Beginner multi purchase questions ...

Jay Black

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#1
Hey everyone - I am in a position that I am starting to actively look for a multi unit building and had a few beginner questions.

A unit that I viewed is 2.8M ask and the cap rate is 5.1%. The NOI is 140K and I just found out that NOI doesn't include debt servicing costs (newbie here remember). A commercial mortgage looks to be about 4-4.5% with about 30% down. A 4% that comes out to be about $10.5K a month in payments.

So my question is how the heck can anyone buy this and make money? With debt servicing costs of 10K a month, that eats up basically ALL of your profits. You might be left with 20K at the end of the year - for your 800K investment.

How does this make any sense financially? Why would anyone buy this? Is there something I am missing? Is the be all and end all in the rent normalization or is this just a HORRIBLE deal? The city I am looking in has a few units in around the 5% cap so it seems that it isn't just a one off.

Thanks for any basic info you can give me!
 

Devin Roberts

Devin Roberts - Brent Roberts Realty
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Nov 17, 2015
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#2
Hey everyone - I am in a position that I am starting to actively look for a multi unit building and had a few beginner questions.

A unit that I viewed is 2.8M ask and the cap rate is 5.1%. The NOI is 140K and I just found out that NOI doesn't include debt servicing costs (newbie here remember). A commercial mortgage looks to be about 4-4.5% with about 30% down. A 4% that comes out to be about $10.5K a month in payments.

So my question is how the heck can anyone buy this and make money? With debt servicing costs of 10K a month, that eats up basically ALL of your profits. You might be left with 20K at the end of the year - for your 800K investment.

How does this make any sense financially? Why would anyone buy this? Is there something I am missing? Is the be all and end all in the rent normalization or is this just a HORRIBLE deal? The city I am looking in has a few units in around the 5% cap so it seems that it isn't just a one off.

Thanks for any basic info you can give me!
Lots of bigger players just pay cash or a higher down payment and then they have a lower debt service. Some also speculate on appreciation.


Devin Roberts — Brent Roberts Realty
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Email: Devin@DevinRoberts.ca
 

CorySperle

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#3
Your not missing anything, and to add insult to injury add in deferred maintenance, roof repairs, etc. not on the proforma and the inevitable turnover of 50% of your building when you take over, pay 10K to upgrade and rent each unit for less rent than before. There are many folks who are nodding as they read this.

Multi family is not the sure thing it was with values flat and falling with no short or long term upside on the horizon. Vendors are also delusional on values, but are under pressure these days as their ability to refinance/renew diminishes.

Buy under only two scenarios: The first, buying at a substantial discount where there is lots of value add, for example 30% vacancy and needs $200,000 of work but you can increase value by $500,000 or more short term to get a full stable building.

The second to find one that is already performing well with no deferred maintenance that you can take over and cash flow with a 75% mortgage. *spoiler* these sellers are not motivated.

The first case is like finding a needle in a haystack, the second a needle in a stack of needles. Good luck!
 
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Jay Black

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#4
Hey Cory! Thanks for chiming in - I was hoping you would as I know you have extensive experience in this realm. This unit is in Kelowna to make matters worse. I have heard recently that the multi pricing here is way out of whack.

I will keep reading and learning and I have an agent or two with some feelers out, so maybe something will come along.

Thanks again :)
 

CorySperle

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#5
If Kelowna, then certainly read my other post about artificially high values determined by extremely low (temporary) vacancy and artificially high rents. Not to mention a government that is determined to pound all landlords into oblivion. Pass unless it's really cheap, but way too much speculation/housing laws in Kelowna right now.
 

Jay Black

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#6
Yeah tell me about it. It's pretty bad right now here. Both the city and province are hell bent on bringing down the investors.

Do you know the ballpark lending rates on commercial? My agent was saying 4.5-5% but curious what everyone else is actually getting?
 

Rickson9

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#7
How does this make any sense financially? Why would anyone buy this? Is there something I am missing?

