Advice on a multi-unit property

General Real Estate Investing
1

I am looking at different multi-unit properties that are 2-4 units in the 300K range. I came across one with the below calculations and would like your input as I am new to this.

Asking Price: 300K
Effective Gross Income: 42,300 assuming 5% vacancy and 1% bad debt
Operating Expenses: 11,600
NOI: 30,700
Debt Service: 16,200

My thought from reading other posts here and the great advice from a lot of you is that the expenses seem low. I have read that they are usually between 45 and 55 percent which if so would eat up the cash flow.

Let me know what you think. Thanks.

2

We need your actual Gross Scheduled Income to start the analysis, not the ‘effective income’. Starting with an “effective income” will screw the analysis six ways from Sunday.

So, what is the actual, scheduled income?

Combine your “vacancy and credit losses” into one figure, not 5% vacancy and 1% “bad debt.” Otherwise, it’s confusing. A credit loss ‘is’ a bad debt.

I have no idea if your NOI is actual or “effective.”

Making broad assumptions since I’ve got time here to guess…

$300,000 Asking Price
$ 90,000 Down Payment (30%)
$210,000 Balance Owed
$ 1,350 Monthly Payment (6.67% 30-years, fully amortized)

$ 44,838 Gross Scheduled Income (Adjusted to compensate for “effective” figure)
<$ 2,538> Less Vacancy and Credit Loss (6% including 1% “bad debt”)
$ 42,300 Gross Effective Income

<$ 11,600> Less Expenses (27.5% of GSI)
$ 30,700 Equals Net Operating Income (66.5% of GSI)
<$ 16,200> Less Debt Service
$ 14,500 Equals Cash Flow Before Taxes

CAP RATE: 10.23%
Cash-on-Cash Return: 16.2%

If these figures are reliable, this would be a good deal. The issue I have is not knowing the age, construction (flat roof, brick/siding, galvanized plumbing, common utilities, actual physical condition and occupancy rate).

The assumption is that this building has copper plumbing, is not more than 30 years old, has a newer pitched roof, with separate utilities, exterior walkways (no interior halls), and is actually operating with a 95% occupancy rate, based on no less than a six-month rolling average (despite the 1% “bad debt” odd-ball item).

Only a new building with no deferred maintenance, in a high-demand area, would operate this efficiently.

I’ve been at this a LOOOONG time and I’m just gonna tell you that making the assumption that you can operate this building on this tight of a working ledge, and you’ll be paying twice to own this building; once to buy it and again to keep it. Just saying.

Figure 50/50 on the expenses, including vacancy and credit losses, and you’ll at least break even. If you figure 50/50 and operate it at 38-42%, you begin to actually realize cash flow after maintenance, management, replacements and reserves are taken into account.

One thing. You will find few people who are honest about their operating numbers, for a number of reasons including pride, greed, and abject dishonesty. Few will offer that replacement reserves are as necessary to the long term operation of a building as is having a plumbing system.

Many owners pocket the reserve capital (spend it) when they should be putting it someplace temporarily to collect interest until it’s needed. These are the same owners that are chronically in a jamb; robbing Peter to pay Paul to keep their buildings from falling apart; or to keep their occupancies from collapsing.

I look for these owners and make creative financing offers to them, because I’m frequently their only “bad management” solution.

As a rough analysis, if the GSI is actually $44,838, then assume you’ve got $22,419 as an NOI. Then whatever you have “left over” is actually a cash-on-cash “profit.”

That all said, profits come from other places besides cutting expenses. Profits can be realized from “any” mortgage pay-down, forced appreciation, market appreciation, higher financing leverage, better management/sales/people skills… and simply not going on ego trips by over-upgrading, or over-improving a given property.

I could say a lot more here, but the bottom line is that I feel you’re gonna wish you hadn’t assumed these numbers were true, and based your analysis on them. They might represent a worthy (challenging) goal, but that’s all.

Good luck! I’m cheering you on…! :beer

3

Thank you for the great advice and you assumptions were correct.

Is it always best to figure 50/50 for expenses even if the seller is showing otherwise? It makes sense from your response as sellers can fudge numbers and don’t account for things making the numbers look better.

4

Yes.

A seller’s “job” is to show the most cash flow possible. Part of that will either include underestimating expenses or simply not offering you the actual numbers.

