I cut to the chase, and assumed a 50% basic income/expense ratio.
I took into account the stated 25% vacancy rate.
The return is good even with the terrible occupancy factor.
I’m guessing this is an old property in a C minus area and it’s management intensive. So, the management costs will be atrocious in return for a 9% return, before taxes, on an as-is basis.
If we achieve an average 5% vacancy factor, on a six-month rolling average, even if we have to offer lower rents, the return will be significantly better.
For example if we have to lower the rents by 10%, or -$2,400/yr, to get a 95% occupancy factor, our GSI will fall from $24,900/yr to $22,410/yr , but our pre-tax cash flow will go from $2,801/yr to $6,536/yr, for a higher annual pre-tax return of 21.8%
If this property cannot be stabilized to achieve a 5% vacancy factor (without a major rehab job), I would stay away from this deal. It’s too much work, for too little money, for too long a time, and with too much money down.
I would rather leverage into a $300k property, with a 25% vacancy, with my $31,000.
That said, if increasing the occupancy on this project by 20% was possible, at this purchase price, we would fill the building as fast as possible, stabilize it, and then sell the thing asap. We can make MUCH more money flipping this, than settling for $5k a year (with $30,000 buried in the thing). But that’s just me.
Let’s examine the pro forma analysis.
The GSI is down 10%, but the occupancy is now 95%; the cash flow is double what it was; the annual COC return is 21.8% instead of 9%.
NOTE: The pro forma expenses are based on the “new” GSI, not the current one. We could use the current expenses (45% of old GSI, not including vacancy) and the return would be slightly less.
However we like to base expenses here on a 95% occupancy factor for our purposes, to keep things analytically consistent.
This issue is verifying the seller’s numbers. If the seller has recently rehabbed the property (how much is a key), or the property is new …the 50% income/expense ratio maybe too conservative. Here’s a summary of the analysis.