How much money do you want to make on your next deal?
And, using reasonable assumptions, how much will you need to bring to the closing table and at what purchase price?
Know the answer to the first question but not the second? Have no fear, a new calculator is here!
Someone asked me yesterday the following question:
“If I want to make $4,000 a month on my next property, how much would I need to raise and what would be the purchase price?”
Well, my first thought is a billion dollar property should cut it. 🙂 But I didn’t think that would be an acceptable answer so REALLY the question is what’s the MINIMUM down payment and purchase price to reach $4,000 a month income.
After doing the math on the back of a junk mail envelope I started talking to my roommate, an Excel and financial wiz. We came up with this handy, dandy calculator.
Using reasonable assumptions like finding a 12% cash-on-cash return property, it tells you exactly what you’d need to buy and how much you need to have in order to create that desired cash flow.
Oh, as far as the answer to the 4k a month question? It’s an $8MM property with cash investment of about $2.4MM using the assumption the deal is syndicated and there is an investor preferred return of 8% and profits are split 50/50 after that.
You can use this calculator if you are syndicating a deal OR if you are just using your own money. If using your own money then make the preferred return 0% and make the Manager cut 100%.
I will always follow the “don’t let a deal die on your side of the table” philosophy. There is really never a reason to not offer SOMETHING to the seller.
Or, at least that’s what I used to think.
This week I was sent a deal for a 351-unit apartment community in Dayton, Ohio. I was told it is a distressed property and only 95 out of 351 are rented. The other units need rehab.
Ok, I’m cool with that. I’ve got team members that can turn that puppy around.
Seller wants 2.8MM for it and it’s been on the market for about a year.
Hmm, ok, something sounds fishy. Why has it been on market so long? But I still moved forward because perhaps it was just an unrealistic seller and now, after having property sit on market for so long, he/she will be more reasonable.
So I offer 1.9MM to get the ball rolling. They counter at 2.3MM.
Hmm, ok, sounds like we’re getting close here. I happen to be in Cincinnati at the time so I decide to take the short trip up to Dayton to view the area and the property. That way I can make a more informed offer.
When I visit areas one of the many things I look for is a McDonalds. And, I want to see how new the McDonalds is. Because if there’s a new McDonalds nearby that tells me some smart Fortune 500 people identified the area as growing. It ain’t the end-all, be-all but it’s a good indicator.
So, where do I begin about this property….
First off, the night before I leave I google the area and there’s a drive-by shooting 2 blocks from the property. And, as I’m driving around the neighborhood of the property there ain’t no Micky D’s anywhere.
So I arrive at the property and notice an iron rod fence that is destroyed. Apparently a drunk driver plowed through it and they haven’t fixed it yet. The most impressive part is the fence is on a 10 foot hill.
Anyway, as I walk up to the leasing office I notice a NO GUNS sign. I’m glad it’s there although later I’d be wishing I was packing some heat. When I tell the leasing agent that I’d like to rent an apartment they tell me point blank “you don’t want to live here.”
Hmm, yeah, you’re right I don’t but I tell her “well, I would like to see what you have available.” They don’t have anything available now but will be able to get me a good deal in about a month. I ask where it would be and they say “we’d put you right next to our office because the closer you are to us the less drama there will be.”
I have a feeling “drama” is code for something.
Still, that wouldn’t deter me from buying the place. As long as the numbers make sense. I know the seller bought it for 1.1MM cash so they don’t have mortgage on it. That means opportunity for me because we could do some owner financing.
Well, turns out they only have 45 apartments leased and none available now because of “renovations.” I tour a “renovated” apartment and…it…is…d.i.r.t.y. They even show me an apartment that just had someone move out – it was TRASHED. I was shocked they would be showing it to a prospective tenant.
The 45 apartments thing is a BIG deal because the 1.9MM offer price was based on having 95 units rented which is what the proforma indicated.
Mentally my offer price just dropped 50%.
At this point I’ve only seen the renovated apartments and still need to get a sense of what the other apartments look like and, specifically, how much work is needed to get them to rentable conditions. While talking to the property manager he lets slip the following bomb:
“The owners live in California and are trying to sell but haven’t been able to yet. They need to figure something out because the City of Dayton just mailed us our last warning on our windows with broken glass. Starting next month we’re getting fined $500 per building for every building with broken glass. There are 49 buildings so that is…(he punches in the numbers on his iphone calculator) a $24,500 fine…per month!”
“Why don’t you just board up the windows,” I ask.
“We’re going to have to but that’s going to cost over $100,000,” he says.
Damn. These owners are in trouble. But still, I’m a glass is half full kind-of-guy, so I see this as opportunity to get a better deal.
So here’s what I know at this point:
– Super motivated owners who are bleeding money
– Management staff that’s not good
– Out of state owners
Sounds like a perfect storm to do creative financing. But, I need to determine one very important thing:
– How much does it cost to rehab the community and how much will I make after it’s done?
The property looked like a Hollywood movie set where they just shot a riot scene and then excused all the cast members for the evening. It needed everything major. Parking lot, roofs, HVAC and everything in between.
I did a napkin estimate of 4M – 5M renovations.
Ok, fine. So what would it be worth after the rehab?
