23 unit multifamily deal

[Warren Straley]

Was hoping to get a little advice on this potential deal. 23 unit single building three stories with rear parking, and a small two car detached garage the is rented to two of the tenants.

12 one bedroom ($325.00) and 11 two bedroom apartments ($360.00) Gross rents of $82,300.00 2016. Expenses for 2016 (according to owners) are as follows:

Ads - $100.00

Travel - $4,018.00

Cleaning - $2,590.00

Insurance - $3,827.00

Legal - $595.00

Repairs - $6,075.00

RE Tax - $10,943.00

Utilities - $11,400.00 (Owner pays water, and electricity for hallways, and gas for hot water heater)

Total  Exp - $39,548.00

Owner is asking $30,000/unit for a total of $690,000.00

What is everyone's thoughts on this? What would be a reasonable sale price? I have already made an offer and have been countered. I would like to have your thoughts first.

I feel rents are low on this building. It is not the cream of the crop, but with a little better management could be nicer. It is known to be a low or lower income building, and owners even said "We aren't out to get everyone and like to help people so we keep the rents low". That's nice of them, but you can still help people, and have good business sense at the same time.

Thanks!

[Jonathan Twombly]

@Warren Straley  I'm not sure whether to say "run as fast as you can for the hills" or "run as fast as you can to the bank" and get a check cut.

Here's my thinking, pro and con.

Cons:  

This deal has NOI of about $40,000 and the asking price is $690,000. That's a cap rate of 6.1% on a small deal in a very small market that is either losing population or growing very, very slowly (depending on which website you look at, and I am assuming this is in your town), as well as slightly increasing poverty between 2000 and 2010 (looking at the Van Wert County data on Wikipedia). That is WAY too high a cap rate for this asset and this market. It also likely has a ton of deferred maintenance at these rents. This owner is cutting things to the bone for sure.

In addition, the seller's expense numbers are not going to be the ones you get.  The seller's insurance is probably based on a very out of date replacement cost, that is related to their low basis in the property.  Yours will be higher.  Your real estate taxes will probably also be higher - you need to ascertain when the property will be re-assessed, whether on sale or later, but in either case, when it is reassessed, the taxes will probably be higher.  I don't see any labor costs here, either, which means that the seller was doing everything himself, and you will have to as well, if you want to keep the same cost structure.  There is no expense for landscaping, snow removal, pest control, waste haulage.

So the nominal cap rate the seller is asking for of 6.1% is likely to be even lower in reality on the expense numbers you would have to pay.

Also, you only have 2016 numbers. Where are the 2017 numbers, at least through November. You need a T12 through November at the very least.

One other consideration, which affects the vacancy rate and your ability to raise rents is that buying a house is very, very cheap there.  So rents have an upper limit.  And with a shrinking population, that means buying a house will only get cheaper over time, dragging on rents.

Pros:

Here is the opportunity I see.  I don't know what rents are like in that market, so take this with a big grain of salt.  But there might be a LOT of room to move on rents.  The median household income in your town is about $40,000/year.  The general rule is that people should spend between 25 and 30 percent of their income on rent.  That means the person in that town earning the median income can comfortably afford to pay between $10,000 and $12,000 a year in rent.  Despite what I said about the poverty rate increasing there, it is still pretty low, so people can afford decent rents.

In the meantime, the tenants at this property are paying between $3900 and $4300 in rent. Even if the building is subsidized housing and has rent limits, there is still probably a lot of room to legally raise rents.  However, this will likely involve a lot of tenant turnover, so you need to brace for high vacancies for a while and to spend quite a bit of money on turns.

In addition, I don't know what the local law is there, but if you can pass utility costs to tenants through RUBS or another bill-back system, this is another huge opportunity for you.

You may have a very good candidate for a rehab/reposition on your hands.  However, you will have to determine how much it will cost per unit to rehab the property.  Also you need to get a handle on the market vacancy rate.  If it is very high, than this strategy will be more risky, and that would explain why the rents are so low.  Also, at those rent levels, I suspect that the insides of these apartments are in bad shape, and they will be very hard turns, not light turns, and those will be costly.  You may be looking at $5,000-$10,000/unit depending on how bad they are.  But, it could still be worth it.  You have to run the numbers and see.

These are my two cents.  Take them for what they are worth.