Purchasing my FIRST MULTI-FAMILY-12 unit apartment-Any Advice?

Question

I'm super excited to be purchasing my first multi-family property, a 12 unit apartment (8 one bedrooms, 4 two bedrooms) in a great suburban area.  I've been a residential Real Estate Broker 17 years and have been investing in single family homes for hold and flip for 12 years; but commercial is a bit of a different ballgame and I'd love some advice, pretty please.

Contract executed yesterday, 21 day feasibility period starts today, planning inspections for Tuesday...

-Mistakes to avoid?

-Items to not overlook inspecting?

-Anything specific I should check with the city?

-Any and all advice is welcome!  I just want to make sure I don't miss/overlook something as I transition into the commercial world.

Thank you!

Erik W. · Answer

@Cody L., you want the most accurate information possible, true.  We have to consider what the Seller's interests and incentives are to report numbers accurately.

When reporting expenses for taxes, it is in the Seller's best interest not to leave anything out.  They have an incentive to include all expenses because they want to claim tax deductions, whereas when they are selling to you they want expenses to appear low, thus raising NOI and thru that they also increase price they want.

When reporting income, it is in the Seller's best interest to claim the least amount possible, thus avoiding paying taxes on rents not collected.  This helps weed out those Sellers who say, "Rents are $700 per unit" but when you see the Schedule E you find they are $650, $625, $700, $685, Units 3 and 6 were vacant half the year, etc.  A lot of times agents and sellers are too lazy to list individual rents and just put down what they "think" the market rent ought to be.  We find the truth on the Schedule E.  And if they are fraudulently  under reporting rents, then your lender probably won't count those toward their lending guidelines unless you get updated leases.

Accurate income and expenses are a negotiating tool.  If they are inflating their expenses or deflating their income when reporting to the IRS, you may be able to use that to your advantage to drive down the sale price.  If a Seller refused to supply me with that information, I would wonder "What's he hiding?"  The Schedule E is basically the "official" version of a P&L statement.  I don't need to see your total return, just that one form.  Any business that refuses to provide an accurate P&L to an interested buyer would concern me.  It is absolutely proper and fitting to disclose this information.

Erik W. · Answer

Be very cautious when verifying Seller's financials on the property.  You are an experienced Realtor and Land lord, so by now I'm sure you know that people lie or "forget" things that work against them.  For apartments, you will have expenses not found with SFH's, such as snow plowing, grass mowing, possibly master meter utilities, cable TV, internet, common area lighting, trash dumpster, etc.

You might also be expected to provide security cameras, mitigate parking disputes and enforce quiet hours.

I would want copies of all leases, not just a "sample" copy.  If there are no leases, an estoppel letter signed by tenants and Seller is a must-have!

Keep in mind that tenants talk.  Once you increase rent on one unit, the rest will know it's coming and may scatter quickly, leaving you with multiple vacancies.  Also, if you are not firm and fair with enforcing the house rules, that will quickly come back to bite you.  No giving Unit A slack on rent due date if you always charge Unit E a late fee.  This could also lead to discrimination claims, especially if one party feels aggrieved and they are in a protected class.  I know we always try to treat everyone the same, but some days just my mood can make me make my decisions slightly faster or slower, or might change how I word a text message.

I would be very cautious about paying any utilities that have variable usage rates controlled by tenants.  To be sure you are seeing an accurate picture of all expenses, request copies of his "Schedule E" to see what he claims as the expense on his tax forms.  He may want you to sign a non-disclosure agreement once you go under contract, which is fine.

Good luck!

Erik W. · Answer

@Cody L., you sound very knowledgeable and experienced compared to the OP, to whom my response was directed.  If you know all this and can forecast market rents and expenses, then good for you!  But these strategies I am sharing may be new information to someone who is learning the ropes and making a first-time purchase.  Now, I'm going back to the chat with @Krystyna Fennelly, who based on her responses has found value in my posts.

To the OP: Definitely ask to see a Schedule E.  It is not "just between the Seller and the Tax man."  Rather, it is a valuable document that will educate you as you move into a new type of investing.  I learned that strategy from a developer / investor from the Kansas City and Lawrence, KS areas with whom I was connected via a local friend.  He and his dad have developed over 3,000 apartment units from ground level up and rehabbed close to 800 others both for themselves and for investor clients.  Wisdom and experience like that is hard to find and a rare gift when said person is willing to talk over 2 hours sharing pointers. When he says to do things, I do them.

