Post Mortem on a 'failed' deal

[Tom Carroll]

I recently made an offer on three properties with a total of 14 units (mix of studio, 1, and 2 bedrooms) of $420,000 (listed at $480,000.  Seller countered at $455, I came back at $450k and we had a deal, subject to the usual requirements.

Per the seller the properties had an annual income of $60,000 and expenses of $25,000. NOI of $35,000, 8% cap rate for his original list price of $480,000.

Rents are slightly below market value so there is room to raise them and the property looked in decent shape.  My expenses would be higher - particularly insurance (new, inexperienced owner represents higher risk), and taxes.  The tax assessed value of the properties is $340,000.  If I buy them at $450,000 the taxes will go up, the only question is how much.  Most of the surrounding properties tax assessment is 1-2% higher than selling price.  In the sellers financials only $1,200 a year was spent on repairs which made me wonder how much maintenance had been deferred and how real his numbers were.  

As I ran my numbers (using the Bigger Pockets calculator, another site's calculator, and my own spreadsheet) I came up with a NOI of $30,000, a 6.8 cap rate using $450,000 purchase price. Financing terms were 4.1% on a ten year note amortized over 25 years, 20% down, $2,250 a month. Worst case numbers I know, but I'd rather plan for the worst and be pleasantly surprised. $90,000 down payment, $5,000 in closing costs, $1,800 for the inspection. I knew going in one building would need a roof within a year (figured $12,00) and another $5,000 in miscellaneous repairs (worst case). Total cash invested would be $115,000. Cash flow of $5,000 a year.

Overall looks pretty good. As long as I'm above my numbers the cash on cash and overall (planned on selling after 15 years) ROI was going to be about 8-9% annually.

Then we did the inspection.  The condition of units themselves weren't bad.  Usual little things like smoke detectors, some non-GFI outlets, a couple outlets wired backwards or not working, some windows that didn't open or wouldn't stay open, some rotten wood and cheap repairs/installs.  A little shabbier than I hoped for but about what I expected.  

The condition of the buildings is a different story.  Building A needed a new roof two years ago.  You can see the plywood sheathing, evidence of past/present water damage, coping replaced by some sort of spray foam sealant, etc -est repair $10,000.  Chimneys needed to be tuck pointed and lined.  They are still the orignial clay lined from when the house had central coal heating.  It now has gas fired heaters in each unit, all going into the same exhaust stack.   Estimated repair $2,000-5,000 and the inspector said it could go higher depending on how much degradation has occurred in the 15 years since the gas heaters were installed.  Second floor units balcony/emergency egress has rotten wood ( rear unit had noticeable movement with two people standing on it, front unit literately came apart) estimate of $500.  Gutters are not attached (see above roof issues) and draining into the foundation.  Conservatively I'm looking at $15,000 in repairs that can't be put off.

Building B has a crushed support post and damaged cross beam.  The seller 'fixed' it by putting 4 jack stands around the crushed post.  Roughly $2,000 to fix it correctly so the floor stops sagging.  Add in another $1,000 for minor repairs of a banister (missing spindles), some rotten boards on the outside steps, a few leaky pipes (and flooring around them) and some serious tree trimming.

Building C needs a new roof, estimate of $12,000 due to the difficultly.  Several steep pitches, dormers etc.  As my inspector descended it went from a creep, to a scramble, to a controlled fall.  Chimneys needs roof caps, furnace exhaust (which doesn't come up thru either chimney) is missing a section so it's basically venting into the attic, and either the furnace or one of the three water heaters has a small gas leak (smell was very noticeable when entered but quickly dissipated).  Gutters need to be redesigned and the yard needs to be graded to control runoff (as is at three points the gutters are "designed" to not have downspouts).  There used to be a garage attached and partially under the second story.  The seller removed part of it due to rot but couldn't completly demolish it as the 'garage' was structurally important to the second floor.  It's door wouldn't fully open and it is currently full of storm windows (for windows that were replaced) so we couldn't get all the way in but from what we could see the exterior wall is floating in at least two places (1-3 inches of space beneath the posts).

All together the inspector (who I found and is very reputable according to my agent) said I would be looking at $40,000 in repairs to do everything.  Not everything he thinks needs fixing/replacing needs to be fixed/replaced.  At a best case I think $25,000, worst case $35,000.  My realtor and the seller's agent think I'm being excessive but

When I originally ran the numbers $450,000 was my maximum purchase price, including repairs, closing costs, etc.  I stretched going up to a $470,000 all included.  The extra $15-20,000 of needed repairs but me beyond what I was comfortable with so I went back with a counter of $425,000 as is.  My realtor thinks the deal is dead, and I tend to agree.

Was my reading of the situation right or did I panic?  What would you have done differently?  What should I do different/better next time?