Advice - First Commercial Deal - Small 8 unit apartment building.
Looking at an 8 unit (all 1 bedrooms), apartment building. They’re currently renting for between $575-$675/month and cap rate is about 6.5% but rents are low so you can improve that number a bit. I have an 8 single family portfolio and am looking to break into apartment buildings. They want a signed contract before we can view but I think that’s fairly normal. Still waiting for full financials. Any advice for first time deal? Process I should follow etc? 

I’m a licensed agent and extremely well versed in construction having completed multiple renovations alone. Will likely inspect the property myself structurally/mechanically but what other due diligence should I perform?

Any thoughts for financing as well. Assuming I’ll end up with some 25yr amt, variable/5year loan. 

I know...didn’t wanna be that guy asking for advice from the masses but it doesn’t hurt.
[{"id": "gublxgp", "text": "Make it subject to Environmental Phase 1, plus contact your insurance broker right away.  Multifamily is getting really hard to insure, especially older stuff.\n\nFinancing is always harder and more complicated and takes longer than you think it will so make sure you give yourself time for subject removal.", "replies": [{"id": "guc1qw2", "text": "Why is older multifamily getting hard to insure?", "replies": [{"id": "guc6rnj", "text": "Brokers are telling me that basically insurance companies lost so much money on wild fires and hurricanes in the last few years they are cutting back on the riskiest policies, and that means condos (floods) and older rentals.\n\nNew and fully renovated buildings are not so tough to insure.", "replies": [], "depth": 3}], "depth": 2}, {"id": "gudd4l7", "text": "Sounds like I should know what environmental phase one is lol", "replies": [{"id": "gudm83w", "text": "A Phase 1 is a questionnaire (for the seller) and historical study of the property\u2019s use. The principles behind this are so that you\u2019re not buying an environmentally contaminated site that may require remediation. Basically, you want to know if the soil has been contaminated. If it has, you will be partially or fully responsible for the clean up, which could include demolition of your building.", "replies": [], "depth": 3}, {"id": "gudox7n", "text": "You may need one for your bank loan, if so make sure you go through their process and do not order one directly or you will wind up getting two.  Also ask them if they have one already as you can typically get it 'updated' and addressed to you which is much cheaper than someone else doing a new one.  Also depending on what it says many people just skip them.  It is mostly based on history and observable issues, so if you have one for 5 years ago and it was fine then and nothing weird has happened its probably fine now.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "gubozoi", "text": "Best of luck! I just got my first MF building under contract this week too. A 9 unit. So going through allot of the same things.", "replies": [], "depth": 1}, {"id": "gubpezn", "text": "I just closed on an 8 unit. Go see it first. Get all the usual financials. And aim for a 4%~ rate with 25 year am, fixed for 7-10 years with a local credit union. \n\nRun comps on what market rate should be, get current lease copies, and evaluate unit condition to decide what rents are currently possible and what terms you might be inheriting. Then have fun!", "replies": [], "depth": 1}, {"id": "gucc3dv", "text": "What part of the country are you in for cap rate to be 6.5? In Alaska the cap rate are 8% but we probably do not have the competition that you have.", "replies": [{"id": "gudl7zv", "text": "Nor population growth! Are you long on global warming?", "replies": [{"id": "gufvqeq", "text": "I think there will be no better place then Alaska for globally warming. But I am thinking about moving to Reno part time to sell commercial real estate.", "replies": [{"id": "gujiptn", "text": "I visited Alaska about 7 years ago. It was absolutely amazing and breathtaking. Because of the glaciers expanding and contracting, I asked many Alaskians what they thought about global warming. I couldn't find one person who believed it. I live in California, btw.", "replies": [{"id": "gujjkfc", "text": "I believe in global warming. The Glaciers that you looked at our melting away as we speak", "replies": [{"id": "gujrcbc", "text": "when I was there, I saw one piece as tall as our ship (14 stories) break off into the water.", "replies": [{"id": "gul36d6", "text": "That\u2019s crazy it must been Quite the experience", "replies": [], "depth": 