Originally posted by
@Warren Straley:
@Jonathan Twombly you are awesome to start with. Thank you for the awesome response.
If you would indulge me a bit I have a few questions for you.
1) Housing is affordable in my community. There are nice 60 to 80k houses to be found that would equal the rent on this specific building, but the rental market is EXTREMELY strong and has been for well over a decade.
I would get some specificity on this: what does "extremely strong" mean? What is the local vacancy rate for rental housing? Is there new construction in the pipeline that will change the vacancy rate?
Extremely strong means there is a shortage of rentals in my area. We have on average 4 people calling our office daily for rentals. That might not seem like a lot, but it is to us. I stopped advertising my vacancies (rarely have them anyway), and just let word of mouth spread between my tenants. Usually takes a week or less to fill a unit. I also just build two brand new duplexes. As soon as I finished a unit there is someone wanting to rent it immediately. I would say vacancy rate in my town is pretty low. Maybe like 5% or less. Not sure how to calculate that, but I hardly see for rent signs anywhere, and my personal vacancy rate is about <1%. There is some new construction coming though. They are starting a new 132 house subdivision, but I don't see how that will affect the rental market here too much. That will free up some existing homes to become more rentals, but don't feel it will make that large of an impact. Rental rates for decent two bedroom home are around $550 and for a three bedroom $650. I have a very nice one bedroom home that I get $525 out of.
We do have a stagnate population growth in a town of about 10,000 people. Still have relatively strong industry base. (One employer does have about 1,000 employees though)
So much dependency on one employer is a little troubling, unless its something that's not going anywhere, like a power utility or a military supplier.
It is not one of those, but I do believe they have some contract with the military to build parts for them. There is also rumblings of a large 300+ employer coming into our town, but haven't heard much more than that.
I feel the rental market will continue to be this way for years to come.
This may well be true, but until you put some evidence behind this statement, it's just speculation. It's always tempting to paint a favorable picture in your mind when you want to do something like this, but you need to think about this like a business and get some actual facts to support your theory.
I know that I am wanting to be positive about this, but I don't see how it will/could change drastically in the next 5 to 10 years. I think the only thing that could do that is if a company leaves, but no idea if that is going to happen. One of the larger employers (about 300+) just renegotiated with the union, and signed another 4 year deal which was last year. And even if we hit another housing recession I see rentals doing even better. People will always need a place to live.
I am curious as to something you have on your profile on BP or on your website. Can't remember where I read it, but you mentioned you are predicting a multi-family crash in the near future (only a few years). Why do you say that?
2) Rental rates on this building in my opinion are VERY low. $325 for a one bedroom (twelve total) and $360 for a two bedroom (eleven total) WITH water/trash included. I feel that those rents could be raised to at least $350 to $375 for a one bedroom and $425 to $450 for a two bedroom AND change water so that tenants pays.
What are the actual market rents in the area? You need to do this research. They could be higher, which would be a good thing for you and make this deal worth doing. Assuming rents of $375 and $450, that brings you to about $108,900 for yearly rents - once you have re-tenanted the property, which will take at least one year. However, we also know that your taxes and insurance are going to rise, let's assume by about $15,000 for both. So that still leaves you with NOI of only about $45,000, assuming that all the other costs stay the same, which I doubt they will. $45,000 of NOI on a $690,000 deal only gives you a cap rate of 6.5% - too low in my opinion, even in this market, for a deal like this.
Rental rates vary throughout town depending if it is a SFH or a multifamily unit. We don't have too many multi-familys in our area. Only 6 different "larger" ones that are all around 20 to 40 units each. One of which I wouldn't touch with a 50 foot pole. There are quite a few SFH rentals, and one guy owns about 138 of them. I would say your standard/average is: 1 bed $350 to $500, 2 bed $450 to $600, 3 bed $550 to $700. This number has grown to this over the past five years. I would say used to be 5 - 10% lower. There are nicer units out there (condo style) that rent for $1,000/mo. Only a couple of those.
I would do some more research on local rents and see what the market rents are for a newly renovated C-class asset, given its location. If there are any local properties that compete with this one, call them up and pretend to be a renter, and ask them their rents. Be sure to try to get an idea of the size of the apartments and the amenities. You might even want to sign up and visit a vacant unit, pretending to be a renter so you can get a good idea. This is called "shopping" the competition, and it is a very good way to compare the rents in the market. Make sure you do this with all the competing properties. If you can establish that the local rents are really more in the $500-700 range, then you may have something here.
In terms of research on newly renovated C-Class buildings I would say there are none. Many of the buildings have not changed hands in a few decades. There are a lot of income based apartments also, but none that have sold and been renovated. On a slight side note I would say that I see people preferring a SFH over an apartment building if the rent is relatively the same. At least that is what I would lean toward if I were looking for a rental. Do you have any experience on apartment buildings like this one (all interior hallways, 3 stories, laundry in basement)? I did the math on the buildings rents x units, and the total amount that should have be collected in 2016 was about $94,000 yet he only collected $83,000. I see that as constant vacancy, or people just not paying their rent. I am not sure if that is poor management or if he just couldn't get the building full. He did say though that he had no trouble filling it at one point.
I'd say that you want this deal to be an 8% cap rate at the very least. At this sale price, that means $55,000 of NOI. Or, at the current NOI, that means a sale price of $500,000.
3) Still learning on the CAP rates (which I should know by now), but what in your opinion is a good CAP rate to shoot for? I am assuming that a higher CAP rate is better, but I still am not sure.
Yes, higher is better. The calculation is NOI/sales price = cap rate, so the higher the cap rate, the higher a percentage of the sale price the NOI represents.
Another very important calculation is the debt service coverage ratio (DSCR). It will be hard to get a loan for a commercial property if the DSCR is lower than 1.25x. The calculation here is usually something like NOI minus required reserves (usually $250-350/unit/year)/debt service = DSCR. So, assuming again the NOI is $40,000 and you have $300/unit/year of required reserves ($6,900), that leaves about $34,000 to work with. However, at this sales price, on this NOI, and assuming a 75% LTV loan at 5.00% interest your annual debt service is going to be $43,116. You will have a DSCR of about 0.80, rather than the 1.25X you need to qualify. And, in my experience, you really need a DSCR of at least 1.5x to make any money, because you will have capital needs to pay after you pay debt service.
4) I never trust a sellers numbers (especially when they all end in zeros!) And the seller did do a lot of the work himself. That was probably why the travel bill was so high as he lives an hour away. I would not have that bill, but would probably be tacked onto the repairs because I would try to hire more out.
