Apartment Deal... Or No Deal... How to tell???

Question

Hello BP, I have a question about a real life, hypothetical, potential deal opportunity. I know a little about commercial multifamily investing in theory, but have no practical knowledge on how to analyze a deal, or negotiate one for that matter. So if anyone has experience in this field please chime in, and let me know if it's worth pursuing...

Okay, I've seen an add for a 6 unit Condo/Apt building on Craigslist for a couple weeks now, and the guy want $170k. There is only one unit finished, and it looks really nice in the pictures. I estimated (based on the pictures) that it would cost probably another $170k to finish the remaining 5 units. He says that you could rent each unit out for $1000/mo, but I'll analyze 20% less and say $800/mo (Im awaiting information on that market right now).

So If we are all in at $340K with a

Annual Gross Operating Income of $57,600 ($800 in Rent x 6 units = $4800 x 12 mo)

minus

Annual Operating Expenses of $28,800 ( We'll say 50% of the GOI)

Equals

Net Operating Income of $28,800...

Divided by

the GOI ($28,800/$340,000) you get a

Cap Rate of 8.4%

Now to my knowledge; I should be shotting for a 10 Cap. So, If the numbers checked out I would have to offer him Approx $118K to get a 10% cap rate. So where would I go from there? What else would I need to take into consideration when making an offer, or negotiating the purchase price? And is there anything that I'm over looking while analyzing the deal?

I greatly appreciate any feedback in advance. Thanks!

Anthony Dooley · Answer

@Cabrin Mills Please do not believe anything that they tell you. Assume the photos only show the best and none of the worst, which means you need to drive it, walk it, and talk it. Talk to the neighbors. If this is such a great deal, why doesn't he finish it himself and get rich? The property is not finished, so the net operating income is zero dollars. This will make it very difficult for conventional lending. Don't buy anything based on the cap rate. 8 Cap in some areas of the country is unheard of. A 10 cap in my area usually means it is a dump in a D area of town. The other red flag is that it is on Craigslist and not with a broker. Can he offer owner financing or carry back on a portion of the price? If so, it may be worth paying more for it. This means price is not always the most important thing. I look for cash flow, which this has none. You are talking about buying a construction project, so I hope you have experience in managing this kind of work. I would move very slow in this process.

Carlos Martinez · Answer

Hello @Cabrin Mills. I'm not going to weigh in much on the deal itself but rather a few things to keep in mind. @Anthony Dooley has alot of good points.

How much is the property actually worth as is, not how much he is asking? Whats potential worth according to comps. How much are the actual rents if it's currently fully tenanted. If its not or if rents aren't up to market value in a 5+ unit property it can play an important role in negotiating price to your advantage. Will you manage yourself or hire a PM. All these things can potentially kill your cashflow. Just my .02.

Good luck!

Cabrin Mills · Answer

@Michael Jones The condos are currently not apart of a condo association, because they were converted (or being converted) into 6 large condos/or appt. Where the building was initially an 11 unit apartment building.

He said it's not too late to convert them back, or redesign the building however you like; which could potentially change everything. It seems to be pretty wide open right now. So I just focused on the deal as a 6 unit condo/ apartment building, and I would lean toward the apartment side of things because of the very point you just made. Thanks!

Cabrin Mills · Answer

@Annette Schneider Thanks! Yea I definitely would not put faith in my estimate. That's kind of why I called it "a real life, hypothetical, potential deal opportunity". I simply estimated 30k per in rehab per unit (30k x 5 = 150k) + an other 20k for the miscellaneous = $170k. Like I said that could be way off but I needed a rehab figure for the sake of the question.

And as far as the value vs potential income. Is the properties value based on GOI? And are you saying that I should analyze the NOI and Cash on Cash return?

Annette Schneider · Answer

You really can't get a solid estimate of renovation cost until you tour the property and talk with a contractor.  Touring the property will also give you an indication if the property will be as desirable to renters as it appears on paper.  All it takes is one crazy neighbor, abandoned building with homeless squatting in it or just a large population of rats and other vermin living in it to scare away potential tenants to the building you want to invest in. When analyzing the deal, I would also compute actual property tax rates (don't rely on seller figures) and check to see if the property is in a flood zone. The properties worth is also driven by real estate value not just income potential. A cash buyer can scoop up the property with no mortgage to pay per month will have a far lower operating expense.

Apartment Deal... Or No Deal... How to tell???

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