7}], "depth": 6}], "depth": 5}], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "gucq2nr", "text": "A few questions... Where is the deal located? I\u2019m looking for general area, not specifics. At an average of $625 per month and a 90% occupancy rate, you\u2019re talking about a $460k deal. Am I close? To get financing, you\u2019re probably going to need a DSCR of 1.2-1.3x. So, your equity need is pretty substantial. Say 35-40% down at a 1.25x DSCR. This means your cash-on-cash return will be negligible. \n\nWhen someone says their rents are under market, that\u2019s a very sharp double edged sword. You have room to go up, but you also face exodus of the tenant base as you try to raise them. Then what? You\u2019re going to experience turnover costs, and those can be hefty. Maybe as high as $5,000-10,000 per unit. Are you prepared to spend that all in the next 12 months while you \u201cright size\u201d your rent roll?\n\nOne beds are typically a place for transient tenants. That is not always the case, but it\u2019s generally true. So, turnover is higher. I\u2019d budget at least 50% annual turns with a cost per turn of $1,500. \n\nHow is the physical plant? Roof, windows, fa\u00e7ade, kitchens, baths, doors, floor coverings, paint, drywall, HVAC? What type of HVAC does the property have? Boiler baseboards with window shaker A/C units? Central heat and air? Who pays for the HVAC? Parking (quantity and surface quality)? Who pays for all the utilities (including water)?\n\nAre the entrances motel style, common exterior hallway, common interior hallway? Is the building all ranch units, stacked flats, townhomes?\n\nWhat\u2019s the current tax value? What is that in comparison to the proposed acquisition price? Have you taken the increase into consideration and how it impacts your cash flow?\n\nAre you buying the asset strictly because your proposed new rents are what make it sexy? Does the financial performance of the asset hinge on those rental increases? \n\nConsider the current economy in your perspective as you evaluate this deal. Take Covid out of the equation. Where are we in the economic cycle? Are we at expansion or contraction? How long have we been at that phase? How long does each phase typically last (historically)? Is it a seller\u2019s market or a buyer\u2019s market? (Spoiler alert: you\u2019re 13 years into a 10 year cycle.)\n\nRemember what the Oracle of Omaha says: \u201cWhen the masses are greedy, be scared. And when the masses are scared, be greedy.\u201d What are the masses doing right now?\n\nGodspeed!", "replies": [{"id": "gucvhq0", "text": "Greedy masses", "replies": [], "depth": 2}, {"id": "gucyw65", "text": "This guy knows what he's talking about. All critical things to consider!\n\nA 6.5 cap for 1 bedroom apts renting under $700 seems way overvalued... Buyt we don't know the market you are looking at.\n\nAlso, who doesn't let you view a multifamily property without a signed contract?\nI've never seen that, but I guess with a \"soft\" contract it's not horrible.", "replies": [{"id": "gudd2kw", "text": "Yeah. I thought at least a LOI was pretty typical. I\u2019ve seen the whole \u201cexecuted contract before any showings\u201d more and more lately. Even in the single family market.", "replies": [{"id": "gudpmfv", "text": "the average small unit deal I've done similar to what you are talking about in Ohio we received multiple offers on and basically disregarded anyone who didn't follow our instructions as a difficult buyer or an inexperienced one.  I'd suggest doing what the listing agent suggests as long as you can keep appropriate contingencies.  You should be able to view pics of a unit and walk the grounds/halls to get a feel for condition.  Adjust during DD if needed.\n\nMake sure you review all leases, tax returns, etc and project your own proforma based on actual quotes etc.  Also make sure you adjust taxes, they will adjust to your purchase price in ohio.  Sometimes if the current assessment is way off this can make a big difference and many sellers/agents will use the current taxes vs the projected taxes in the proforma, which is wrong.", "replies": [], "depth": 4}], "depth": 3}, {"id": "gudok3p", "text": "&gt; Also, who doesn't let you view a multifamily property without a signed contract? I've never seen that, but I guess with a \"soft\" contract it's not horrible.\n\nvacants only until contract isn't abnormal here.  