To Keep or Sell - Under Performing Multifamily Property

[Michael Henry]

For Context - I understand real estate is a long term deal but, after holding a property for 1.5 years I feel as if the performance is lack luster and have considered selling off the property in pursuit of something larger and more profitable.  

This is a 4plex which was purchased June 2019 

Purchase Price: $152,500 (20% Down - 30yr Commercial Loan @ 6.5%)

Appraised Value: $182,000

Rents: $1,750 

PITI: $1,099

Everything checked out, the building was fully occupied, I purchased with an instant $30K equity, and the property met the 1% rule. The first thing I did was hire the top rated property manager in town since the previous owner had self managed.I was in process of a refinance pre COVID but that severally delayed the process and I was unable to complete, I also struggled to find a bank which would refinance and keep the property in my LLC.

From a pure cash flow prospective, its hit or miss in terms of profitability. There has been higher than normal turn over all but 1 tenant have moved at some point. Maintenance has been high (A/C issues, appliance issues, etc). Rents have been stagnant. All my other properties have performed much better so im wondering how long does it take to see real gains from a property like this or is it best to just cut my losses sell for market price and invest in another property?  

Ive attached my financials with the address blacked out for YE2020

[Michael Henry]

[Dave Spooner]

@Michael Henry if it’s not losing money, I would hang on until you at least have a lead on something you believe to be a better store of value for you.

If it’s another property, you can take advantage of a 1031 exchange. As a general rule of thumb, I would get out from under a poorly performing property sooner rather than later.

Good luck!

[Bjorn Ahlblad]

I would be inclined to sell. The property looks good but the numbers tell the story.

[Gerald Gardere]

Hi Michael - Is this class B, C or D neighborhood? Combination of high expenses and interest rate is killing your bottom line. You'd have to work on addressing both to be profitable or at least break even. Financing: I also had this issue and stopped looking! I picked up the phone and called my real estate agent for referrals, issue resolved. She found me not 1, not 2, but 3 lenders that would take LLC. Today my issue is finding deals - leaning toward working with wholesalers.

A few things to consider: raise rents, or sell, or take section 8 - if it pays more?  Hopefully we'll get more feedback from the Pros.

[Julius Chinn]

1% rule isnt applicable to quads n little multis.   Expenses just pop up out of nowhere and eat you alive.

Pro forma everything look good.   Due to unaccounted expenses Ragular maintenance will not be done.   This is why so many quads n the like suffer from neglect,  not enough money to go around.

About turnover , probably never ends unless you have 4 related parties occypying all units.  I mean who want to live that close to your neighbors.  You bring a girl home everybody knows, You fight with MIL everyone knows,etc.

So what is the correct ratio?  i dont know but closer to 2% than 1% id think.

But then Sir i cant buy a quad there are none that meets your standards.  Mt response- sell option premiums.  Its a world unto its own.

Wait till the numbers make sense.  When is that you ask?  If i knew id be golfing buddies with Warren.

[Rion Redinger]

@Michael Henry - I'm curious to know the age / remaining life of the HVAC system(s), Plumbing fixtures, cabinets, and flooring. If they are now sitting at a place where your extimated remaining life is a few years or more then I would think the profitability would start to come up and the net income should remain in the black. 

The other thing I would be looking at is how to cut costs. Does it pay to have the best manager handling them for you? Could it be beneficial to revamp the contract with them to minimize the expense? In any case I would consult with them on why the property is underperforming, maybe they have a few good ideas of how to turn it around.

[Rion Redinger]

Another thing I noticed with the financials is that the utilities is part of your expense. Is this normal for your area? Most places I have rented have required me to pay for the utilities, and have had their own meter for power and water. If this is not the case with your property you should consider on new leases adding a monthly utility charge. One apartment I lived in for a while did that - $150 per month for utilities, $25 per month for garbage, and if I wanted a designated parking space that was another $25 a month. 

Just a few thoughts I had

[Brian G.]

@Michael Henry I would sell unless there is good reason to believe you will experience price and/or rent appreciation over the next 5 years. Another option is to consider strategies other than LTR that may increase the gross revenue like renting a unit or two by the room to college students or perhaps testing a corporate furnished rental concept. Is there a creative strategy that might make sense trying? Also, if you put conventional financing on it you could lower your interest by 2% and increase your cashflow by $200/mo. Presumably you feel strongly about using an LLC so that may not be an option. Finally, is there anything that you can do to limit turnover, ie the biggest cashflow killer? Good luck with your decision!

[Steve Vaughan]

The debt service and mgt are the problem. 75% of mgt is tenant selection. 

Put it in your name to qualify for GSE conventional mortgages to cut your rate in half.  Asset protection LOL

[Michael Henry]

@Gerald Gardere

I have found lenders since that time but with Commerical financing the rate drop is minimal (around 5.5 - 5.65%) doesn’t seem worth it when rolling in the additional fees into the loan.

Rents are at market rate and the units have been brought up to date from where there were previously.

[Cole Simpson]

How much cash is in the property?  How much would you make on a sale?

[Michael Henry]

@Cole Simpson I could realistically sell for $165-170k which would net me approx $40k

[Cole Simpson]

How much are you in it for 20k?

