Analyzing an 8-plex; is their price too high?

Question

The good: This property is owned by an elderly woman who is in the hospital; her two daughters manage it, but they live out of town. They don't seem to know a lot about marketing their property; it is not listed for sale online, and they are not working with a realtor; it's just a cardboard sign in front of the property. It is located directly next door to a major hospital, so there is stability in the neighborhood.

The bad: I have very little cash on hand. I'm wanting to run the numbers on this deal to see if it is an incredible deal. If it is indeed incredible, I will explore options for creative financing, but I'm not interested in highly leveraging myself for a ho-hum deal.

The numbers (as provided by the daughter; I have not independently verified anything.)

8 apartments, 6 upper and 2 lower

Building age 47 years.

Building Area SF 8,448.

Site .881 acres

Property Taxes $8,442

Sewer/water and electric $3,420

Gas $3,072

Apartment

A   $700.00

B    $635.00

C   $700.00

D  Available asking $700

E   $595.00F   $620.00

G   $540.00

H   $575.00

There is a $25 discount if rent is paid by the 1st.

Asking price $375,000

+++++++++++++++++++++++++++++++++++++++++++++

So, assuming everyone pays on time, that brings the net monthly income to $4,865. I asked her to provide me with more details so I could figure out the NOI, and she sent me tax returns for 2014 and 2015 (why is 2016 not included? Not sure...something to check on if I decide to pursue this deal further.)

So, the NOI for those two years averages out to $22,000 a year. (at least, that's what they've claimed on their taxes) Now, if I understand the math correctly, I need to divide that number by the cap rate to get the property value. However, I am not sure of the cap rate in the area (we're new to the area...and I'm new to multi-family!) Digging online seems to indicate the cap should be about 9% (which sounds reasonable), but I don't know if those numbers are at all reliable. At 9% cap rate, the property should be worth $244,000, which is a pretty major price difference from $375,000. Have I done the math correctly? What information am I missing, and how should I go about getting that information? I don't want to go to the owners and tell them they are over-valueing their property unless I am 100% that I am correct.

Finally, what advice might people have about maintenance and CapEx estimates? It's a single building built in 1970; two stories with a basement. There is a detached garage building with 8 garages. What percentage would you figure on this?

Peter B. · Answer

@Samuel Bavido

I have multifamily in the area. When appraised they used a 8.5 cap.

Why is there such a spread in rent? 540-700..Is there an opportunity to bring all closer to 700? Better marketing...

From first glance the expenses you itemized don't seem to far off. (I have an 8000 sq ft 8 unit)

Our gas bill is a lower. About 2k. We have a new high efficiency boiler.

Water/looks good. That can vary a lot from town to town.

Taxes.. What is the assessment? Is there room to appeal?

I would get some more details why the tax returns looked so poorly? Break down the expenses further. Ours are no where near 37k for an 8. Closer to 28-30.

The deal in multi-family is not in the sale price it is in the management... Find what they have not done efficiently and see if you can improve it. Check out the last to pod casts they explain it further.

Peter

Douglas Thiessen · Answer

I have done a preliminary analysis. I added expense consideration of $2,500/year for insurance, $4,000/year fro repairs, $2,400 for reserves (because you never know!), and 5% of revenue for mgmt fees (if you manage it yourself, you still want to get paid!). I applied a running 5% vacancy rate and used a Cap Rate of 7.5%. Provided that these inputs are correct, the asking price represents a Cap Rate of 8.3%, which appears to be a relatively good value.

Question - when you calculated the NOI did you account for mortgage payment in arriving at your NOI of $22,000/year? Usually mortgage payments aren't included in NOI or Cap Rate calculations.

I could not find any comps directly in Steven's Point, but I there were a few in nearby communities. It would appear to me that $46,875/door for townhouses at an existing Cap of 8.4% is a good deal. However, I would caution you to have a professional do a thorough physical inspection and add any deferred maintenance/capex into your purchase price calculations.

