(2) six plexes, first deal- How does it look?

General Real Estate Investing
1

I am a new investor but have had a rental property (SFH) for about 10 years.

I’m currently working on my first deal which is a set of sixplexes. The owner is asking $390K for both. He will not split them up and he has owned them for about 3 years.

After some research I see that he paid $366K when he purchased them and the only improvements that he has really done is a new carport in one of the units, a new furnace (boiler) in the other unit and various minor repairs as tenants moved out.

Currently all units are being rented. I see a lot of room for improvement as far as increasing the value of the units. For instance I called around to similar apts. and found that he is charging a lot less than the median. $440/mo max and $400/mo to some tenants, where as the other buildings are charging $460/mo up to $480 for multiple tenants. He also has all tenants on month to month leases after their leases expire he doesn’t renew them. This is my first question. What should I do about this. Is it in my best interest to put everyone on a lease once I obtain the property?

I thought about a questionare being given to all the tenants. Asking if they smoke, how many people live there and if they have pets. Then readjusting their rent accordingly and providing a no smoking policy throughout the building(s). My only fear is that everyone will move out and I will immediately be scrambling for tenants, which would be a bad thing. Some of the tenants have been there for 7+ years and are paying the same as when they moved in. I don’t want to scare them away but I think that a rent increase is fair.

Ok now the numbers.

Total current rents= $59,760
Total current expenses= $26,274 - this includes previous years utilities, Taxes and insurance, a vacancy rate of 3% (is this right?) and repair costs of $850 per building (too low?).
NOI= $33,486
Debt service for ($390K) 30y @ 7.5%=$2181/mo or $26172/yr
With the above numbers I come up with $33486-$26274=$7314/yr or $609/mo cash flow.

My plan is to offer $370K which would be about $2083/mo $24996/yr for a cash flow of $8490 or $707/mo.

The cap rate that I figured is between 8.6% and 9.05% with cash on cash of 9.38% and 11.5% depending on my final price.

Seller has agreed to do owner financing for 40k 8%/3yr balloon.

Am I missing something? What else should I consider before moving foward? I have not inspected the properties yet, should I make an offer price before I have inspected or make an offer that is contigent on inspection?
Thanks for your time and replies in advance, I hope to be on these board for a long time.

2

G Whiz,

I think the expenses are off. I certainly do not believe that the maintenance expense for a six unit building is $850 per year. That sounds to me like the owner isn’t doing any significant maintenance. Although I don’t try to itemize expenses for the purposes of evaluating a property, I usually figure about $50/month/unit. $850 wouldn’t even cover carpet for one unit, let alone all the other things that happen in low income rentals!

As for the smoking policy, I would NOT do that. That is a great way to empty a low income building. The truth is that people in the lower class smoke in great numbers. If you enact a no-smoking policy, you will be the proud owner of an empty building. Remember, the purpose of your rental business is to make money. You are not living there. While you and I may not smoke, low income tenants do. If you are going to be in that business, you need to get comfortable with that.

Back to the numbers. I would estimate the operating expenses at 50% of gross rents. Therefore, the operating expenses would be about $30,000 and the NOI would be about $30,000 (or $2,500 per month). With a mortgage payment of $2,181 per month, your cash flow would be $319 per month or $26 per unit per month. OUCH!

I’d pass!

Mike

3

Thanks for your response Mike. I checked out your link and read a couple of pages from your book, good stuff.

These are 1 bedroom loft apts. in a nice area. I know for sure that I could rent them at $440 each giving me an income of $63k. Should I even consider buying them if the cash flow is under $500/ mo? What is a standard for $$/mo/unit?? The seller seems very anxious to get out of the business, these are his only rental properties. Should I try to low ball??

4

g whiz,

I won’t buy anything unless I get at least $100/unit/month. That’s probably why the owner is really selling - he’s not making enough money to make it worthwhile.

Mike

5

Mike,

What would your advice be to someone who would be glad to get started at having any cashflow, no matter how little that might be (just to get an actual hands-on experience without going in the red as newbies do in the beginning)?

James

6
What would your advice be to someone who would be glad to get started at having any cashflow, no matter how little that might be (just to get an actual hands-on experience without going in the red as newbies do in the beginning)?

That’s probably what the current owner thought. Now, he’s anxious to get out of the business!

