Multi-unit income analysis?? Is it worth the purchase??

Question

Hellow fellow BP's I have a question about numbers. I need to know how to guage whether an acquisition is worth the purchase or not. I want to get used to scrolling through the MLS and do then numbers in my head based on expenses and NOI.

Here it is: Please break down why this is or is not a good deal:

Deal #1:

$750,00 price
4 units
NOI: $58,827
Gross Income: $72,264
Gross Rent: 5,900 month or $1475 per unit
Expenses: $13,437
Taxes: $10,693.34 yr
Sq ft: 3060

100% occupancy

Deal #2:

$1,300.00 price
24 units (2 bldgs being sold together) 12 units a piece
Gross Income: $200,333
NOI: $110,012
Gross Rent: $14,111 month (varying rent levels for 1,2,3 bdrm)
Expenses: $90,322
Taxes: $13,330
Sq ft: 3457

80% occupancy.

Help me with the numbers please. What is considered a good deal? I thought about it and I'd prefer to start off with at least 4-8 units. The larger property is my max but obviously thats $200,000 down for 20%, so I'd have to sell a property to get that amount down. Is it worth it?

Thanks,

Benaiah Grimes

Benaiah Grimes · Answer

George Paiva Thanks i will go to the bookstore today.

George Paiva · Answer

Benaiah Grimes - well I have developed a spreadsheet from years of studying apartment investing.  There is actually a thread I just saw that a few members here have developed about a year ago that does this analysis.  Here is a link - http://www.biggerpockets.com/forums/432/topics/64824-quick-model-template-small-apartment-complexes

You may have to research those metrics like Cap Rates, Cash on Cash Returns, Monthly Cash Flow per Door, DTI, DCR, PITI ratios to gain an understanding before heading off to the calculations.

Remember at the end of the day its dollars and cents.  You need to find out what rent income vs rent expense is taking place then add in the debt service to see what you have left.  If what you have left is comfortable for you to continue with the deal then go ahead.

Benaiah Grimes · Answer

George Paiva that makes sense. When you look at a property can someone break down how to do the numbers? How do you get the cap rate and estimate expenses?

George Paiva · Answer

Benaiah Grimes - you need to use the 50% rule to base your expenses then see what your cap looks like.  Some say it has to be 55 or 60% if landlord pays utilities.  Remember sellers always keep certain hidden costs in the closet.  Its the due diligence you need to do to uncover them.

Kevin Young · Answer

hi benaiah,

based on what you shared, i'd stay away from both of these.

first red flag! the numbers don't add up.  e.g., when i multiply the monthly gross x 12, in both cases its less then your stated annual gross.

with expenses, the suggested 50% rule is a good rule of thumb.  depends on your taxes, maintenance, turn-overs, etc.  my Hawaii properties run at 40% with property management BUT, HI also has the lowest tax rates in the union.  i owned in dallas and had a 55% expense ratio.

So you need to verify.  never take the sellers current taxes/expenses for face value.  e.g., they could be paying taxes on a very low appraised value. call the assessor to understand how much taxes would be. other expenses can and should be verified.  you can get ave water bills, power, etc by calling the utility companies.  they will usually give this out, at least they have for me when i've called.

i always include a mgt fee in the expenses whether or not i'm managing the building myself.  you should too even if the seller does not.

debt service is a factor you should consider.  for example, i currently have a 3.5% rate on my apt buildings, which adjusts every 3 years.  i underwrite using the ceiling interest rate to ensure my cash flow is protected should rates go back up, and they will some day.  ask a broker for a referral to a mortgage broker who works with banks on smaller commercial deals.  you could talk to them to get estimates.

with insurance, i always call my agent to get a swag price on insurance.  they turn this pretty quickly for me, usually same day.

my take on the buildings: 
the 4plex is grossly over priced, IMHO.  just based on the numbers, assuming a 30yr fixed @ 3.5%, the most i'd pay is 500k, based on the return i'd expect.

at 500k, with stated income/expenses, you'd be buying it at a 8.63% cap.  you would need to understand the prevailing cap rates in your area to know if this is good or not.  e.g., in san francisco, investors buy at a 2-4 cap, which i think is crazy, but ppl buy for appreciation and make it up on the back end on resell.  in the SF east bay, you can pick up similar properties for 8-10 cap.  you would need to do some homework to understand what the prevailing cap rate is.  local brokers will share this with you.

for the larger property, with your given income/expenses, at 1.3 your paying 4.4 cap.  unless this building is in san francisco, its grossly overpriced.  i can appreciate that its renovated, but what you are buying is an income stream and the income doesn't support this high of a price unless you know you can significantly increase the rents.

also, underwrite using actuals vs proforma numbers.  e.g., if its 20% vacant, thats what you should plug in.  why should the seller get the upside if they aren't going to do the work of filling it up with good tenants.

i calculated gross annual income at 169,332 (vs your 200,333).  the difference is 15% so i'm not sure if vacancy is included or not.  you mentioned 20% vacancy ... so the numbers don't bridge.  i'm skeptical.

adding up expenses, I get 103,652, putting you at a 61% expense ratio.  i think this is high.

also, with commercial properties, the amortization period is almost always 25 years vs 30 years on <5 unit buildings.  this has an impact on your monthly payment, so for >5 units, us 25 vs 30 years.

Benaiah Grimes · Answer

Ken,

I can only hope I could be that lucky. I doubt he'll come down its been on the market for quite awhile hes basically charging double for both properties to sell together and make a huge profit. Ill keep looking. How did you find yours? Kevin Young i inboxed you.
Ben Leybovich and Joel Owens how do you know immediately if the deal is bad? Cap rates are a tell sign?

Ken C. · Answer

Hi Benaiah,

Given your comment about the $1.3M  property being your max and the 20% vacancy, I would make an offer of $650 on the 4 plex.  This assumes you have done you due diligence and your expense and income number are accurate. This give you room for a counter offer to 675k and you still get a 8.7% Cap rate which is excellent if in an upscale growing area I assume you are in.

I bought a 4plex 5 years ago with annaul operatign expenses averaging 17% including 5% mgt fee. The property is in a execllent location so I have had zero vacancy.

Good Luck.

Ken

Benaiah Grimes · Answer

Very Much so. So I'm better off taking it slow and picking up a property that is 4 units or below to et FHA financing and better rates. How did you estimate cap percentage so I can do it as I'm looking through listings?

Ben Leybovich · Answer

Benaiah Grimes I am not reading too deeply into the numbers, just looking at the NOI vs. Purchase price.  Presumption here is that you NOI is correct and includes vacancy/repairs and all the rest of it.

In the 4-unit, the NOI of 54k and the full asking price of 750k would constitute a capitalization rate of 7.2%.

In the other scenario, the achieved CAP Rate based on the full asking price would be 8.46%.

Neither is particularly good.  In most markets investors are able to achieve above 10 CAP right now.  Also, remember that your financing options are going to be much narrower above 4 units – higher interest, 20-year ARM…With this in mind, whatever higher CAP you are achieving with the larger building may be eaten away relative to cash flow.  Hope this helps :)

Benaiah Grimes · Answer

Please break down math so I know how to read it like you're reading it. I figured the second option was better due to the sheer number of rentals. However 200k down just to get a 4500 mortgage is expensive. How can I look at numbers and immediately tell if the numbers are off? What do I look for? I'm looking for cash flow because I plan to hold. Nothing to be done for option 2 its renovated already.