Multi Property Deal

General Real Estate Investing
1

met with another investor who wants to sell 16 rental houses. He’s 62, has a house in Florida and wants to get rid of his properties and move. I met with him yesterday. He said he would sell them on contract but wants to cash out in 2 years.

I have no idea how to approach this deal and could use some advice. Where do I begin? With the previous deals I’ve done it goes something like this…I get information from the seller, arrange a time to look at the house, and make an offer. He wouldn’t give me any kind of idea about what it would take to buy them. Wouldn’t even throw out a number if I could pay cash what’s the least he’d take for them.

I will be starting to look at these properties. I’m looking for advice on what I need to do to prepare an offer that would make sense.

How do I approach this deal and what kind of due diligence do I perform? According to the seller the properties don’t need much repair with the exception of 2 or 3. I was also given the rent for each property and it looks like the current rent is close to the market rent for this area.

I don’t believe the seller has kept much for records in terms of repairs completed, occupancy rates and that kind of think but will be checking this out for sure.

Could use help with this huge potential deal – Thanks!

2

Brian,
Sounds pretty exciting. Hope this works out for you. When we did a big package deal from a seller, he already had prices on every house. I started by making a simple spreadsheet with columns like:
address, price, beds, baths, sq ft, rent amount, taxes

Then I took a notebook and went around to all of the houses to take notes. We know what we want our houses to look like, so I just listed all of the repairs they would need. I was just doing inspections of each house like I would if I was just buying a single rental. If the seller tells you some repairs he’s made, at least you can check that out and see how well it was done. Otherwise, I’m just looking at things for myself anyway on the houses…

I would rather the seller speak first to put a value on the houses. He who speaks first…loses. That being said, I would put my own value on each house and add them all up to see what the package would cost. Also consider the rents vs purchase price.

I wouldn’t care a whole lot about what the seller has for occupancy rates. You never know how good/bad someone is running their rental business. If there’s an overall problem with rentals in the area, that’s one thing but the guy we bought several houses from would just throw whatever crackhead loser in there that had a couple hundred bucks.

Remember to check if you’ll be paying any utilities on any of them and factor that in too. Usually it’s just an issue for small multi-family buildings, but we actually have a 2br house next to a 1br house where there’s only one water meter so we pay the water on those.

For insurance, make sure your company will insure that many houses for you. We started out using Guide One, but they quit after eight properties. Too bad because they’re very affordable.

If you’re not going to pay cash for all of this, the next thing to worry about after getting an idea on the price is to start shopping that around at some banks. You already have experience, so get all of your finances together and put together a nice little binder of your last 3 years of P&L, tax returns, current income, property portfolio (I like to use MLS listings in my binder), etc. Kill the bank with information. Don’t make them ask you for more. Have it all there for them. It will impress them because most people won’t do this. Our bankers are always impressed that we bring our annual P&L numbers and tax returns in to them without them requesting it. I thought that’s what everyone did, but apparently we’re in the minority there.

Good luck with it!

3

2 years? Really? That’s just like a cash sale. Forget that.

You need at least five years for the properties to either/both build up cash reserves (build up more down payment funds to pay off the seller); to appreciate enough so that you can actually cash out the seller 100% (without having to cough up more cash, or create a second) and not something like 80%; to show a solid, reliable, verifiable occupancy/cash-flow/performance record to negotiate better rates and terms with the bank(s).

Otherwise, your bank rates and terms will be out the roof with only a few months of performance numbers from these houses. Forget that, too.

You need a minimum of 60 months to demonstrate performance, capture appreciation, and pay off seller 100%, or no deal.

If the seller insists on two years… Then say “OK. In two years we’ll borrow as much as we can on these houses, and you carry the balance at zero interest, zero payments for an additional 10 years.”

This way, you’ve got time for the houses to appreciate and/or the cash flow to to increase, allowing you to actually cash the seller out in 10 years without facing a financial crisis.

Hope that helps.

4

Thanks for the responses! I’ve got a lot of work to do in terms of looking at these properties and starting that process.

I will be finding out just how good of a relationship I have with my banker. It might take more than just letting him beat me at golf!

