Analyze This Apartment Deal

[Fred McIntire]

I'm looking into buying a 10 unit, 1 story apartment building in Indiana. The building is brick and in good condition.

Asking price is $575,000.
Operating Expenses are $1350 / Month
Potential Gross Income of $5450 / Month

If I use a cap rate of 12 percent, I see the property being worth $545,000.

What do the experts think of this deal? How is that cap rate? Your thoughts and suggestions are greatly appreciated.

Thanks!
Fred

[DannyTheGreat]

What is the effective gross income?

How about an itemized list of those operating expenses...

Does the cap rate fit your return requirements and debt service eligiblity?

[LIGHTBEING]

You need to get all the real numbers before anyone can answer properly.  

Based off the numbers you provided NOI = $4,100/mth $49,200/yr (potential)

Debt service on say a 500k loan at 7.5% 30 yr am = $3496/mth $41,952/yr

Cashflow = $604/mth $7248/yr

That is less then $100/unit !!

Also, you need to consider that insurance and RE taxes will most likely go up and cut into your cashflow.  Was this building well maintained?  Does it need any capital improvements, this will also cut into your cashflow or bottom line.  How are you going to manage this?  This could also be an additional expense.

It's typical that those numbers aren't the real numbers - which will cut into your cashflow even more.  It's possible you could break even

Jordan

[LIGHTBEING]

Also, based off the numbers provided ofcourse, and buying this at $545,000, it's more like a 9% cap, not 12%

$545,000 x 9% = $49,050

and after you purchased it ,it will be even less due to the additional expenses I mentioned above.  Maybe a 7-8% cap.

[Fred McIntire]

The expense figures are broken down as follows:

Insurance $3291
Property Taxes $3498
Personal Property Taxes $165
Trash Service $744
Water Softener $1293
Electric $2750
Sewer $3726
Water $640

Total $1342.25

I don't know. This building is beginning to look overpriced and not a good buy unless there is an unseen advantage to owning it.

What should I be looking  for as far as a return goes?

Is this course, Apartment House Riches by David Lindahl, educational at all? Is there a better course to get? A better book to buy?

Thanks for everyone's input.

Fred

[DannyTheGreat]

Fred,

Take a look at the list of possible operating expenses from my post.

http://www.reiclub.com/forums/index.php?board=28;action=display;threadid=23518

There are a number of expenses that the current owners haven't included in their numbers given to you that you WILL have. This deal is garbage unless you can knock that price down considerably. Focus your time on deals where there is room to create value. - Bad management, need of repair, motivated owner, low rents for the market, etc.

[Fred McIntire]

Danny;

Thanks for the input ! It is appreciated. I have saved your list for future reference.

What would you place the value of this property at? How much do you feel that you need to profit from each unit to be a workable deal?

Are there any good courses or books that you suggest? Any other web sites to scour for information or educational materials?

Thanks again!
Fred

[DannyTheGreat]

What this property is worth will be determined by your investment value. What is your required rate of return? How much money or equity will you have in the property when you buy? What's the mortgage constant on the best loan you are eligible for? Do a search for something like "band of investments method" to explain this more.

Cash flow per unit is up to your criteria, I'd recommend you determine one based on what you feel your time is worth. The general consensus among the members of this forum start @ $100/ month and go up from there.

Any book on commercial RE, multi- family properties, property management, etc. should be able to help. I'd give you a list but I'm short on time. Maybe someone else will chime in.

[propertymanager]

Fred,

This is a TERRIBLE DEAL!  

Throughout the entire United States, operating expenses run 45% to 50% of the gross rents.  In this case, operating expenses would be about $2,725 per month, leaving $2,725 to pay the mortgage (P & I) and to provide profit.

A 20 year mortgage for $575,000 at 8.25% would be about $4,900 per month.  This would give you a LOSS of about $2,175 per month!  OUCH!  

One thing is very common with apartment buildings.  The owner almost always overestimates the gross rents and almost always underestimates the expenses.  It is imperative that you understand the real world numbers before you buy anything!

Run far and fast!  This deal STINKS!

Good Luck,

Mike

[Fred McIntire]

I agree. It's a very nice building but overpriced. I am going to move on in search of another deal.

Thanks for everyone's input.

Fred

[Sean_L]

I wouldn't walk away from it. Try to negotiate the deal you want. All they can do is say no. I am willing to bet that if he doesn't sell he may come back to you.

