if you have a deal where it’s owner occupied in the penthouses and there are other family members in some of the nicer units that command higher rents…how do you factor this in your analysis? do you just consider them vacant?
No, you want to analyze the project, using the current scheduled income, regardless of who’s occupying the building.
The problem comes when you adjust the rents to market value on the previous owners and their relatives.
My experience has been that once the relatives discover that their rent is no longer a ‘deal,’ they’ll bail. However, before they go, they’ll squeal like stuck pigs and throw a fit about ‘something’ you’re doing that is none of their business.
A new owner/landlord is perceived as an unwelcome stick twirling inside their bee hive. You’ve got to be prepared for anything.
Make sure you’ve got clear lease agreements, that show any side agreements between the OS and his relatives.
Estoppel certificates (may be a tad overkill) will reveal any discrepancies from what you understand the agreements should be, and what they actually are.
For example, the OS may have offered his relatives a five-year lease at a substantial rental discount; with non-existent late fees and charges; and no due date.
In that case, unless you can negotiate yourself out of the agreement, and into a new one, you’re stuck with lower rents, and getting your money whenever the OS’s relative feels like giving it to you. Not to mention you’re locked into a certain profit loss for the entire term of the lease agreement.
Confirm the terms of the leases, and make a judgement about the value based on the current performance of the property.
Hope that helps.
Thanks again javipa. The owners relatives do not currently have any leases in place and are not paying any rent. When determining NOI I figured I would put this in as the units being vacant since they are not producing.
Again, you use the gross scheduled rents to determine the NOI. In this case, the GSI includes units that do not produce rent.
However, you’re gonna have a hard time using those effective vacancies to negotiate a lower price/value, because the potential income exists in those units occupied by the OS’s relatives.
Whatever you do, make sure you’ve got lease agreements with ‘everyone’ in the building, BEFORE you close on it. Otherwise, this is going to be a serious management problem for you.
yes that’s correct you do use GPI for NOI, however, what’s the appropriate vacancy then?
Can I assume GPI is gross potential income?
You’ve got to use the existing numbers to determine what the existing NOI is.
In this case, you’ve got non-paying tenants in the building.
In this case, the OS’s relatives ARE part (all) of your vacancy factor.
I’m imagining after discounting the lost rent on the OS’s relative’s units, the vacancy factor is close to zero, because this project is not being treated like a business.
The owners have surely become all chummy with their tenants; the rents are way under market; and nobody is complaining, or moving.
Don’t complicate this analysis.
You’ve got the existing GSI/NOI, with all the non-payers and hangers-on to account for, and you’ve got the potential GSI/NOI with all the non-payers gone.
I would pay attention only to the existing GSI/NOI, and forget what this project might do in the future, in order to negotiate a purchase.
To answer, “What is the appropriate vacancy?” I don’t know what you’re asking.
The appropriate vacancy factor is whatever is happening right now.
If you’re asking what ‘should’ the vacancy factor be?
As far as I’m concerned I want an average vacancy of 5% based on a 6-month rolling average. And vacancy is broken down by location, floor, and unit size when/if there’s enough units to meaningfully analyze.
Going by that rule, if the occupancy is above 95%, the rents are too low for the marketability of the project. If the occupancy factor is below 95%, the rents are too high for the marketability of the project.
Which brings me to another point. Just because the landlord 2 doors away is able to rent a 2/2 for 1,000/mo, does not mean we can. It depends on the overall marketability of each building including its age, location, condition, design, parking, etc.
yes, that’s what i figured. that’s what i was asking…if the nonpaying relatives are considered part of the vacancy factor…i just wanted to confirm.
thanks for the additional info as well…great points.
If your going to make a deal on this property make sure all these relatives are moved out before closing!
You sure don’t want the time and expense of trying to evict after the fact the sellers relatives!
For that matter you should be asking that all non-paying tenants be evicted before closing and financials income / expense should reflect these units as empty / no cash flow!
any harm in having them sign leases and keeping them in?
If they’re willing to pay normal rent on time, it would be fine. My money is betting they’re so used to the gravy train that they’ll think they can get away with the same stuff with you. A personal example is that we looked at a house a couple years ago where the owner felt sorry for the tenant family so they let them stay for free for years. I automatically figured I’d have to evict them if we bought the house. The owner didn’t sellto us. I guess our ooffer wasn’t good enough. They decided to keep the other family in there so they could lose money every month.