I hope you find this helpful

Michael Henry · Answer

@Samuel Bavido the good news is that many banks will not finance a bad deal. The bad new is that many sellers don't care what bank's think and they want their price no matter what. There are industry standards for evaluating commercial real estate; like 10% management fee and 5% reserve, and very depends and which market you are in. If you don't include these percentages in your pro forma the bank will and they will only lend based on those standards. Go to a local commercial bank see if you can get a loan and have them look at your pro forma.

Chase Leavitt · Answer

NOI/purchase price = Cap Rate

$22,000 (NOI which I haven't verified but got from you) / $375,000 = 5.8% cap rate

The biggest question is verifying the expenses to make sure your NOI is correct. Awesome price for an 8-plex from what I'm use to seeing here in Utah. The other thing I would look into is if there's anyway to increase the rents to bring up the NOI. If not, to me and what I'm use to a 5.8% cap is just average, especially for the age of the unit and repairs that will be needed. Just curious, what's the average cap rate you guys are seeing in Wisconsin? Here in Utah average cap is 5-5.5% which those seem to be selling all day long. I wouldn't settle for just average and continue looking for something more than average.

Douglas Thiessen · Answer

They very well may be, though I think that the rents that are in place are very low as well. My properties are all larger than 200 units and I generally pay 3% for PM. Multifamily PM is less than single family simply because it's easier....you only have one boiler, one hot water heater, etc...etc...If you look closely at the tax returns I would expect that they included interest expense which is the largest portion of a mortgage payment.

Think about it this way....including the cost of the land you would be lucky to build that size of a building for less than $1.2M ($150/sq. ft all in). If you can get the average rent up to $700/month the value of the property will appraise somewhere between $450,000 and $500,000, at which point you could refinance and do an equity takeout. Remember, the most important thing is what the bank is going to value it at! I would think that if the property is stabilized at average rents of $700 they will find an appraiser to use a 7.5% CAP. It's not an unreasonable number. Green Bay average capo in Class C property is 7.5% and that's going to be the closest data point an appraiser will likely be able to find. Average rents in Green Bay is $764 and vacancy is 2.2%

If the metrics in Marshfield are anywhere close to this I would suggest purchasing as many 8.4% Cap properties (at roughly 40% of the replacement cost) as you possibly can because rents should be increasing significantly.

I am mentoring a young man who is just starting out in multifamily. He purchased a 7 unit property in Racine at a substantial discount, poured all of his cash flow into fixing it up and less than a year later it was appraised at more than double the purchase price. I can't guarantee you will do that well, but certainly a 25% bump within one year is a reasonable objective.

Peter B. · Answer

@Scott Schultz

I do appreciate your conservative approach on financing.. IMO your opinion on multi is way off. These 2,3,4 percent properties are not where the money is at. They will never perform where you project over time. Maybe a year or two but not consistantly over time.. I know because the first properties I bought were of this type...Nearly 20 years ago.....

So i will bore you with a story.... My uncle who made a heck of a lot of money on lake front property in southern Wisconsin retired and moved north... He bought a 3.5% 5 unit (50 k for 1800 rents) thought it would be a cash cow and would supplement his already laid back retirement.. Over 7 years he never even came close to projections. He offered me the property for 30k as a gift.. Like I said he didn't need the money. This is now a 6% property. I still passed... Why bc I already owned a 2 plus percent 4 plex. I have been to court more times than I can count. I have a collections guy. I had tenants that will never see the outside of a prison cell.. I can tell some pretty funny stories on tenants say the dumbest things.. But more importantly I also own quality assets and have for over time.. Their performance is predictable. The quality of tenants is superior and the abilty to force appreciation is there.

If I shared the purchase price and financials of some of our multis at time of purchase you would call all of them a bad deal...

These 4 buildings (there is a twin to the first one) have appreciated just short of 400,000 over time and have consistant cashflow,more than 15 yrs of tax returns to prove it, with proper manegement and using the very systems shared in the last couple pod casts.

