Is it worth it to buy a cheap Class “C” building and renovate?

Question

I saw an apartment building down in Tampa that has 9 units it’s worth  $550,000 and it has a cap rate of 11.79% which seems pretty high to me and it looks like a good investment. I’m new to this I don’t know much. I know there’s more costs that go into it but I was told a high cap rate is always good  to make your money back. I know “C” class buildings are older and charge less rent but I was thinking maybe to renovate it and put it up to date more modern. The rent probably would have to go higher or By renovations it would probably add good. Amount of equity in the property and from there I’d probably be able to do something with that money right like take it out in equity and buy another property?

Account Closed · Answer

@Franklin Marte, first of all, I love that you're up to a big game. Secondly, I would highly recommend consulting with a mentor before taking on a project like this. 11.79% is a high cap rate, yes. One of the most important things is the location of the building. How's the neighborhood? Have you checked rentometer.com to determine what rents should be?

Erik W. · Answer

First, my background.  Been an REI since 2005.  Exclusively Class C units.  Mostly SFHs, but a few duplexes and one quad-plex.A few thoughts....

Class C is the highest rent to "all in" ratio I've found.  Class B and A you may get appreciation, or not.  Depends on what happens.  Class B and A hoods can and do turn into C or B hoods respectively.

Class C hoods typically hold their own, as long as you don't buy one on the fridge of the ghetto.  They can change quality down to D, but I don't see that often.  Usually, guys like me go in, fix up some houses, and get it moved up a little toward Class C+ or B-.

Class D has too many turn overs and damages for me.  I know some folks do it, but it's not in my temperament to deal with folks like that.  Buy a unit that you / your manager can deal with the typical customers who will rent those units.  Land lording is a PEOPLE business first, and a property business second.

You will spend the same money replacing a roof on a C unit as on a B unit.  That makes B look better since you get more rent for B.

However, you will also be remodeling/updating a B unit more frequently than a C unit.  I have some units with 40-year-old kitchens.  They still rent like hot-cakes, because C tenants want "clean, safe, and functional."  They don't care about the latest trends and paint colors, and therefore they won't pay more for those amenities.  B tenants want something out of an HGTV show.  If that kitchen looks old, tired, or dated they'll pass you by.  So plan on spending an extra $5,000-$7,000 per unit every 8-12 years for "freshening up" B or A units.  I will pocket that same expense and just keep my units clean, safe, and functional.  Those update expenses alone may use up all of your higher profits on B units....or even drive your return negative.

I'm not anti-B units, and I know investors who have done them successfully.  I think C is a good place to start, though, especially being new to this business.  Less cost to enter the market, less demanding tenants (if you screen them correctly), and more opportunity for value add which is critical to generating solid cash flow.  Cash flow is the life blood of real estate, and as a wise man once said, "You can't eat equity."

Best wishes!

Tamiel Kenney · Answer

@Franklin Marte

Hi Franklin, How did you calculate the cap rate for this property?

This is an area where people use incorrect information to calculate the cap rate. For example, some people just take the T12 (this is the Profit & Loss) and the Net Operating Income (NOI) and the selling price and calculate the cap rate. Using the T12 to get the cap rate is typically not a good idea because you are using information from the seller and that doesn’t mean you will run the property the same way and your costs could be drastically different. For example, what if your property taxes will go up...this should be accounted for when you calculate the cap rate. What if your payroll will be higher or lower. You need to consider this when you are calculating the cap rate.

Also, have you bought a commercial property before? Have you talked to a mortgage broker yet to see what you might get for financing?

Have you driven by the property yet to see what rehab budget you can plug into your analysis? {Roof, foundation, windows, balconies (if any), driveways, building structure, landscaping, signage...are all things to consider for repairs in this early stage - to decide if you want to move forward with a full tour of the property).

Hope this helps... Good luck!

Marc Winter · Answer

@Franklin Marte is right about the location/neighborhood of this C property. If it's in a B or higher area, it is worth looking into it, because you usually make money buying the 'worst' property in the 'best' neighborhood.