Good Luck

[propertymanager]

Sean,

This property would have to be bought for about $273,000 to make it a good deal.  It is easier to find a real deal than to try to turn a retail sale into a deal.  However, I agree that it can't hurt to make an offer.

Mike

[ChiBroker]

Gross income has nothing to do with CAP, only NOI.  I recently looked at a 3 building medical park for a client with 70% expenses, partly due to 360k/year RE taxes and gross leases rather than net.  If CAP was based on GOI, it would have been a 32 CAP at asking price.    But obviously it wasn't, it was actually a 9.7 CAP after filling vacancies, an attractive CAP for a stabilized office property.

45-50% expense across the US is not in fact standard for multi-family, but it is close.  Here's a realistic rule of thumb for armchair owners employing property managers:

50% cold climate landlord heated
45% cold climate tenant heated
40% warm climate(electric baseboards) and no heating system maintenance

Your deal is in Indiana so here's your scenario IF the property is fully leased with no deferred maintenance:

Landlord heated:  $2,725 mo/32,700 yr
Tenant heated:     $2,997 mo/35,970 yr

Indiana is a secondary market, unless you're downtown Indianapolis, so your upside and exit strategy is only strong performance, YOY rent growth and good management. A 10 CAP is attractive if you have your financing in order (under 7%), but shoot for an 11 CAP or better.   Otherwise, your interest rate +3 is a good target CAP. In a primary market, multi-family in the 7-8 CAP range are even attractive, especially with good debt(prior assumable loans under 6%).  CAP is not the end all unless you are buying all cash.  It's the relationship between capitalization and financing.

So here's what your property is worth at an 11 CAP, in perfect condition, no deferred maintenance, 100% leased and not accounting for vacancy:

Landlord heated:  $297,270
Tenant heated:     $327,000

At the proposed purchase price of $545,000 TH CAP= 6.6%, LH CAP=6.0%.  This is a negative  deal even if the building is perfectly maintained and 100% leased.

[propertymanager]

CHIBroker,

While I generally agree with what you said (in fact, we said almost the same thing), you have certainly managed to take something that is very simple and turn it into something much more complicated.  

What I, as a rental property owner, am interested in is Cash Flow and Equity.  You can either go through all the gyrations that you listed in your post (and still not have cash flow information), or you can subtract the operating expenses and mortgage payment from the gross rents to determine cash flow.  I like to have $100 per unit per month, but a person could go with whatever they like.  

Why is all the rest of that nonsense needed?  Why should I do the additional step of calculating the cap rate?  Why should I "shoot for an 11 cap" instead of shooting for an actual cash flow of $100 per unit per month using 100% financing?   Almost none of the investors on these forums are paying all cash and many (including me) are not using ANY of our own money.  Why should I?

My personal opinion is that all this talk of CAP RATE, GRM, DSCR, etc is all extraneous nonsense.  What really matters is CASH FLOW and EQUITY - whether you have a Duplex (why bother in your words) or a $100 million dollar high rise.

Mike

[ChiBroker]

  All the rest of that "nonsense"? Brilliant Mike, you should market your ideas to investors as a new method of valuation that discards useless indicators like capitilization and debt service coverage ratio.

I guarantee the bank doing your 100% financing 2 flats cares about DSCR, but why should you? You're much smarter than such silly notions and have a brilliant new tool called $100 per unit cash flow.

It doesn't matter, apparently, whether you are paying 10k, 50k, or 100k per unit, as long as you get $100 per unit, right? You've managed to completely eliminate the relationship between price and income with one swift stroke.  LOL.

In reality, Mike, CAP is the simplest way of looking at a property's income.  It is much easier than looking at "$100 Cash Flow per unit." Looking at "cash flow per unit" is like a little kid trying to sound out a word letter by letter rather than just reading the word.  That's the reason behind all the endless "nonsense" about CAP rates.  Of courese I didn't have the cash flow information for the subject property in this post "after all those gyrations".  Neither did you. Why? There's a variable missing:  Input his debt service info and POOF, like magic, there it is.

Why "shoot for an 11 CAP" rather than just figuring out $100 per unit after expenses and mortgage? Because, if you did,  you might stop deceiving yourself as to whether or not your deals are profitable.

The CAP rate is not the "additional step" silly, it's a primary step.  Why should you go through this oh so laborious 30 seconds to figure out a CAP rate? Because $100 dollar per unit doesn't illustrate any relationship between your income and the value of your property.

$100 per unit tells you nothing about a deal.