Investment with 12% Cap rate but not the greatest apartments/tenants

[Danny Colacicco]

So in seeking wholesale deals, I came across an investor looks to sell two apartments with 5 total units in a decent area of Baltimore (Greektown). All of the apartments are currently being rented, however, when viewing them, the apartments were dated/not in the BEST shape and the tenants (not all) had very poor hygene. Nonetheless all teneants have been living there 1.5-4 years and do not want to leave. I have negotiated the property to a cap rate of 12% (after taking out all fixed/variable costs and my fee) but I am still weary of putting it under contract as I am nervous that I wont be able to find an end buyer given the condtion of the property/tenants?

Can anyone give any advice as to how they would proceed with these? Would you put them under contract?

Thanks in advance for the advice!

[Kevin Brown]

Im no MFH genius, but from where I sit a 12% cap rate is a 12% cap rate. Not sure why you would have a tough time selling that. Especially if theres room in the rent market to increase rent by upgrading the units as the tenants leave. No reason to be worried about dated units if you built that into your purchase price, which it seems you did.

[Chris K.]

Originally posted by @Kevin Brown:

Im no MFH genius, but from where I sit a 12% cap rate is a 12% cap rate.

Agreed. I don't know what numbers you used to get the 12% but if they're accurate then you shouldn't have much problem.

Those properties have been on the market for quite awhile and were always priced too high to consider. But if you have them negotiated to a price that you think works then no reason not to get it under contract.

[Danny Colacicco]

I just calculated as:

[annual rents - fixed costs (taxes) - variable costs (avgs provided by seller for water, gas and electric]/(negotiated price + my fee)

I dont believe im missing anything in calculating the cap rate?

[Matt Devincenzo]

Originally posted by @Danny Colacicco:

I just calculated as:

[annual rents - fixed costs (taxes) - variable costs (avgs provided by seller for water, gas and electric]/(negotiated price + my fee)

I dont believe im missing anything in calculating the cap rate?

Are you sure your variable costs are all inclusive? I think you're hesitant because you might have forgotten things: insurance, maintenance, management, capex.

[Danny Colacicco]

it did include insurance but it didnt include the others. I assume the investor manages there own property, capex could result in higher rents if you are upgrading the property so this could potentially be offset, and maintenance I believe is way to variable to account for.... are these normally included in the calculations?

[Joel Owens]

Landlord pays utility go 60% costs of expected gross rents.

So if gross rents were 30,000 annually times (.40) = 12,000 NOI

100,000 sales price would be a 12 cap. Putting your fee in maybe 95,000. Then if 10,000 of immediate capex is needed that comes off so 85,000 offer price.

When you get to the real numbers you might find you are not marketing a 12 cap. Remember even if seller is self-managing they are buying a job and when selling the buyer pool will be reduced as many buyers use a PM and include the cost when buying.

[Wayne Brooks]

You absolutely have to include maintenance, repair and capex. You don't get higher rents because you have to replace the HVAC and roof. "maintenance is way to variable" so you pretend like it doesn't exists?

[Danny Colacicco]

What percent of rental income is approriate for maintenance, repair, capex? management fee?

[Ned Carey]

Originally posted by @Danny Colacicco:

What percent of rental income is approriate for maintenance, repair, capex? management fee?

Typically all expenses other than financing will be about 50% of income. As @Joel Owens says that can be 60% if the landlord pays utilities. Of course these are just averages and can vary. Without knowing actual numbers you would be foolish to assume lower.

Personally I don't think 12% is anything special in Baltimore. There are other factors like is there equity at the price you are selling? Are the rents below market? If the tenants move out how easily can they be replaced? If repairs are needed at tenant turnover what is the return on investment of those upgrades?

That 12% number means notheing to me without knowing the rents and the price.

[Marc Ramsay]

I would include some reasonable dollar value for deferred maintenance as part of the purchase price calculation as it sounds like a new owner will probably have some work to do despite the tenants apparent desire to remain.

What happens in the first couple of months that the tenants decide they don't like the new owner, have a change in employment status, or any number of other things that can cause them to move out. Now you're stuck with an empty unit that probably can't be rented out as is and will need some amount of rehab. I'd consider what it would cost to rehab half the units and add that into the acquisition price calculation and call it deferred maintenance to assist with determining the CAP rate.

This suggestion is based on personal experience, unfortunately.

[Phil Z.]

I didn't see anything for repairs, management or vacancy.

[Danny Colacicco]

So I redid the numbers. To allow for defered maintenance I assumed a maintenance percentage of 9% above the norm of 5%. Mgmnt I alloted 8% and Vacancy 5%. All of the other expenses come from the current owner (tax, insurance, water, gas, electric). Lastly I multiplied the total expenses by 1.05 to allow for a 5% safety net. Currently the owner is asking 300K which give the investor only 8.94% Cap Rate after my fee however I enetered a goal price of 250k which gives a 10.73% cap rate to the investor after my fee. Does this look better?

[Andrey Y.]

I'd add 10% PM fee and @ might tell you if 5% vacancy is ok for your targeted area.

By the way feel free to add my email to your buyers list: [email protected]

or better yet send me the info about the properties ... I am not a wholesaler and will not go directly to your customer :)

[Danny Colacicco]

So I know that Ned has said that he like a much higher cap rate so I do think that I need to get the price down a decent amount from 300k but for other investors that know and invest in the baltimore area, for multi unit properties in the 250-300k range in greektown, what kind of cap rate do you require? Would you consider 10% cap rate a good deal (5 apts at 270k) or do you think this needs to be way down to a price like 225k (12% cap rate)?

[Bryan L.]

Don't trust the owner's numbers for anything. Ask to see his tax returns and check with the utility departments to verify utilities.