5

Before you waste a lot of your time with all this other research and imagining what it would be like to own all these buildings, find out what the cap rate is. And make sure it’s done properly with estimates for maintenance, vacancy and repairs. This is what banks typically look at because it’s good practice. Then, verify it against his income tax returns for the past three years. Forget about everything else because it makes no sense wasting your time if the cap rate is too low to get the buildings reappraised for 170%+ of what it’s worth today in two years so that you get it refinanced through the bank and pay him out. Talk to an appraisalist in your area that does bank appraisals and find out what would be an acceptable cap rate to get it at the point you need to get it.

All you should care about at this stage is the numbers and if they work for that two year game plan. Then you put your offer down conditional upon due diligence such as home inspections, being able to transfer the insurance over, etc.

6

Thanks davewindsor for your advice. We have moved away from the idea of purchasing all of the properties and just selecting the ones that we feel are best in terms of location and condition. I think that’s more than we want to tackle right now. We are planning to look at the houses that are in the best locations and possibly make offers on those.

Davewindsor…can you give me an example of calculating the cap rate on a house that has a 30K purchase price and rents for $600/month with no repairs needed. Taxes and insurance costs would total $100/month. I’m not familiar with the cap rate.

Thank you!

7

Normally CAP rates don’t translate well in analyzing singe family properties.

The income/expense is too volatile.

For example, a 1 month’s vacancy on one house is effectively a 100% vacancy rate for that month. Annualized, this comes to an automatic annual “average” of vacancy rate of 8.3%. That’s not too bad, as long as you don’t have any additional hiccups, like a stolen a/c unit; vandalism; theft; or a skip on rent. Well, any of these will throw the CAP rate off so hard it’s like pushing grandma off a cliff in a wheelchair.

Notwithstanding, repairs and maintenance costs are not ‘straight line’ predictable. Innumerable variables effect the annual costs, including the original quality of the workmanship, intervening weather occurrences, tenant screening, and acts of God.

Not to mention that the amortization of management and maintenance costs stretches to only one property.

I could say a lot more, but if this were me, and I could afford to consider buying 16 houses, I would rather buy a 16-unit apartment building with one roof, one plumbing system, one manager, etc. and much more leverage.

My first apartment building was 30 units that were 90% vacant, and occupied by several drug dealers. I got into it for $25K and got the seller to finance the balance.

I could have gotten into it for nothing, if I had better known how to negotiate on a non-performing property full of drug dealers (and no operating numbers to review).

Meantime, we leased up the project and created over a half million in equity for ourselves. It was more complicated than that, but the point is, I found a property that had a huge upside; the owner wanted nothing to do with; and was willing to dump it in order to rid himself of the liability.

You could do the same thing.

Meantime, I don’t think it’s wise for you to cherry pick this seller’s inventory. Do you think you’re gonna get the best prices, if you strip out the “cream puffs,” and leave him with the moldy ‘doughnut holes’? Get real (in the most respectful manner possible). :anon

Rather, offer him a “bulk discount” price for the entire inventory.

Theoretically, if you got say a 20% discount bulk discount, and insisted the seller carry the financing 100% for 24 months. Over the next two years, you sell off 80% of the inventory by piecemeal, and pay off the last 20% of the inventory.

Now, within two years, you’ve got 3 properties paid off, and producing rent, and the seller’s been paid off. It’s win/win. (And you’re not having to manage hell holes.)

Just some food for thought.

8

I don’t know what all the expenses are, which is why you need to see the vendor’s tax return. Rule-of-thumb is expenses are 50% of rents. 600x12=$7,200. Half is $3,600. This could be greatly off and that’s why you need to see his tax returns. But, at 10 cap (another rule of thumb) working backwards, you’re looking at $36K per house (10x$3,600). Personally, I wouldn’t suggest offering more than $18K (half that) because you need to reappraise the building for at least 170% more than you bought it in two years for you to get to get a bank refinance to pay him out and I suspect other expenses may be higher. Don’t count on getting higher rents to raise the appraised values; base it on what you know today and think of anything else as icing on the cake.

So, I would offer around $288K conditional on verifying the numbers and home inspection for the 16 houses if they’re all producing about the same income. I doubt you’d get any kind of discount if you pick and choose his best properties and he might even tell you where to go at $288K for everything. But, that’s what I would do. Personally, I think $30K a house is too high and will put you in a bad corner–just too many things can go wrong IMO. But, then again, find out from an appraisalist what you could quickly sell off some of the properties piecemeal if you needed the money–if you could flip some of the properties for more than you bought it for in a short period of time, it may still be worth it, but get some expert local advice on what you could flip these properties for in that area. Find out what your worst case scenario is if you have to quickly sell the project off. If your worst case is you will still make a couple grand, it may be worth it to offer more than $18K a house.