[Michael Henry]

@Cole Simpson I put down 20% - $30,500

[Cole Simpson]

I would talk to your property manager and ask him what you need to do to keep It rented.  It cash flows well when it is fully rented out.  Do what he says, give him 6 months and if you don't see results fire him and hire someone else.

[Christopher B.]

Originally posted by @Cole Simpson:

I would talk to your property manager and ask him what you need to do to keep It rented.  It cash flows well when it is fully rented out.  Do what he says, give him 6 months and if you don't see results fire him and hire someone else.

 I was going to say the same.  It cash flows well pretty good when rented.  Ask why so much turnover?  When selecting tenants, we ask how long they planning to stay.  There is no guarantee they will stay beyond the one year lease, unless they sign a two year lease, but at least we try and separate those that move after every Lease, just because.  

[John Nachtigall]

I would suggest a more logical approach to the issue.  In general, humans like to use past experience to predict the future.   For example, if the quarter was flipped 10 times and came up heads in a row, some would say it will happen again or some people will say that tails is "due".  The issue is that past experience could predict the future, but not always.  The "sunk cost fallacy" and other game theories express this quite well.

You are asking if you should sell the property, but you have not established the root cause of the problem yet.    Using a simple investigation technique like "5 Whys" this is an example.

1- Why is this property losing money?   Because the turnover, capital, and maintenance costs are higher than the original predictions

2- Why are the costs higher than prediction?  Because tenets are staying less than a year.   (you would split it here and examine the other costs in a different question but I will keep with tenets as an example)

3- Why are tenets leaving early?   Because the new management company insists on prompt payment of rent unlike the previous owner.  OR   Because they lost their jobs with COVID.   OR   Because the tenet screening is poor   OR   The neighborhood is  [Note:  The way to decide this is to actually investigate.   Talk to the management, speak to the tenets, etc.]

4-  why etc.....

This is just an example, but looking at the 4 made up causes for tenets above some are temporary, some are not.   Some are controllable, some are not.  How you would react to those things is different.   For example, turnover caused by management change is already done, so selling now would be illogical.   Tenet screening would be a solvable issue.   COVID would be out of your control, you would have to decide if the risk and uncertainty is worth it.

This kind of formal decision making is not worth it for simple things like "why did the milk go sour?".   But when talking about hundreds of thousands of dollars perhaps a more systematic approach would be 

In summary:   Before you make a decision, establish a root cause.  Don't make a decision exclusively on past experience.  The decision will be much more obvious when a root cause is established.  
 

[Jamie Atkinson]

@Michael Henry

How about a refi? And, give your PM a budget and link it to an annual bonus as incentive to hit specific numbers.

[Chinyere Orie]

I agree with what's been said.  Talk to the property manager and find out why the turnover rate is so high.  It seems like the property manager is not screening tenants to see how long they plan to stay.  It cash flows when fully rented so I would try to keep it. 

[Michael Henry]

@Christopher B.

Thanks for the responses property manager has stated these were bad tenants that I assumed from the previous owner. At this point there is one unit left that is about to be filled with a new tenant. From this point everyone is new and on a yearly lease. (Some were on month to month previously)

[Michael Robbins]

Are the tenants paying market rate? Are there any improvements that can be made to increase your rental rates? Once any deferred maintenance is taken care of will the annual maintenance expenses subside? And lastly, is there any future development or re-development in your area? If the answer is yes to any of those questions then I would keep the property, improve its NOI, and then consider selling.

[Christopher B.]

Originally posted by @Michael Henry:

@Christopher B.

Thanks for the responses property manager has stated these were bad tenants that I assumed from the previous owner. At this point there is one unit left that is about to be filled with a new tenant. From this point everyone is new and on a yearly lease. (Some were on month to month previously)

 That's good, so maybe things will be on the upswing going forward.  I would still consider looking for longer-term tenants when filling the vacancies, if possible.  

[Gerald Gardere]

@Michael Henry - If 2021 lays COVID to rest, how do you feel about Airbnb? How far is the property from live bands, night clubs and beach?

[Michael Henry]

@Gerald Gardere

I live out of state and the property is in a small town outside of Atlanta not an ideal market for AirBNB. I’ve suggested other options to the property manager like short term leases for traveling nurses at a higher rate since there are several hospitals within 2-3 miles.

[Brad McCance]

@Michael Henry Everyone is giving good advice hear about revenue, expenses and financing. Investment property can always be tricky and not as rewarding as calculated on paper. I always ask the seller or seller's agent when evaluating a deal, why are you selling. I always get a number of reasons, but it has been my experience if an investor is making money he rarely sells, unless he absolutely needs the money. One thing you should ALWAYS ask for on acquisitions is the rental properties bank records. Accounting records can be manipulated to show high cap rates, but the actual NET proceeds in a bank an account are hard to manipulate. I say this since the current PM informs that you've inherited bad tenants. I've been managing and investing in real estate over 20 years and that typically saves me from overpaying for an investment. A majority of all money made on a real estate deal is made during the purchase not the sell, so best to sniff these issues out upfront.

I own and operate a PM firm in the Atlanta area, and the market is HOT!!! COVID-19 has certainly caused some difficulties, but overall the demand for rental properties has overcome the pandemic. I would get with your PM and get a full report with pictures of each individual unit. The unit with the least amount of turn cost which also has the worst tenant gets the axe. Replace with a more qualified tenant, and he rinse and repeat.

Let me know if you have any questions or concerns.

Brad

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