve got to understand that the rent doesn’t justify the asking price.

[Josh C.]

Current cash flow isn’t really that important. Just because a building is currently way under market and vacant doesn’t mean you treat it like any other 8 cap. I bought a building with zero income and unfortunately it was a lot more than zero dollars. People aren’t stupid and know what rents could be and will price it at that. Whether that’s a good deal for you or not you’ll have to decide. But someone will pay close to what’s its worth or “should” be worth.

Good luck!

[Bryan Mitchell]

@Spencer Hoogveld, total agree. Who knows, maybe they’ll call us back. Regardless, it’s a good idea to follow through on your campaign or marketing plan and call them on a regular basis. You never know where the real opportunity is until you see it.

[Bryan Mitchell]

@Josh C., yes, they will price it close to what they think it will rent for. However what they “think” and what actually is can be different. I’ve seen this in nice desirable locations in Atlanta.