I apologize for coming at you, but I think the whole 2% rule thing is dangerous and should not be glorified on here. These properties are not for beginners.. They are for folks who don't know they are beginners. Give it time. It took almost 3 years before I realized what I really had. Fortunately I made it through and focused on better properties. The only value in those properties is the education they will give you. It is truly landlord/investor college.

Ben Wilkins · Answer

@Samuel Bavido - it's always fun when you find a property that isn't advertised very well - that always opens up more opportunities.

Most of the others hit some key notes about NOI, CapEx, etc. The major things: CapEx should be 10%, maintenance should be 10%, vacancies should be based on the market average (8% - 10% is conservative usually). Don't forget these numbers when calculating expenses.

Now, on to what you can do in order to make this deal better for yourself.

Expenses: Did I see correctly that the landlord pays water, sewer, and gas? Find out if you can split these utilities up through metering (likely not very cheap), or consider splitting the bill with the tenants. A third option that I have in my lease for properties where I pay the water:

"If Landlord pays for water and sewer TENANT will not use excessive water and understands that he/she will be billed for water and sewer for any amount over the normal charge.

If Landlord supplies electricity to the Premises, the use of air conditioners, electric space heaters, or other heavy duty appliances requires the written consent of the Landlord"

There should be a way for you to lower your utility expenses... the key will be figuring out which path is best for you and this property.

Second: you have eight garages? Find out what the average rent is for a parking garage / storage unit, and rent them. At $35 per garage, you're making an extra 5% income... and that might be cheap for storage units or garages. Either way, there's income on the table that is being missed.

Last: Once you have the tenants under your own lease, you don't have to keep the early payment bonus. That's almost 4%-5% and should be needed if you screen your tenants.

With those three things, you can increase your cash income by somewhere around 10% without actually having to do anything other than implement your own leases. My point is that these people didn't manage the property, so they came up with the easy solutions - you can benefit by taking over and increasing the cash flow by managing it better.

Food for thought!

Shawn Ackerman · Answer

@Peter Bowen solid points!

Scott Schultz · Answer

Thanks for that @Peter Bowen everyone has a different way of investing and what works for one does not for another,  I keep my properties maintained well, plan for the future when doing initial rehabs,  and use a professional manager, we also tend to charge premium rents, and allow pets, most of our tenants have stayed for many years to this point, and take pride in the home they rent from us, there are exceptions, and the rougher properties that cash flow better can come with more challenges, but the entry point limits my overall risk as generally I can pay back the initial investment in 5 years or less, they are mostly SFR's so i have a large buyer pool if I want to exit. at some point I will get board with these, and move to A-B multi, then probably NNN Commercial, my only thing with deals like yours is, with Debt I dont see how they cash flow.  I have run the numbers many ways and they either break even, or are negative each year, at least in my area. I just ran a 10 unit (C-B class) at $450K looking at the average expenses over the past 5 years, its fine with no debt, but is negative on a 15 year, and positive like $2500/year on a 30 I just cant see that being worth the work you would put in. in a rough year you could easily go negative, I have looked at several of these recently, and this one is at least positive on a 30 most are not. maybe i dont understand. So for me I will stick with what some will call PIGS, I know many a landlord that ran portfolios of these for decades, and have done quite well. and if they become headaches I can always 1031 them to something else.

Scott Schultz · Answer

everyone has a different strategy, but if it doesnt make money on a 15 year assuming you could borrow 100% dont buy it!, the way i run my numbers, you would loose money every month.  the mortgage alone is $3164/mo   ($375K @6% for 15 years)  I use 6% for potential rate hikes at renewal over that 15 years. your other expenses eat up everything left over. my opinion is to only buy  crazy good deals right now, as our market is inflated. I just locked sown a 3 unit in SE WI for $46,500 with gross rents $1,650/ mo taxes are $1872, and all utilities are separate,  these are the deals that make money. add in the appreciation for buying a great deal, this one last sold in 2002 for $93K so i can pull 100%+ back out and still cash flow like crazy.   Your deal does not look great.

Analyzing an 8-plex; is their price too high?

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