Multi-Family - Student Housing Opportunity

[Adam D Rinehart]

Good morning everyone,

I've got an opportunity that I've run numbers on myself but wanted to "Red Team" the deal to the community to see if there are any fatal flaws I overlooked. Here are the particulars:

• - Located 1.1 miles away from a in a rural college town about 40 miles outside of a major metro area. The property is on the campus bus route.
• - The University has seen massive enrollment growth within the last years and welcomed it's largest incoming class in it's 140 year history in 2018.
• - There is a current shortage in available housing, both on and off campus and multiple new apartment complexes are being built.
• - There are 3 furnished buildings (built in 2015 but renovated in 2018 to convert to this use) with 25 units that currently have 31 beds in a dorm style layout.
  - Rent is per bed.
  - Rent roll shows 0% vacancy and monthly gross rent of $13,880. All leases are paid in full up front for each semester and this is the first academic year they've been open.
• - Utilities are split evenly among the students.
• - $5/month fee for cleaning supplies and toiletries.
• - Currently self managed and no maintenance costs were provided.

The onsite management office can be utilized as an additional unit if an off-site property manager is used. There is an additional 1,000 SF of space above the existing units that can be converted to additional units, per the seller. They are asking $1.4M and advertising a 10.23% cap rate. 

I can't get to their valuation since gross income is only $166,548 and NOI based on asking price and cap rate would be $143,220. This would put operating expenses at only $23,328/yr or ~$1950/month. This seems WAY too low for 3 buildings and 31 college kids. I pointed out this discrepancy to the sellers agent and they conceded that the cap rate was a proforma cap rate and assumed the additional 3,000 SF was being utilized.

That said, I still think there is a great deal to be had here so I put an offer in today structured below:

1. $800,000 "sale" price with 10% down ($80k cash to seller at closing)
2. Seller finance $720k for 10 years, interest only @ 8.25%, with a balloon payment at the end of the term.
3. 5 year lock out period in which I can't refinance and a remaining interest payment kicker if refinanced or sold before the end of term.

So if the seller accepts, he would get a monthly interest payment of $4,950 for 10 years totalling $594,000. $594k +$80k + $720k = $1,394,000 total. Just shy of his $1.4M asking price. Plugging in all of these numbers, plus my carrying costs and anticipated insurance, taxes, management, etc... I still show a cashflow of over $2300/month. This goes up to over $4200/month if the additional units upstairs (12 total) can be built. I've put a contingency clause in the contract verifying that the local building official confirms the additional space can be legally built out for living space.

All that said, what have I overlooked and/or what errors have I made in approaching this deal have I made? Thanks in advance for your input.