Direction on 54 unit REO deal structure

General Real Estate Investing
1

Here is the skinny:

Just acquired 54 Unit Reo for $400,000.

In the process of inquiring on potential partners for renovation… Approximately $180K to $200K

How should I structure this deal? As a limited partnership offering (equity) or mortgage (lender)

Here is the quick proforma if your curious. Estimated rents taken from HUD fair market value for the city and county.

Located on 2.9 acres, 37K sq. feet are rentable

25 1/1 - 532 sq feet @ $506
5 2/1/ - 615 sq feet @ $580
24 2/2/ - 888 sq feet @ $623

1st YR Proforma
Gross Revenue = $366,024
Vacancy Factor (15%) = $55,012
Operating Expenses (47% of Effective Gross Revenue) = $148,722
1st Yr Stabilized NOI prior to Reserves = $162,960

Estimated Value based on 10% CAP rate = $1,631,184

Primary exist strategy: Sell
Secondary exist strategy: Refinance to long term debt

As a side note, I have a loan commitment for $280K. i am putting 30% of the acquisition from my own pocket. interest rate is 7% for a 12 year term.

Thanks for your help

2

Hi,

Here is the Pfhatt!! First I am somewhat confused as at the top you say "Just Acquired" and at the bottom you "I have a loan commitment for $280k" so do you own it now or are you trying to acquire it?

First thing for you is a generic “Estimated Rents taken from Hud Fair Market Value for City and County” is not accurate per say because there numbers are strictly an average for that city or county! You need an actual “Rental Market Analysis” of the quarter mile, half mile and mile around your subject property and you want that data as fresh as possible, within 1 to 3 months!

Never buy property with an assumption of value based on a generalized market report because obviously you can have in one county, say Los Angeles County, both Beverly Hills and Watt’s! And most cities are large enough you can have very good area’s and very poor area’s so taking numbers from a statistical guide is inacurate!

Now so you know, your proforma should obviously have a vacancy factor, but your lender and any investors want to see a 50/50 split of income being half to Expenses and half to Debt service as NOI! If you put anything less than 50% the lender and investors are going to percieve that you are intending to milk the property for cash and that your not putting enough money into maintence and reserves!

I buy a lot of apartment properties, you can not tell me the property only needs $200k in repairs and your purchase price is $400k, it does not make sense as if the property is worth $1.631m and only needs $200k in repairs they can easily get $1m dollars for it right now as a property!

My experience tells me this property needs more like $800k in repairs and remodeling to bring back rentability and restore longevity! A property like this with 54 units and only needing $200k worth of repairs is the equivelent of new carpet, paint and vynal flooring!

If this property is vacant, you will need to draw a permit, if it’s been vacant more than 6 months you will probable need a new “Certificate of Occupancy”!

You can not go the route of mortgage lender (Debt) capital because anyone with any real estate knowledge will want to be in first position and that means raising a bunch of money as debt capital, and then you have monthly payments during construction!

Equity capital is great except you need very accurate numbers, you will need to rebuild a estimated rent rolls, an exceptable expense estimate, an estimated profit and loss statement, put exceptable numbers to reserves (50/50 rule!), and make sure you can support your numbers with an accurate basis, and make sure your area is actually 15% vacancy factor? (Forensic Analysis)

You will also need construction estimates and a critical path schedule! You will need to ask the city if you can work out renting up the property as you complete units (Prefered way) or if they will require you to completely finish all units and final out (Final the building permit and recieve new C of O) before you can start renting units!

With a 15% vacancy factor it will be hard to find investors wanting to get into this kind of a depressed rental market as an investment?

Normal lenders just don’t sell $1.631m dollar properties for $400k so I would go back and look at roofing, insulation, fire doors, sprinkler systems, fire-life-safety issues, mechanical, electrical, plumbing, HVAC, windows, parking, structure, drainage and mold / mildew - Termite and pest control issues!!!

Unless you have done this before it is going to be very difficult to find investors or private / hard money lenders willing to get into this and just because a property seems to be a good deal does not mean it is!

Good luck,

            GR
3

I forgot to mention, I put the property in escrow. Have not done a complete renovation analysis. I will be doing that this week. Obviously, if the renovation costs exceeds ROI and feasability, I will cancel escrow. I just wanted an opinion on structure because all my current assets in my portfolio was purchased with my own capital.

As far as market rents, it has been verified by a local property manager in the area so it is in line with the Hud estimates.

I will get a good handle on renovation costs by the end of the week and revisit this topic.

Thanks Goldriver

I have the capital to purchase the property outright but i want to use as much leverage as possible. My expertise is in hotels but this too me if the renovation numbers are inline is good hidden deal.

I am familiar with this property because this is the location where i was raised and i go there often.

The 15% vacancy factor is an estimate i put in to be extremely conservative in my revenue estimates. I did not want to put 5% factor. I wanted to see on an extremely conservative basis, will this property be servicable.