Some sellers will tell you that they are operating their building at something less than 40% of gross. And they might be. However, they’re likely either donating their management skills and/or maintenance labor; and/or not accounting for replacements or reserve costs.

On a smaller building (less than 30 units), it’s very hard for one project to support both 3rd party maintenance and management. There’s not enough units/income to amortize these costs. So the owner will most likely donate his time to the cause.

A problem for newbies, when negotiating deals, is that they don’t fully understand their numbers. As a result they can’t negotiate with as much clarity, or conviction, as to why the building doesn’t make sense until it offers an “x” cap rate at 50% overhead.

In your case, you have a working NOI of about $22,419, based on 50% overhead. However, you don’t have specific numbers to back up the 50% figure. You need to figure out what your assumptions should be when analyzing any deal. Meantime, in order to achieve the same cap rate the seller is claiming you can achieve with his stated 31% overhead, you need a price of around $219,000.

If a Seller is claiming a certain cap rate, I like to use that figure to negotiate the price until it reflects the return I want using my overhead numbers. And I would tell the seller that’s why the price is $220k and not $300k.

Of course you use all the ammunition to justify either the price or the terms you need in order to achieve the return you want. It’s either price or terms. You need one or the other to make the deal work. And of course you keep looking until you find a Seller willing to give you one or the other (or both).

Here’s some (gross) assumptions I make when I analyze a property that is five units or more… Some of these won’t apply to a four-unit project, but…

$ 2,241 Maintenance (5%)
$ 2,241 Repairs (5%)
$ 2,241 On-Site Management (5%)
$ 2,241 Off-Site Management (5%)
$ 1,335 Replacement/Reserves (3%)
$ 1,000 Accounting/Tax/Legal (2%)
$ 3,500 Pool (7.8%) One reason not to buy buildings with pools.
$ 3,750 Taxes (8.4%) 1.25% of Sale Price in CA. This is really geographic-dependent
$ 900 Insurance (2%) Minimum of $3 per thousand of coverage.
$ 1,800 Landscape/Gardening (3.6%) [$150/mo]
$ 1,200 Bonus/Commissions (2.7) 50% commission based on 5% vacancy factor.
$ 1,800 Internet/Phone/Cable (3.6%) [$150/mo]
$ 1,800 Trash (3.6%) [$150/mo] Unless included in water?
$24,951 Total Expenses (56.09% of GSI) which doesn’t include the costs of utilities.

Now, add in the utility expenses.

Utilities:
Gas?
Electricity?
Water/Trash?
Heating Oil?

Hope this gives you an idea of how fast the costs pile up…

Of course the real profits come in reducing overhead, as much as increasing rents, without sacrificing marketability.
:beer

That’s a lot. Hope I didn’t bore you.

5

This helps a lot. Thank you for the response and didn’t bore me. :biggrin

6

Keith,

I was just listening to a local mortgage broker discuss the different types of financing on multifamily properties and what is required and the costs of putting the loans together.

He mentioned that in the higher end deals where you’re going after federally backed funding, the underwriters make assumptions about reserves for future repairs and replacements and will require that reserves be maintained with regular deposits along with the mortgage payment, much like an insurance or tax impound account.

Frankly, this could be a great negotiating tool once you’ve determined that certain costs are built into the price by “force.”

I’ve recommended this elsewhere, but was reminded again that it’s really a great idea to find an aggressive mortgage broker that deals with commercial (multifamily residential) financing and let him tell you what to expect, or what any building you’re attempting to purchase will qualify for terms wise.

An interesting thing the broker told us was that it’s really hard to get good financing on properties under $1M. However, once passed the $2M range, it gets easier, and the loans are nearly always non-recourse. There’s a gillion little exceptions and qualifiers, but the bottom line is that the bigger and more expensive the project is, the more motivated all the parties are to get you financing…

Another little note here that I learned is that you can still get 100% financing on some projects even if it includes Seller financing.

And another really juicy tid-bit is how much easier it is to get “refinanced” on commercial loans as an owner with a successful track record on a given property. So, if you could get a Master Lease on (pick a number) a 100 units for two years, stabilize the occupancy to 95 (or more doesn’t hurt here), you could theoretically secure 80% financing based on the current numbers and perhaps (depending on how much increase you had in rents) pay the seller off 100% with the new financing.

There’s so many options/possibilities with commercial real estate it’s breath taking.

7

Very useful tips thanks for sharing…