Evaluating an apartment complex

[Mark Yuschak]

A BP member and I are considering a relatively small apartment complex in the southeast Michigan area.

Here are the details which we know of at this point...

48 unit complex (44 2 bedrooms, 4 1 bedrooms) in good condition with all new roofs and windows, and seperate heat and a/c in each unit. There is a laundry facility in each building (4 buildings). The grounds are well kept and the complex is in a good neighborhood.

60% occupancy rate. The seller has indicated that the on-site property manager has simply walked out. There is no on-site management, or even anyone answering the phones. We have requested the current rent roll, but have gotten nothing since the owner claims the books were not being kept up. Furthermore, the owner is going through a nasty divorce and just wants to walk away from this property. The broker is related to the seller. She said he is about to let it go into foreclosure because he wants nothing to do with it. However, she said he would accept an assumption of the current mortgage. Of course, that is dependant on the bank granting it.

They claim the occupancy rate is also high because several units were mid-rehab when the owner ran into marital issues. That's when the money dried up to finish those rehabs.

We're ordering preliminary title work today to uncover where they stand with notes. Based on what we've been given from the broker, he currently owes 1,580,000 on the first as of 4/1/07 and ~200K on the second. Taxes are ~$38,500 annually. They have owned the property for approximately 11 years, so we're assuming 9 years left on the debt service. Despite their inability to produce a rent roll, I know the area well enough to have a strong estimate that a 2 bedroom is renting for $575 a month and a 1 bedroom is renting for $500 a month.

At an initial glance, this may not seem like the must lucrative deal. However, doing an assumption is attractive to us. We're confident we could increase cash flow by adding carports, a small playground, a storage facility, etc. Furthermore, with finishing the rehab work in the incomplete units, improving management, and doing an appropriate advertising campaign, we're confident we can get that occupancy rate much, much higher.

Our approach would be to form an LLC as being equal partners and get the property under contract. We are prepared to keep the property as a long term investment, or simply hold for a few years and cash out.

What are your thoughts?

[Jon Holdman]

I think there's little doubt expenses being 50% of rent is about the best case in a property like this. With 60% vacancies, it will be much higher. IMHO, proforma = pretend. Ignore it. If you can get actuals for the past, I suspect you'll see them low, too. "Look, its a great deal", the seller will sell. "He's cut corners on maintenance, and left a mess" you should think.

Figure out what its going to take to bring it up to market conditions. Back into a price using your desired cash flow, current rents, and assuming 50%.

Looks like this to me:
Gross rents: $27,300
Expenses: $13,650 (once all the issues and vacancies are fixed)
NOI: $13,650
Desired cash flow: $4,800 (you won't convince me there's any other play here.)
Max payment: $8,850
Max price: $1.14 million (7%, 20 years)
Subtract off whatever its going to take finish those rehabs and deal with all the other issues (you've looked inside each and every unit, right?) and the vacancy loss while you get it up to market levels.

Are the existing loans really fixed rates? I suspect they may have some provisions for adjustable rates.

$1.78 million is way too much. Let it foreclose, then buy it from the bank after the fact.