Quick question:

Can you elaborate more on 50/50? Where 50% is for DSC and 50% for Operating expenses. I never had that experience in investing in other asset types. I thought it would be similar for apartment.

4

One last note. The property has been vacant for two months. Lender took it over in early november at a 50% occupancy. The previous owner was out of state and had bad management and declared bankruptcy on his other deals that he could not support this one appropriately. Spoke to the lender, it was cheaper for them to shut the property down versus hiring a property management firm to manage the property.

I will get a better handle now the property is in escrow to see if this truly is a deal of a lifetime. Who knows. They do happen believe it or not. Hard but not impossible.

Yuhanna

5

One last thing Goldriver, for vacant apartments, how do you analyze rent rolls? There are no historical rent rolls to analyze. I can do an estimated rent roll analysis based on market assumptions but am I missing something?

Thanks

6

I think it’s a mistake to analyze your numbers with the assumption that you’re going to operate at a 15% vacancy factor. If you actually realized a 15% vacancy factor, there are two things potentially wrong…

  1. Rents are too high for what you have to offer.
  2. Refer to option 1.

BTW, how would you attract any money to this deal by making these kinds of assumptions?

It’s better for you to underestimate the rents, overestimate the expenses, and finally show a 95% occupancy rate, than to overestimate the rents and claim a 15% vacancy.

54 units for $400k is $7,400/door. If the rehab costs are only $200k, as you say, than the per door cost is about $11,100. If that were really all there was to it, then this would seem like a steal if the actual rents were something like $500/mo.

I think Gold River has it right. This building has something MUCH more going against it, then is advertised. I’m suspecting a lot of deferred maintenance, obsolete design, area vacancy factors over 10%, and an economically depressed area to start off with.

What is the GSI? What is the projected NOI? If the NOI isn’t hovering around 50% of the GSI, something is wrong.

How old is the building? What the unit mix?

7

You have made a great point. Even after discounting market rents by 20%, reduce vacancy factor to 5% and OE to 48% of revenue, NOI is still $129,599 prior to DsC.

Unless I discount market rents by 40%, I don’t see from an income standpoint how the property is a loser. From a ROI standpoint in terms of renovations might be a different story.

The property is situated on 2.918 acres occupying approximately 127,120 sq. feet. The
property was constructed in 1943 and has pier and beam foundation. The collateral is wood frame constructed. The walls are brick veneer and roof composition is pitched shingle. Each individual unit is separately metered for electric and water. The collateral consists of 10 buildings occupying 2 stories in each building. There are 40 available parking spaces.

Each unit consists of dishwasher, disposal, washer and dryer hookup, air conditioning, carpets,
drapes, blinds and walk-in closets. The units are not central air but the positive is each unit is individually metered so it won’t impact utilities cost.

This is a working class neighborhood so modern design technique is not the primary driver.

We will see.

Thanks for your post. The renovation estimate will give me a really true picture.

8

What were the repair/remodeling estimates?

9

I negotiated the purchased price to $300 and the repair cost via my contract to bring the property to code is $415,000.

I have also had a better idea of going rents and occupancy in the area from a local real estate agent and redid my proforma based on those numbers. 3 apartment complex in the area have 95% to 100% for the last three years.

Average rent for 1 br/1ba is $450
Average rent for 2 br/2ba is $575

So GPR is $325,680, OE is $149,270, NOI is $163,546 on a 54 unit. Value @ 10% CAP rate is $1,635,460.

Yuhanna

10

Hi,

My gut tells me looking back on your original figures that you have not deducted a vacancy factor from your $325,680 GPR, then your expenses including reserves should be exactly half of your adjusted GPR, which leaves your NOI exactly half of adjusted GPR.

A conventional lender, a private lender, a hard money lender or investor will take your numbers and adjust it to the 50 / 50 rule which says in commercial investing half of revenue goes to expenses and reserves and half to debt service and cash flow!

The reason this rule is used and I said before if you take more than 50% of adjusted GPR and apply it to debt service and cash flow the lenders and investors believe your not keeping adiquate reserves to cover appliance replacement, repairs, new roofs, landscape, etc.

When you show any number that is not 50 / 50 lenders and investors believe you don’t know what your doing or you intend to suck cash out of the property and let repairs and replacements suffer!

Now once you figure out your vacancy factor and there has to be one, then split expenses and operating income you can then factor it by a 10% cap rate!

If repairs are $415k then your going to have overhead and debt service while remodeling so you have to calculate everything!

Good luck,

             GR
11

I have included a 5% vacancy factor with a 10% reduced rate from the market rate as my assumptions. the operating expenses are currently at 48% of Gross Revenue. I have calculated Reserves to be 9% of NOI.

I would like to send the proforma for your analysis if you like.

As far as debt payment during renovation, I did not calculate that. I need to calculate that in the holding cost analysis.

thanks