Well, the property is the largest in its submarket and the submarket’s average occupancy is about 85%. That means the much smaller properties are having a hard time leasing and if I have 351 units ready to be rented I’m going to have a VERY HARD TIME (i.e. impossible) renting them out.
It’s called “absorption”. Yeah you’ve got 351 units but that doesn’t mean people want to live in that area! Plus the rents on the existing 45 units were already very low.
I determined that if we did the 5M rehab then it might, MIGHT be worth 8M IF we could get it 85% occupied. And I just didn’t see any way of making that happen.
So, when do you walk away from a deal?
If the seller isn’t realistic about their property’s worth after you do your due diligence
If the cost and time to rehab the property is more than the after repair value
I scooted out of there having learned a very good lesson.
As far as the property goes? If I were the seller I’d recognize I made a bad investment because I didn’t know the area. Because that’s the key to all of this. If the area was ok or growing then you could make it work with a rehab. But the area simply won’t support the amount of rehab that’s required.
I’d actively market it everywhere and tell people to name their price. I’d take whatever I could get. Including, but not limited to, a 6-piece chicken nugget from the McDonald’s in the neighboring town.
Anytime you evaluate an apartment community you need to know the income, expenses and debt service. You also need to get answers to these 11 questions…
Why is the seller selling? 1031 exchange sellers have a completely different motivation level than sellers looking to “entertain offers”. Estate sales are different from someone who wants to retire and move to Florida. This is a critical piece of info that you’ll want to ask at least 3 times because the answer could change the more you ask.
How long as it been on the market? Tells us more about the motivation factor and perhaps if there’s anything glaringly wrong with it
Will owner do seller financing? Ahh, the two most beautiful words in the English language “seller financing.” Get this for every deal if you can. Make the terms so it’s a win-win for both sides.
What is the screening process for new residents? Do they take people out of homeless shelters and give them an apartment? I’ve come across this. It’s ok to do but you just know what you’re getting into beforehand. Or do they have rental history, income requirements, work history, credit score and criminal background check qualifications.
What is the effective occupancy? You and I can fill ANY apartment building so it’s 100% occupied. That doesn’t tell us squat. We need to know effective occupancy which tells us how many of those residents are paying.
What is market rent? What do similar apts rent for in that area.
What is market occupancy? You can get this from the property mgmt. company or broker.
What type of work is needed on the property? Take with a grain of salt. There will be plenty more they don’t tell you that you discover during due diligence.
When was the last time the ac units were cleaned? This question is for when you meet in person. It’s a silly question to ask over email but when you meet in person at the property ask it. If they don’t have an answer that’ll tell you they likely don’t have regular, ongoing maintenance as a priority. That means more money to be allocated in deferred maintenance.
When did they buy the property and what did they pay? Find this out by asking your broker. Tells you what the seller is thinking in terms of what they will get out of the deal.
What kind of financing is currently on the property? If their loan is set to mature in a year then that might mean there’s more motivation for them to make a deal happen vs. a loan maturing in 4 years.
I’ve been involved in many negotiations throughout my career – both in real estate and just general full-time job circumstances. Here are three negotiating tactics that were used against me and worked. Only thing I ask is that you please use the following info for good not evil.
They are so damn likeable
Problem: Do you find it’s tough to negotiate against someone you really like? Boy, I do. It can be awkward at first. Maybe you don’t want to offend them but there’s some serious business that needs to be addressed.
Solution: Stick to the facts. Facts are emotionless. The facts do not have trigger phrases like “this is unacceptable” or “but it’s not fair” or “but I’ve worked really hard on this” or “but I’ve been here so long” or curse words like…well, you know.
When you’re a calculated surgeon at the negotiating table sticking only to the facts – your stance can’t (logically) be disputed.
They demonstrate they have more knowledge on topic than you (and gray hair helps)
Problem: They have more experience in the industry, more knowledge about the topic and are older. And, when they talk it’s clear they know more about the topic than you do. Quadruple wammy.
Solution: First, align yourself with people who can have all the things you’re lacking. Then bring them in to actively participate with you. If that’s not possible, don’t worry because here’s a technique to use regardless of if you have seasoned backup.
Another solution: Think like a lawyer. The opposition might throw a lot at you and, quite frankly, say stuff you don’t understand. Dismiss the irrelevant information (stuff they say to demonstrate their expertise but isn’t relevant to your outcome) and only focus on the outcome. I like to think of me going 1000 mph and all the stuff they are saying are the blurry objects They might say a lot of stuff but only focus on the info that will get you to your outcome. It’s one heck of an exercise in concentration but it works really well once you master it.
They devalue your contribution (ex. payment, time, thoughts)
Problem: “For that price I’m basically losing money on this deal,” says the seller to the buyer. But then the deal goes through and somehow they stay in business and are happy with the transaction. Has that happened to you before? It’s happened to me many times.
Solution: Create a list of 5 reasons why the seller should do the deal. This helps you understand from their perspective why it is favorable. You can choose to bring up those points or just keep them in your head – regardless, once you have that list you’ll remind yourself of the value you’re bringing to the table. They wouldn’t be having this conversation with you if they didn’t agree you do bring value. Whether it’s money or time, you are adding tremendous value to this arrangement and don’t let them tell you otherwise.
What are some negotiating tactics that you’ve seen work?