"Below market rent" ??

Question

I am looking at buying my first multi-family home and my searches (mostly in the Sacramento, CA area) will often read "below market rent" or "well below market rent". that sounds like code, but I don't know what it is? Can someone explain?

Derek Daun · Answer

@Sue M.

It’s code for multiple things:

“I bought the property for cheap and am only selling because values are so high.”

“It won’t cash flow at current rents”

“I don’t want to be the bad guys and raise rents, which will likely require the current tenants to move, even though I know the buyer will do exactly that.”

David Brent · Answer

I agree with @Derek Daun.  It's totally code.  You just need to figure out what the code is. WHY would any owner EVER leave money on the table??? (I was told by seller's broker that it was below market because "the owner is a nice guy and has known a lot of these people for years and doesn't want to raise rates". That was true for 1-2 units, but there was a bigger story.

and would add:

4) "I know the T-12 doesn't look so good... but look at this 'proforma'!  If the property made more $ with higher rents, it would be worth a lot more - so that's why you should pay me more $$ for it.

5) "Let me compare my lower rents on this older property with deferred maintenance issues to 'brand new' apartments in the area. It will be "Easy" to raise the rents."  (That's not accurate comparison.  Make sure the comps are REAL apples to apples).

6) Finally, "I scraped the bottom of the barrel when finding and screening tenants.   These residents can barely make the rent as is, and are often late.  So I could never get to market rents and am pushing that problem to you"  (I investigated this by looking at rent rolls going back 3-4 yrs to see rent increase history).

Bottom line - TRUST the T-12 the most. Demand in diligence to see the t-24.  Ignore the broker provided Proforma. If you plan to put in some $ and are ok with turnover - MAYBE think that we can close the HALF gap to TRUE COMPS over the next 3-4 yrs.

Theresa Harris · Answer

It means you can get more for rent than is being charged.  So if 2 bedroom apartments in the area are renting for $1500, they are only charging $1300...so it is below market value.  The difference between the two is the amount.  I have no idea what they use, but below market might be $100 and well below market might be $200.

Ray Johnson · Answer

@Sue M.  The code being spoken is an owner who either wasn't managing their property and raising rents in small increments over time, or a property in bad condition and doesn't warrant increases in rents in the current condition, meaning you'll have to update the property then raise rents.

Things to look out for when someone is offering a property and the main selling point is it's currently well below market rents.

1) Usually the current owner either doesn't have the money to do the upgrades, or the owner knows when you factor in vacancy during the rehab, cost of the rehab, and new tenant lease-up timelines, your break-even from this scenario, is too far in the future and not worth it, so they sell the property.

2) Another thing some investors make a mistake on is buying one of these properties advertised under the guise of "well below market rents", but the seller isn't comparing "apples to apples". I looked at a property advertised this way, the owner was using comps for apartment buildings that had pools, in-unit laundry, gyms, rooftop decks, etc.. but trying to sell a rundown 12 unit building, no laundry at all, no pool, gym, or anything, but telling potential buyers rent for 2 bedrooms in the area are comparable.

3) Make sure to take a look at the leases if you're going to try going the route of not renewing leases, then doing a rehab, and lease-up at higher rents. Tenant friendly municipalities are not good for this type of strategy, as getting the tenants out typically do not go as quickly as planned. Doing unit turns happen over time, so make sure to factor your rehabs, and unit turns over time when looking at your future cashflow projections.

Keep in mind that if a property is well-below market rents, it's that way for a reason.

Good luck analyzing your deals!

Dave Peterson · Answer

Be aware that Sacramento has rent control so if you buy an existing rental you will not immediately be able to raise the rents to market rate.  It will likely take several years.  So base your offer on the current rents, not what they could be.

Sue M. · Answer

Thank you all SO MUCH! I couldn't image a GOOD reason to leave money on the table. I definitely want to understand how to make a property like that work.

Andreis Bergeron · Answer

@Sue M. good questions! & responses you've gotten so far, what markets are you looking at and seeing this?

"Below market rent" ??

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