Brian Garrett · Answer

You don't need any of these requirements for commercial/portfolio loans as long as the numbers work.

Jeff Ronningen · Answer

4.95% for 5 years seems a bit high.  I was shopping in August and found more than one lender offering 4.5% for 5 years.  I would think rates should be equal or lower now.  Ended up doing a Freddie Mac SBL for under 4% and longer duration, but those loans are challenging with additional costs and requirements.  That was a learning experience.  Also minimum loan amount is $1M.  I have a good mortgage broker who really knows multifamily financing programs and lenders.  He shops my loan out and finds the best offer.  In my opinion, commercial loans are where a broker can really shine and provide value.  You really only need one, if you don't have one yet I suggest you investigate finding one to work with.

Jeff Ronningen · Answer

@Krystyna Fennelly

I assume you figured out how to get it financed. Lock in as long as possible. In my experience 5 year ARMs are most common but some lenders offer 7 or 10 years.

As for the city, check for code violations or any other records with city/county offices.  Also check historical utility, water, and trash costs.

Beware tax reassessment if purchase price is much different from assessed value for tax purposes.  Get to work on your insurance quote early and get a big liability umbrella policy.

Big ticket repairs that can bite you include roof, foundation/structural issues, outdated electric and plumbing, HVAC and paving parking areas. Try to understand age and condition of each. Also each apartment, do they need updates, repairs, or renovations when they turn?

Do you know people when you need a handyman, carpenter, snow removal, mowing, landscaping, plumbing, electric, roofing, HVAC?

Do you have a standard lease agreement? What’s your application and screening process?  How will you advertise vacancies?  How will you do bookkeeping and accounting?

Account Closed · Answer

Congratulations! You sound like a seasoned pro, but just to cover your bases I would highly recommend getting Peter Harris's book - Commercial Real Estate Investing for Dummies - he has an extensive checklist of due diligence tasks and advice for how to manage the process.

Krystyna Fennelly · Answer

Account Closed Yes financing still has to go to the board for final approval but my banker has reviewed the property detail and believes there will be no issue.  I use a local bank, I have a few accounts with them, a line of credit and one other small commercial loan. They do pull my credit, I have to provide a financial statement annually and I'm a personal guarantor but much of the weight is put on the property itself.

@Erik W. @Jeff Ronningen  Thank you both for the detailed list of information, I've added a few things to my due diligence list. Jeff: My bank is of offering 4.45% on 3 year or 4.95% on 5 year, 25 yr amortization. I'll being going with the 5 year; do you feel like the rate is competitive with what you've seen?

The sellers p&l matches pretty well to what I would expect and is pretty well detailed. Though I do have extra questions outlined for her. I'm shopping insurance, as well as having her provide a copy of her current ins. She has multiple tenants that have been there years, as many as 10 years and her rents are low.  I don't want to piss everyone off but rents are way past due for a raise. I plan to spruce up the exterior and each unit as they come available (only one vacant currently that the listing agent asked her to leave vacant for showings).

Also any recommendations for exterior amenities for a small complex like this?

Nick Atwood · Answer

Commercial lending space is a lot different if this is your first commercial venture: increased appraisal costs, inspection costs, etc. . Check out commercial loans of Texas, if it's a city with over 100k population, they're willing to write fully fixed term loans which is pretty rare in the commercial lending space; they've also got some great reviews online. Also, find a quality inspector and make sure there aren't any big ticket items needing fixed like foundation repairs.

Erik W. · Answer

@Logan Freeman, unfortunately that isn't possible.  As I mention in my initial response, the only reason I got introduced to him was thru a friend of his, who knew me as an investor and friend for almost 4 years before making the introduction.  For lack of a better term, he "vetted" me.  I'm sure you realize how valuable such a person's time is, and if I post that info or start sharing it with people via PM he will be receiving calls from people he doesn't know.

I encourage you to continue seeking out such people via your current network.  No doubt if you've been active in a market for awhile, you'll eventually find a connection who has a lot of experience and is willing to share.  I invested for over a decade before stumbling over this gem.

Purchasing my FIRST MULTI-FAMILY-12 unit apartment-Any Advice?

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