9

As a retired appraiser, there is basically two ways to value a bulk purchase. First is to determine the value based on comparable sales. An experienced real estate agent that has access to 12 months of similar sales in the area off the MLS should be able to give you a price per square foot. Note that there is going to be a price difference between 2 BR and 3 BR homes - so factor that accordingly. For a bulk purchase you should discount the total purchase price between 10 - 15%.

The second, and perhaps the most important, is the income valuation. This has been addressed by some of the previous posts. Lenders are going to look at cap rates. But as an investor, you need to really focus on the cash flow. The 50% rule does not include mortgage payments. Personally, I would create a spreadsheet based on market rents, 10% vacancy, 40% other expenses for two years (add another 10% if you will need a property manager). Then after 2 years figure out the payment on a jumbo mortgage and factor that in. Your minimum target is $100 monthly cash in pocket per unit.

If the property can cash flow well then apply a 10% cap rate and see where you stand. If the owner is willing to take a bulk discount (which means he does not have to sell each home using a real estate agent and paying their commission), this could be a very profitable decision.

10

We looked at 3 of the properties yesterday. 2 of the homes were 2 bedroom and one was a 1 bedroom all on the same street in a good neighborhood. All were in decent condition and didn’t need any repairs with tenants in each. However the furnaces were old in 2 of the 3 houses and the floors sloped in 2 of the 3. A thorough inspection of the structures would be important by someone more knowledgeable then me.

Rents were $425, $425, and $325.
Owner said he’d sell them to me as a group deal for 60K. Owner would sell on contract with 10% down with a balloon payment in 3 years. However, I believe my banker would finance this deal as well and I would get a better interest rate with my banker. (I didn’t ask what interest rate the seller would give me.)

The best I can tell the numbers would look like this with financing with my bank and 10% down.
Down Payment $6,000
Mortgage payment at 6% interest and a 15 year term $421.93
Tax cost each month $120
Ins. costs est. $120

Montly income: $1,175

Expense: PITI $662

Interested in the opinion of you experience investors.

Thanks!

11

You’re at 50% overhead, without management, maintenance, or reserves.

Do the tenants pay all the utilities? If not, that’s more overhead.

And vacancy should run 5% on average.

Meantime the analysis is bass ackwards.

Start with the GSI, then deduct vacancy/credit loss, taxes, insurance, utilities, maintenance, management, and reserves (or just assume 50% of your GSI as your total expenses by percentage), and the balance is your NOI, or what’s left over for debt service.

Monthly income: $1,175
Monthly Expense: -$ 588
NOI: =$ 587

Monthly Debt Service: -$ 422
*Monthly Cash Flow: =$ 165
Cash On Cash Return: 33%

*Assuming you have no vandalism, theft, skips, etc. One a/c compressor theft, and your overall cash flow will be negative for a couple of years.

One furnace replacement will knock out the cash flow for another two years. Two furnace replacements, and a stolen a/c will make sure your overall return sucks drain water for the foreseeable future.

This is a highly volatile and financially risky investment, since the rents are so low, and the financing rates and terms are so stiff.

I’m betting this is not an appreciation play, which means the rents are NOT going up much over time, and consequently, neither is the value. So, whatever you negotiate today, is effectively what you’re gonna have to live with for the entire investment period.

You’d make more money, faster, and more predictably, by moving up a price point, or into multifamily, where the rents are stronger, and the cash flow isn’t as vulnerable to hiccups.

To be fair, any single family investing is more risky than multifamily. SFH’s are just easier to get rid of in a jam. However, you can amortize your time, talents, treasure, and losses, across more units with multifamily, than you can with a house. Even 3 houses doesn’t represent enough amortization of risk (imo).

Hope that helps.

12

Thanks Javipa! You make some great points and I appreciate your analysis. The tenants do pay all of the utilities but you make a good point about how one major expense can change the cash flow. I do believe these houses will appreciate over time though. I’m not as excited with this deal as I’ve been with others, however.