If this C property is located in a C or lower area, I'd pass. Hard-to-impossible to get A/B tenants in a C/D area.

If this C property is located in a C or lower area, I'd pass.  Hard-to-impossible to get A/B tenants in a C/D area.

Ronan Donnelly · Answer

@Franklin Marte, although you are, in your own words, 'new', you have ended up in a good market in Tampa and you have picked a good strategy in Class C value add. I would recommend educating yourself on underwriting multifamily properties so that you can ensure that you get a good entry price and I would also encourage you to plan the renovation business plan carefully as this is the area that carries the most risk.

Some elements to consider are:

1) Do you have the capital necessary to execute the renovation plan?

2) Does the property have enough cash flow to support increased vacancies during your improvement plan?

3) Do you have a strong team in place on the ground to execute the renovations?

4) What level of rents do comps command and do you understand the specific level of improvement required to get those rents.

Good luck!

Jay Hinrichs · Answer

@Erik Whiting  I get the U cant eat equity.. rationale.. but there are other uses for equity that are not really talked about on BP simply becasue 95% of the folks here are in one asset class rental houses or units.

In other real estate endevours equity is a critical part to enable one to take down different types of debt IE construction and development loans.   Along with larger MF loans.. to get a larger loan say 3 to 5 million you must have a 3 to 5 million net worth to match it.. this is where equity comes into play.

So for sure if your leveraging C class rentals by all means they better cash flow other wise you will go under pretty quickly as they tend to be non liquid or you will lose money if you do liquidate as other investors are your only exit and they look at these the way all investors do.. with locals looking at them that much harder.

Tamiel Kenney · Answer

@Franklin Marte Have you listened to podcasts or read books on commercial Multifamily Investing? Attended any MeetUps or Conferences? This might be your 1st step before you consider taking on this big project. It is not the same as buying a single family house, fixing it up a little and renting it out.

You will definitely need to consider where is your rehab money going to come from... Will the lender give you money for Rehab or do you also have to come up with that money as well.

You will need to have a net worth equal or greater than your loan amount.

You will also need to have liquidity after closing - which the lender requires - in case their asset needs capital improvements.

With 9 units...At least 8 of them has to be leased out...if not all 9...for 3 months or more before the lender will consider giving you a loan. Otherwise, you may have to get what is like a hard money loan to purchase the property...(higher interest rates for sure!) and then refinance once it is 90% or more occupied.

Anything the broker posts has to be taken with a grain of salt as they are trying to sell the property. You have to know enough about the market, the rules of thumb for expenses, rehab costs, how to fully analyze deals, etc to make your own educated decision to move forward on ANY deal.

I know it is exciting to think about purchasing an investment property..but Please don't jump into this without educating yourself first. You don't want to start off underwater. It is AWESOME you are starting to look at things now...but consider it an opportunity to build your relationships with the brokers and learn how to analyze deals that are posted on Loopnet.

Also, start attending MeetUps and as many events as you can get to. You will have the opportunity to learn...in addition to meeting potential future partners and maybe even potential passive investors - if you choose to syndicate your deals in the future.

Get people talking about their lessons learned in this industry...as there are LOTS of things to look out for. We like to share our many (MANY) lessons learned so others don't have to face the same situations/struggles we have faced.

Good luck Franklin! This is an exciting journey!

Jeff Bousquet · Answer

I bought my first C class 4-unit in October. I was hesitant due to the conditions and the existing tenets. I bought it for 105k. The existing tenets left. I did light updates. Paint, flooring, new few new appliances. 3 of the four units are rented. The last has a bunch of showings. Gross rents are $2775. There is more tenets management involved, and thinks do break. Overall I've had a good experience thus far.

On the other side. I knew a guy with a C class 6-unit and was in housing court every other week.

Experience may vary.

Franklin Marte · Answer

I got about $770 per unit and there’s 9 and the neighborhood is looks like its low income its right by the university of south Florida. That’s about all I know

Account Closed · Answer

@Franklin Marte, is the apartment for sale? How did you find it?

Is it worth it to buy a cheap Class “C” building and renovate?

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