You’re right. It doesn’t make sense. Seller is looking for someone they can take to the cleaners (or for someone get rid of a mistake that they made buying it)

In a way it’s obvious that the product makes no sense: cap rate is the implied return on an all-cash purchase so if it’s not all-cash, a 5 cap with lending rates around 5% wipes out the return

The only way this product makes sense is if there is an opportunity to turn it and raise rents, but that’s another story
 
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Willyboy

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#8
You’re right. It doesn’t make sense. Seller is looking for someone they can take to the cleaners (or for someone get rid of a mistake that they made buying it)

In a way it’s obvious that the product makes no sense: cap rate is the implied return on an all-cash purchase so if it’s not all-cash, a 5 cap with lending rates around 5% wipes out the return

The only way this product makes sense is if there is an opportunity to turn it and raise rents, but that’s another story
That's an important point Rickson. In your opinion how much should the minimal spread between lending rates and cap rates be like if the lending rate was 5% would 6%, 7% or 8% as a cap rate be enough or no?

I did some calculations myself and found out that for the investment to be worthwhile a 3% spread at least would be necessary. What do you think?
 
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ThomasBeyer

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#9
You’re right. It doesn’t make sense. Seller is looking for someone they can take to the cleaners (or for someone get rid of a mistake that they made buying it)

In a way it’s obvious that the product makes no sense: cap rate is the implied return on an all-cash purchase so if it’s not all-cash, a 5 cap with lending rates around 5% wipes out the return

The only way this product makes sense is if there is an opportunity to turn it and raise rents, but that’s another story
That's an important point Rickson. In your opinion how much should the minimal spread between lending rates and cap rates be like if the lending rate was 5% would 6%, 7% or 8% as a cap rate be enough or no?

I did some calculations myself and found out that for the investment to be worthwhile a 3% spread at least would be necessary. What do you think?
Less than 1% in the real world, for large diversified job producing cities.

3% in fantasy land, or in remote risky locations.


Thomas Beyer, Asset Manager, Investor, Community Improver, Author, Father, Mentor www.prestprop.com
 

CorySperle

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#10
Less than 1% in the real world, for large diversified job producing cities.
exactly why you need a REALLY GOOD reason to buy a building these days.. A sharp value add scenario is one of those reasons. The usual story, a standoff between vendors wanting previous years prices however cannot refinance vs. those looking for decent deals.
 
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Willyboy

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#11
Less than 1% in the real world, for large diversified job producing cities.

3% in fantasy land, or in remote risky locations.


Thomas Beyer, Asset Manager, Investor, Community Improver, Author, Father, Mentor www.prestprop.com
Less than 1% is the reality. Understood. but the question is will it be worth the investment in real estate then.

My calculations show with a low cap rate the ROI will be low as well so why bother and buy real estate? Wouldn't a well researched and managed stock portfolio be way better and less headache? all you would need is a computer and your investment is liquid and hassle free. And even if real estate will eventually yield a slightly higher return would it be worth your time and efforts for a slightly better ROI?

I personally find the stock market a better investment or at least as part of a diversified portfolio you can have both real estate and stocks.
 
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adriano

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#12
I agree with Cory that unless you can get a real good deal then why would you get into that for a projected 1%. All the buildings I have bought over the years have always had some sort of deferred maintainence that the realtor tries to tell me won't happen. Remember this is only a quick pay check for the realtor so they always want to try and get you to pay what the market was and not what it really is.
I have walked away from many deals for being too much and I have had them come back a year later and I got it for what actually made sense.
Proceed carefully. Good luck. I hope you find something that works you in the multifamily arena.
 

ThomasBeyer

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#13
I agree with Cory that unless you can get a real good deal then why would you get into that for a projected 1%. All the buildings I have bought over the years have always had some sort of deferred maintainence that the realtor tries to tell me won't happen. Remember this is only a quick pay check for the realtor so they always want to try and get you to pay what the market was and not what it really is.
I have walked away from many deals for being too much and I have had them come back a year later and I got it for what actually made sense.
Proceed carefully. Good luck. I hope you find something that works you in the multifamily arena.
Discussion on a fictitious (or real) $1M invested in an apartment, all cash or with 50% or 75% leverage. Makes sense almost always - in flat and of course, rising markets, which most are by at least inflation. http://myreinspace.com/threads/what-is-better-cash-flow-or-higher-roi.26596/

This was written assuming a 4% interest rate and a 6% CAP rate. Re-run with perhaps 3.5% interest rate and 5% cap rate to see similar, albeit slightly lower numbers.

Thomas Beyer
Asset Manager, Investor, Author, Father, Mentor www.prestprop.com

==> Check out our latest RRSP or TFSA eligible two year investment with a 40%+ yield target at www.investoliver.ca
 
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Matt Crowley

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#14
Less than 1% is the reality. Understood. but the question is will it be worth the investment in real estate then.