We bought our first duplex and a 3 unit commercial building this past year. Those are working out great for us. This seller does have 2 duplexes and we’ll be taking a look at them also.

13

$20K a house for rents averaging $390 a house?? :shocked Forget that! It’s not just the old furnace that would scare me off in overpriced slum housing; it’s the low rent tenants themselves.

Whoops, I fell in the kitchen, I better call 911 to see if I’m alright. Ambulance attendant shows up and sends the fire marshal over for wasting their time. Fire Marshall shows up and orders 10 grand worth of retrofits. Had that happen before.

Oh ya, we can’t afford new furniture, so we’ll buy those old bed bug filled couches and mattresses off of craigslist for 20 bucks that the garbage truck won’t pick up off the street for free. That’s another grand for spraying the whole house with some kind of warranty. Good luck making a dime off of properties like that. :flush

14

The only way to consider these properties as a profitable investment is to make sure that the tenants are paying market rent. If that is the best you will be able to get, I would bet there are some much better deals out there.

Another option is to find out what is the market value of the property as a SFR rather than as a rental. If it is more than $20k then you could consider selling the home after the tenant’s lease expires. But make sure you factor in the holding costs, agent commission and closing costs.

15

Campbell,

Let me tell you there are better deals out there then that package. I have seen packages of recently rehabbed houses bringing in 700 + rents a month. Depending on the size of the package you can usually close them at 40-50k a group. Of course these property are in lower end areas of a city. These do bring in a 15-18% net yields. The other option you have is get into a higher end property yes it is a lower return but better cash flow. I currently have a property that is producing with a tenant that pays 6 months at a time. This property has had 0 maintenance calls and tenant loves it. I have eliminated property management on this property because tenant takes care of the property. Yes you are looking at higher entry into these at 80-100K with only a rent of 1200 a month this is getting me a net yield of 8-10 %.

16

AREI,

I’m dubious of a tenant willing to pay me six months in advance; never calling me about repairs; and is “happy.”

Of course, he’s happy. I would be, too.

This just screams that my rents are so grossly under market, that my tenants will do what’s necessary to keep ‘that’ applecart upright.

Meanwhile, all rental units NEED regular, routine, maintenance and attention. They don’t repair themselves.

17

Evidence does indicate that “slum” properties do usually have a higher cash on cash return and a larger profit margin. The downside is that these tenants tend to be very hard on homes and they can be a real pain to collect the rent every month. But it is that “risk” that increases the profit margin.

Now take a cheap “slum” house with below market rents and add financially irresponsible tenants and that only spells a financial headache to me.

18

Bad management is bad management regardless of the price point.

Buying wrong, is also a kiss of death.

The primary reason low-end properties are considered “cash flow” plays is because that’s all they’re usually good for.

Frankly, you find investors going in and out of this niche all the time, and going out, because they’re either not skilled managers, or they bought wrong, and couldn’t afford management, or they just didn’t buy enough units to amortize the overhead profitably.

The ones that do well, and stick with it, are the ones that bought right, bought enough units, and applied good management to the business.

The ones that don’t do well, and want out, are the same ones that don’t own enough of these units and/or aren’t good at managing, and/or bought wrong.

Five poorly-managed, low-end rentals will kill the owner. 30 well-managed, low-end rentals, will create a profitable business.

There’s safety in numbers.

How fast you can get to 30, well-managed, well-purchased units, is the key to a reliable, predictable, cash-flow, as far as I’m concerned.

19

Jay,
Very well said. You just described the keys to the low-income rental business perfectly. I wouldn’t recommend everyone get into it, but it’s worked out well for us. Now I’m at the point where I have my “base” portfolio built and I’m looking into doing some other things.

20

Do not get me wrong here a great tenant like this is hard to find. I do routine checks on the property to make sure it is good standings. But, getting a Happy tenant is not hard when the rehab is done right and the property is at the right price point. This property I am talking about is at the high end of rents for the area. Of course the house is worth it so tenant is happy to be in a quality property.

I guess our bottom line is quality over quantity.

Right now we are working at every end of the business from Buying to holding and even doing some selling. We believe in helping other achieve what we have. It is hard to find the right properties for every portfolio but, we have accomplished just that. Our team has dedicated themselves to help all investors in their needs. We have to all build on a solid foundation of knowledge.