First Investment Property - Too Good to be True?

Question

Hello and good evening everyone!

Long time reader, first time poster!

I've been keeping an eye on 4unit multifamily unit buildings (to stay qualified for FHA loans) in markets that I am interested in/would be alright occupying my first property in.

Tonight i found a listing that seems a little too good to be true! Here are the following financials listed:

Year2012
Scheduled Gross Income$42,600
Effective Gross Income$40,740
Operating Expenses$10,088
Net Operating Income$30,652

listing claims the building is only 75% occupied (3/4 units). Solid brick building, 3 car iron fenced garage. tenants pay for electric and gas. A new roof was installed in October 2012. Hard wood floors were placed in the building 3 years ago.

The property is currently listed at $140M, listing claims county assessor valued the building at $330M. Discount is due to "need for fast sale."

My calculations: (approximate)
Bought at 20% discount of asking price (110K)
20% down =  88M mortgage
Even with 100K 30 year mortgage, payments will be less than $450 a month.

NOI - 5400 (annual mortgage payment) = 25,252 CF/year (roughly 18% cap rate)
CF about $2100/month
2100/4 = $525CF/Unit per month
(my calculations even assume 100% occupancy is generating this CF/unit calculation. listing claims its 75% occupied.)

Questions:
How accurate are provided financials in online listings?

Do these "operating expenses" include taxes, insurance, etc.?

Is it in my novice nature to assume this deal is too good to be true - or is that the general consensus?

I contacted seller and I am waiting to hear back -> What list of questions should I have ready when i speak to the seller?

My concerns:
Fluffed up financials/completely inaccurate

tenants pay for electric and gas, i'm assuming this is an old heating system. Do I ask the seller about this? What would be a rough estimate of the cost of replacing a heating system for a 4unit 4500 sq ft building?

New roof installed -> was the building leaking? is the new roof doing the job it was replaced for?

Hidden expenses?

When was the last time the pointing work was done? if roof had to be replaced, does there need to be brickwork done?

I guess i'll start it there and see what everyone thinks. Any and all information/feedback is much appreciated!

Thanks

Christopher Cruz · Answer

Ivan Alfaro Haha ohh man, that must've been some experience! The building I was looking at was in East Humboldt, Chicago. (West of pulaski) Google search says it all.

Ivan Alfaro · Answer

Haha, I ran into a similar situation, except I went to go check it out...As we were walking up, my agent told 1 of the tenants we were thinking about renting there as a false story repeatedly, the 2nd time irritatingly, then I heard a gun clap as we were entering 1 of the vacant units and a guy saying 'you need me to handle these guys [X person's name]'. Needless to say, we got the hell out of there after the coast was clear.

Even more ironically is that it was a brick quadruplex too!

Christopher Cruz · Answer

Brandon Turner Thanks for the great feedback!

The numbers did work out, and from the pictures provided the property did seem to be in good shape. If my partner and I were to follow through with this deal we would've most likely put the 20% down to reduce payments and retain more equity in the property. (any thoughts?)

As we did further research of the neighborhood, as opposed to the city, we discovered that this was one of the worst parts. It is said to be gang ridden. Apparently in March of 2012, there were over 67 shootings in this paticular neighborhood and surrounding areas.

As a first investment, we decided to stay away from this property and continue the search. Dissapointing, but definitely a learning experience.

On to the next one.

Thanks guys!

Brandon Turner · Answer

Looks like Joel Owens has given you some great advice here Christopher Cruz - but I'll chime in with my comments as well.

Gross income is $42,000, so at 50% (using the 50% rule) that's $21,000 per year left over for paying the mortgage. Subtracting out another $3000 for water, leaved $18,000 to pay the loan, or $1,500 per month.

If you bought this at $110,000 with a 3.5% down payment (FHA) you're looking at a monthly payment of around $500 per month, which leaves $1000 per month in cashflow on 4 units - $250 per unit, per month.  That's not bad at all. You could technically still afford to pay more if needed, and be okay - if all those numbers work out (as Joel said)

I'm curious as to the condition. How much work would it take to be fully-functional? If you'll need $5k worth of paint and carpet-  be sure to have a way to do this as well.

I, personally, wouldn't worry too much about the roof. If it was replaced, it was probably because it was old. Obviously, verify this - that there is not a big mold problem - but if it were leaking for years and years and wrecking things - you'd probably know the minute you walked into the place.

Anyways - looks like a neat opportunity. Be sure to verify everything, as Joel has talked about.  And let us know how you proceed moving forward. This seems like a great opportunity if the numbers are what they say they are.

Keep in touch!

Joel Owens · Answer

I would run the numbers then like the property is vacant and has no income and the  numbers cannot be verified from what is stated but that is just me.

If I can't quantify and verify something to be true then there is a huge risk and unknown going into a property. You simply offer a much lower price and tell the seller since you can't verify anything you can't count it and thus have to offer lower because of it.

Christopher Cruz · Answer

Joel Owens okay, so simply ask the seller. I'm assuming if he doesn't have them on hand he would contact the owner?

What move would you suggest if they are unable to provide me with these records.

Thanks again!

Joel Owens · Answer

Schedule E is filed with the tax returns for the IRS. Should be a monthly log of deposits into the business bank account getting rent from each of the units and when it is paid each month (late, on time etc.).

The larger buildings are usually professionally managed and have great records. The small buildings it's a crap shoot and varies on the landlord. Some keep great records and others are horrible.

Christopher Cruz · Answer

Joel Owens Thanks for the great feedback! this is a great and simple way of calculating NOI, and purchase price at 10% cap rate.

I will definitely be inquiring about the list of questions you brought up.

Will the seller of this property be able to provide me with schedule E returns? Is that standard procedure? What if he tells me he can not? (I do not know if the seller is the operating landlord, what if he is just an agent)

You brought up a great point about verifying deposits made into their business account. How would I go about doing this? Again, is this standard procedure? What if he tells me he can not provide this information.

Thanks again for the thoughtful and informative feedback! This is exactly what i was looking for!

Joel Owens · Answer

Hi Christopher,

Simplest way. So purely on income alone.

If 3 units give off 42,600 expected gross that is 14,200 per year per unit or around 1,183 a month per unit rent.

Take 1,183 by 4 = 4,732 by 12 = 56,784 potential gross.
Take away 60% of that for expenses since landlord pays the water.

56,784 - 34,070 (60% costs) = 22,714 NOI which is purchase price of 227,140 at a 10 cap without having any immediate repairs needed.
So it seems the numbers work for the purchase price.

"need fast sale" find out the WHY on this. Make sure there is no eminent domain proceeding, epa cleanup issues, or pending litigation etc. that would affect the property. Look at the schedule E tax returns to verify numbers. Financials can easily be manipulated on other forms so do not put too much weight on that and verify deposits into the business account. If some deposits the landlord says were paid cash and they have no record then you can't count them. The landlord could be adding money to their bank account to make it appear the tenants are fully paying to unload a problem property.