With a zero vacancy rate, his rents are low. How low, is a matter of knowing the market rents for similar units (age, quality, location).
Until the project is achieving a 5% vacancy on a 6-12/mo rolling average, the property is NOT running at full operating temperature.
Vacancy averages above 5% mean the rents are too high.
Vacancies averages below 5% mean the rents are too low.
And then we can break it down by unit size, location, and story, to really zero in on the optimum rental rate we need to achieve for each unit type/size we offer.
For example (this probably is not a major deal on 16-units), our first story 1/1’s may show a vacancy, on a rolling, six-month average, of 7%, but our 2/1’s, on the second floor, may show a vacancy on a rolling, six-month average, of 3%. This means the 1/1’s are too expensive, and the 2/1’s are too cheap.
That’s why we analyze the vacancy rates separately by unit type/size, instead of 'raising all the rents by say, 5% across the board.
Our initial NOI assumption should hover at 50% of the GSI. At the current GSI, the NOI comes to $84,000.
Of course, the actual expenses might be higher than 50% of the current GSI, because the rents are lower than they should be.
We would need to know what the market rents are for similar units and then create a pro forma using that data. In the interim, just for giggles, we’ll add 5% to the existing GSI to move the income more in line with market rents (assuming the building needs nothing), since the vacancy factor indicates the rents are too low.
Meantime, our guesstimate pro forma GSI would be $176,000 and the NOI would be $88,000.
Now…here’s the really juicy news.
Landlords with zero vacancy rates, are the same ones that let their rents go stagnant; and are often the ones that are managing their own buildings, and want as little contact with their tenants as possible.
Tenants with bargain rents don’t call for repairs …and will pay their rents on time. Why? Because they don’t want to upset their little bargain-rent apple carts. And no calls and no repairs is the artificial holy grail of amateur landlords.
These are the same owners that let a BOATLOAD repairs go undone, because nobody is complaining …and then get caught with their pants down later, when it comes time to start fixing things.
That’s when a lot of owners decide to sell.
And just to add insult to injury, they’ve been living off the cash flow and have no money to fix anything.
Well, well, well, that’s of course why these owners can tell you, with a straight face, that their overhead is only 25% of the GSI.
Of course it is. Nobody is maintaining the building in real time, or putting away money for routine maintenance, future repairs, and replacements, much less including any meaningful management costs (because they’re donating that time to the cause, and it doesn’t show up on paper).
So, waiting lists and zero vacancy situations are often very good opportunities to buy a bargain, or get bargain terms. Why? Because nobody wants to put up two down payments to buy a project; one to buy and another one to fix.
So, this project is overpriced by my guesstimate by at least 1.5x’s, starting with the overhead projections being unrealistic.
With an actual $84,000 NOI and a 10% cap rate, we’re looking at a value of $840,000.
The asking price we’re looking at represents $140,000/unit…! :shocked
The rents are only $873/mo/unit. You would theoretically need the rents to be at least 1% of the unit price, or $1,400/mo.
But at the $840,000 (10% CAP) price, the per door cost would come to $52,500.
Of course that number makes a lot of sense (at a 10% CAP), but that’s hard to achieve on a building that only needs the rents raised.
Notwithstanding, the owners of this project are hallucinating. As in,
“out of their ever living minds,” kind of hallucinating.
You know how to overcome ridiculous prices on nice properties? Ask for ‘ridiculous’ terms. Why? Because the price makes little difference, if you get bargain terms. The opposite is also true.
Meantime, find out what the sellers want out of this sale, and try to give it to them, and take everything else.
Here’s an example of what I’m taking about and something to chew on.
Could you offer the sellers their current NOI, fixed for say fifteen years, as “interest” on a seller financed loan?
If you offered them full price, and then agreed to pay the ridiculously higher tax bill (based on $2.5M) you would offer zero down, coupled with a 30/yr note, due in 180/mo, with an annual payment of $84,000.
By the time the note comes due, the project may only be worth what you paid, but you pocketed all the cash flow for 15 years…!
The sellers got all the money they’d get if they were operating the property properly (50% EXP of the GSI), without a minute more of management, and you take everything else. In this case, who cares what the price is, the terms made it a bargain. And of course whatever principal was paid down over 15 years is also yours.