HELP - 10 Unit REO Apartment Complex

[Tom C.]

Drafted an offer on a REO apartment complex in Texas (Houston Area). Only problem is the bank has only owned the property for about 2 months and has a PM running it. Currently it has 3 vacancies, with one lease signed but not yet started (last month it had only 1 vacancy) and all units charge ~ 450/unit. The apartment was built in the 50s and likely needs some work, but I am looking to buy and hold but how do I know if the price is "right." I think it is, but I have first deal jitters. It needs almost zero capital improvements to continue to operate at this level. I will have a good deal on the sidelines just in case. It seems to have a high turnover in the first 2 months being "managed," but that might actually make some sense under the circumstances.

I have put the numbers to paper and worry that I am adding layer after layer of conservatism and may be "thinking my way out of a good deal."

The complex is approximately 7,000 rentable square feet and I can grab it for $21/sqft or just under $15K/unit. Again, this is in rentable condition at the rates above as I have walked through all the vacancies... they will rent at the current $450/unit. What I don't know is how transient the lower end of the market is and where my estimates fall... There is no track record. I fear I am overly conservative... or maybe not?

So I thought I would throw my assumptions out there. I think I may be overloading this with fear... My assumptions are monthly and I have normalized them by unit.

Price: $15K/u
Rent:.................$450 - (Market above $500, though)
Vacancy Cost:.....($90) - This assumes 2 months vacant on average.
Repairs.............. ($30) - Estimate
Property Tax:......($60) - (assessed at 2x sale price, I plan to challenge) *
Insurance:..........($36) - No data
Utilities:.............($63) - Water / Garbage have no data on this...
Misc:.................($11) - Admin
Fixed PM:...........($60) - Quoted, known
Variable PM:.......($30) - First month's rent, assumed amount
Asset Op:............70

Other - All cash deal, but I plan to refinance the property to pull out 75% appraised value. (Don’t know what this would appraise or whether they can appraise on pro forma estimates) If financed, the PMT would be $69/unit.

Upside 1: - I should be able to challenge the assessed value adding 20-30/mo to operating income. (Currently assessed at $30k/unit)

Upside 2: - My property manager said I should be able to qualify these units for section 8 and that would lower vacancies and increase the rates to $550/u, minimum BUT more likely $600/u. That is a lot of upside in the deal.

Am I grossly overpaying, or just adding layers of uncertainty on a good deal, with solid upside.

[Don Konipol]

Property built in the 1950's renting at $450 in Houston is low C to high D type. Cap rate on those is 12 +, so using more usual expenses being 60% of gross your annual gross is $54,000 and annual net is $21,600. Translates to a 14 cap. so at first glance the deal is "interesting". Now you have to get real numbers. Since operating history of property is unavailable, you will have to get a realistic idea of income and expenses from comparing similar properties. If you are unable to get this info yourself or unable to competently analyse and evaluate comparable information, you will need to hire an appraiser or real estate consultant.

If the numbers do turn out like my example, i.e net around $21,000 annually, then you need to answer the following questions
1- As my first deal, do I want the higher risk/higher return of lower end property?
2- Am I willing to put in the extra work and aggravation in dealing with this class of tenant?
3- How much deferred maintenance actually exists?
4- How costly would it be to bring property into compliance with current standard?
5- Given the circumstances what return would be satisfactory?

As I mentioned cap rates for this type of property is 12 +. Lets say average of 13. With no operating records that brings cap to 14.
Built in the 1950s brings cap to 16. So IF net is $21,600 at 16 cap price would work out to $135,000.00

I personally have experienced the problems of old, apartment complexes in low income areas; I much prefer the easier returns of private lending or even the lower cash flow/higher appreciation of properties in A areas, so I would need a 20 cap to be interested. Actually bought an Arlington Texas 12 unit at a 20 cap, made money, sold it in 14 months, still was not worth the aggravation.