My calculations show with a low cap rate the ROI will be low as well so why bother and buy real estate? Wouldn't a well researched and managed stock portfolio be way better and less headache? all you would need is a computer and your investment is liquid and hassle free. And even if real estate will eventually yield a slightly higher return would it be worth your time and efforts for a slightly better ROI?

I personally find the stock market a better investment or at least as part of a diversified portfolio you can have both real estate and stocks.
Yep... but this doesn't register right now. Boardwalk is trading at $42, under $140k / unit and they have a lot of good product and a modest development pipeline. Their average unit price well above that mark. Better value on publics right now...
 

adriano

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#15
I still think in the long run you will make a lot more with real estate than with stocks. I find I have more control on making money with real estate as I can increase values by raising rents and by upgrading property to raise values. When I have people tell me different I have at least 6 of my 8 multifamily buildings that have gained huge value in a reasonably short period of time. For example I have 1 building that I purchased for $900k and 8 years later refinanced it for another purchase and the appraisal came in at 1.8 million. So it doubled. Not to mention I still hold the property and bought 2 more buildings with the increase in value from just that 1 building. At least with real estate you can buy a million dollar investment with 250k but with stocks you can only get 250k for 250k.
Yes I think having both stocks and real estate is a good idea but I feel real estate will make you far more in the long run.
 

Shane564

Shane Melanson, Developer & CRE Investor
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#16
I'll take a bit of different angle on this.

If the Kelowna MF market doesn't' make sense- maybe it's time to look at different markets or, different asset classes in Kelowna.

If multifamily has been bid up (caps depressed and very little upside on rents- if that is the case)- then you can search for the needle in the haystack (as Cory suggested)- or, look at other commercial assets that are not as favorable (as an alternative to just MF).

I'm in Calgary and office buildings are being sold at 35% of what they traded at in '07 (recent transaction- 35M building traded for 9.5M, from a publicly traded REIT). Now, I'm not a fan of Office (for various reasons), so I'm not suggesting this as an investment- I think the fundamentals of Calgary office have shifted- that's another story. But, there are some big players coming from Van to Calgary and buying 10 office buildings at a time. They have an investment thesis - and time will tell if they're right.

That's too risky for me. I would focus more on industrial and retail side, where there are still reasonable buys- 6-7 caps, good cash flowing properties in great locations and tenants that can and will pay the rents. 1 possible alternative.

Getting back to MF for a minute- I've talked with several MF investors who are still able to find properties for significant discounts. How? They are closing fast and have the ear of the MF agents. In any market, there will be sellers who need to move their buildings fast. If you look at Mainstreet's model- they're known for closing fast (deal certainty) and for that, they buy buildings at 10k-30k/door less than the 'market'. Can you do this? If so, you still might be able to find a MF for a price that makes sense (but, it may take time to find).

In my experience, if a property is listed with a broker, in a hot market- you're likely going to be in a bid situation (not good). Depending on what your investment goals are- will determine the type of properties you're looking for. Some investors with 20+ year holding periods, are ok to bid on core assets- because they know they have predictable cash flow and better liquidity and are ok with 4-5% returns.

One last thought. Even in a hot market- deals can be found. The major advantage you have (if you're local in Kelowna) is finding off market properties and pocket listings much faster than an outsider. Too often investors have the grass is greener mindset (me too). I'm taking my own medicine on this and starting to refocus locally in Calgary/Edmonton.
 

CorySperle

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#17
I lost a large deal to Mainstreet so I know exactly what you mean. Good post and lots of insight here. Office is also high risk in my category. Industrial or retail with a strong tenant covenant is a much better bet and is what we are searching for in Kelowna at the moment but the market is quite small. Yes keep digging for multi's and pull the trigger when you find a good one.
 
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ThomasBeyer

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#18
I lost a large deal to Mainstreet so I know exactly what you mean. Good post and lots of insight here. Office is also high risk in my category. Industrial or retail with a strong tenant covenant is a much better bet and is what we are searching for in Kelowna at the moment but the market is quite small. Yes keep digging for multi's and pull the trigger when you find a good one.
Retail highly location dependent and threat of online shopping real, unlike MF or industrial !! I also love mobile home parks - more stable than MF but less forced upside in good times doable.

Thomas Beyer
Asset Manager, Investor, Author, Father, Mentor www.prestprop.com

==> Check out our latest RRSP or TFSA eligible two year investment with a 40%+ yield target at www.investoliver.ca
 
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