Mike

7

You’re not learning anything if you are buying properties wrong from the start…do it right the first time.

8

How am I trying to buy properties “wrong” from the start? I just asked for his insight on purchasing properties that might be below his set standard of at least $100 positive cashflow a month. As long as the properties properly cashflow a month, I don’t believe it’s a wrong buy; just depends on how much of a “success” it is by how much it cashflows.

9

Anything less than $100/mo cashflow just seems too darn close the being in the red to me. Why not just put in the extra effort to buy lower (more equity from the start) with more cashflow?

10

NOI is $2,500 a month. If you’re looking for a breakeven amt then your mortgage pmt can not be more then $2,500 a month. One thing you will notice is that the longer an investor has been around, the more profit per deal they will require. NEVER be afraid to lowball, so when in doubt lowball. I would rather buy 1 or 2 great deals a year, then 6 breakeven deals. Everytime you buy a property you need to feel like your going to hell for how cheap you bought the property.

11

I know I should not look at the future value of the building when making an offer, only the current, which is what I used in the example above. However I know for a fact that the property is being mismanaged with rents far lower than average for the neighborhood. So with that in mind, if I were to use the $100/unit formula that mike mentioned, is that after I get the property to where it needs to be or should I only look at the current value of the property???

12

g whiz,

If you are SURE that you can immediately raise the rent, then I would use the rent you will actually receive. The thing that’s important is what is really going to happen. For example, when I take over a vacant building or house, I don’t ask the previous owner what rent they’ve been getting (they’ll probably lie anyway). I KNOW what the market rent is and I use my own number.

Mike

13

Mike,
How about for loan approval? The bank wants to see copies of all leases. The only thing is that most of the leases are expired and tenants are now month to month. Should I bring my projections with me for financing, or the expired leases, or should I have the seller get everyone in a current lease maybe a 3 mo so that I can raise it when I take over.
Thank You.

14

The leases probably aren’t expired. The initial term may be up, but if the lease is any good at all, it will have a provision that says the lease reverts to a month-to-month lease when the initial term is up. So, you are not without leases - you simply have month-to-month leases. There is nothing wrong with that. In fact, with low income tenants, I won’t sign anthing longer than a month-to-month lease anyway. The only person that benefits from doing so is the tenant!

So, if the bank wants leases, I would take the existing leases. It will certainly look better to the bank to have leases that show the tenants have been in the property for a while. You can also take in a cash flow analysis with the revised rents.

Mike

15

Well I made my offer today on the above listed properties. Please tell me what you think of this deal. It hasn’t been finalized yet or the purchase agreement drawn up, but if it goes according to plan this is where it’s at…
2- six plexes total price $365K
Owner financing $36.5k @ 8% 5yr int. only /balloon

Gross rents $ 66k
Expenses - $ 30K
NOI =$ 36k

Debt service $292k @ 7.5% = $2180/mo = $26,160

Profit =$9840/yr $820/mo

16

g whiz,

That must be some of that new math or your calculator might be broken. For some reason, you only included $292K in your debt service, although the purchase price is $365K, apparently with $36.5K of owner financing. That doesn’t make much sense to me. How can you conly count $292K when the purchase price is $365K. Someone is providing the difference and you should account for that even if the money is coming from you.

Here is how I would evaluate this property.

Gross Rents: $66K per year or $5,500 per month
Operating Expenses:P $33K per year or $ $2,750 per month
NOI: $2,750 per month

Debt: $365,000 (20 year, 8% commercial): $3,053 per month

Monthly Loss: $303 OUCH!

Again, I think this is a VERY POOR DEAL.

Mike

17

Thank you Mike,

The $292 came from… $365 - $73k down ($36.5k owner + $36.5k cash).
Is this any better???

18

It’s clearer, but unfortunately it’s not any better.

Mike

19

g whiz,

I have a 2 bed 1 bath 900 sq. ft SFH that I’m listing. I will sell it to you for $1,000,000. If you put $970,000 down it will cash flow like a champ. My point is that putting money down does not change the quality of the deal.

F.Y.I let me know if your interested in my property. You sound like the perfect buyer I’ve been looking for. :slight_smile:

20

Good example, the large numbers definitely make it easier to understand. I don’t think people get it when you’re only talking about 10-20% down.