First off, thanks for the excellent responses. I appreciate it!
JBaldwin, I ask because I don’t know. I haven’t financed a commercial real estate deal of this size before and though I’ve done my homework, I haven’t approached local banks yet. I guess I look at them as a limited resource and I don’t want to look too much the fool on first meeting. If I’m asking the bank for something that is beyond the pale, I’ll end up a topic of discussion at the next rotary club meeting and I don’t need that. If I need a cash partner, I’d like to know that going in!
Christopher, you have a good point with respect to the utilities. I believe that tenant paid utilities are the norm in the area. I would only meter units when tenants change and I don’t expect the full amount of the utilities to flow through to the bottom line. I can’t say yet what percentage will be realized in the NOI, but my first pass guess is about 50-60%.
When I say I’ve got little cash, I mean that in relation to a 20-30% down payment. I do have 3+ months capital reserves (no tenants / all expenses & debt service). I find it unlikely that I would lose all the rents at once since the units are spread out geographically (same city but concentrated in several different parts of town). A bad tenant or drug dealer problems can’t tank the whole portfolio like they could in a single location apartment complex.
I also have no immediate need for cash flow, so any BTCF that comes in will go into reserves as well, for at least 6 months. I’m actually a pretty conservative fellow, and I believe the riskiest part of this deal will be the first two months of ownership.
Equity, your point is well taken. When I see a deal like this, I also ask myself “Why is it underperforming? What can I do that the previous owner cannot?” and I agree that there must be extenuating circumstances. I believe that in this case there are such circumstances (specifically an absentee owner who purchased as a hands-off investment that has deteriorated because of lack of supervision of his in-house management staff). I will say, though, that I think you’ve convinced me that I might want to do a bit more pre-offer digging.
I assume that you calculated the cash-on-cash return using the encumbered 20% on the cross-collateralized property. I hadn’t really thought to do that but it does make sense. I have invested it, in the sense it can’t be used for anything else.
With respect to the upside, I guess I have to disagree. The upside here is good and I believe is worth the effort. A 6% increase in occupancy, a similar increase in rents and recouping 40% of the owner paid utilities would add about $140K-$160K to the NOI. At a 10% cap, even if it takes 3 years to implement the changes, it’s a decent return. (Conservatively: 35-40% per annum.)
Realize that everything we’re discussing here is in the context of pre-offer due diligence. I won’t know whether I’m right or not about the turn-around possibilities of the property (and the condition, and the expenses, etc.) until I begin due diligence in earnest. That will be a significant amount of work and probably end up costing several tens of thousands of dollars. I just don’t want to be making a commitment in money and time if I’m on a fool’s errand when it comes to the financing piece.
Again, thanks for all of your input. It’s greatly appreciated and has caused me to look a little more closely at the deal in a couple of areas.