That wouldn't bug me much.", "replies": [], "depth": 3}], "depth": 2}, {"id": "gudcobx", "text": "Is your cost/turn basically lost rent + fees property manager would charge to backfill?", "replies": [{"id": "gudlnyw", "text": "My cost per turn is lost rent, hard costs to get the unit rent ready (carpet, paint, repairs, upgrades, new locks, etc.).", "replies": [], "depth": 3}], "depth": 2}, {"id": "gudgyte", "text": "I\u2019d say I\u2019m interested in it to break into the commercial world, it\u2019s in my price range, And I\u2019m familiar with non-business tenants so it\u2019s more comfortable. I\u2019m not banking on the rent rolls increasing but will also not go in at asking price. Condition of the property looks good but again, need to see in person. \nI\u2019m looking at it as this: if I can pick up a small apartment building that manages itself and cash flows another 20K/year; that\u2019s easier (in my eyes) than acquiring another 4 single family homes in the market I\u2019m in (assuming $450/month cash flow) because non-investors are driving those prices way up and hard to get them. I know, there are a million different strategies. Small apartment buildings don\u2019t go up for sale often here.", "replies": [{"id": "gudlcbx", "text": "There are a lot of unanswered questions from above. I\u2019m not trying to rain on your parade, but everything outlined above is just a start to what you need to think about. Otherwise, you\u2019re setting yourself up to be whipsawed. \n\nIf you\u2019re paying cash for the asset, and these items above aren\u2019t considered, you\u2019re better to hold your cash than invest in this deal. Cash in the bank isn\u2019t going down. It may not go up by much, but it\u2019s not going down. Without a really good understanding of what I\u2019ve asked, the likelihood that your investment will go down is very high. So, cash with negligible growth is better than a loss in a real estate investment. \n\nWhen everyone is chasing what you buy, making it very challenging to acquire it, that\u2019s a great sign of market cycles. It\u2019s telling you to hold onto your cash because a correction is coming. Corrections are great for buyers and terrible for sellers. That\u2019s a buyer\u2019s market. Right now, you\u2019re in a seller\u2019s market. Not a time to buy.", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "gud2tzh", "text": "Commercial lender here. My insutition would be 25% down, 25 year amortization, 5 year fixed term at 3.3 to 3.5%. 7 years in something this Small is generally pretty tough to justify.  Cap rate seems pretty low. One bedrooms I'd imagine would be high 6's low 7's for this market. Class A buildings that are new construction (under 30 years old) are trending in high 5s, low 6's. Thing to remember is since cap rates are historically low you are buying at the top of the market. Run some cap rate scenarios where cap rates increase to 7 and 8 and where that value leaves you. Depending on the lender, they might require you to right size the loan if they find themsleves at a 80% LTV when the market calms down.", "replies": [{"id": "gudl4hu", "text": "Do you lend in TX?", "replies": [{"id": "gudpyfn", "text": "Unfortunately no. We only lend in south eastern Wisconsin", "replies": [{"id": "guhlkp2", "text": "My company has lenders in TX depending on the type of project you're looking for. DM me.", "replies": [], "depth": 4}], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "gud3lb1", "text": "6.5 is very low considering the capital and time you\u2019ll need to get rents up and continue to manage it. You\u2019re close to national credit tenant / NNN lease cap rates there. \n\nI wouldn\u2019t sign a contract yet. Maybe give them an LOI, or at the very least make sure the termination clause is in your best interest prior to signing. There may be terms you want changed/added etc. after seeing the property.", "replies": [{"id": "gudh9bn", "text": "Meaning NNN rates are lower bc you\u2019re getting less rent bc tenant has to maintain everything right?", "replies": [{"id": "gudrqc2", "text": "It's apples to apples because cap rate is based on net operating income which takes all the expenses landlord is responsible for out of gross rents which doesn't need to be done for net rents.", "replies": [], "depth": 3}, {"id": "gudus4f", "text": "CAP rates make investment properties as close to apples to apples as you can, so I was saying 6.5% seems like a pretty low cap rate for an apartment complex, usually (at least in my area), they are higher. \n\nIf you\u2019re in like southern CA, maybe 6.5 makes sense. Mid Atlantic, not so much. \n\nEven though cap rate is based on the NOI that would include management expenses, it doesn\u2019t take into consideration soft costs or opportunity costs, like your time (selecting a management company, etc.). You also need to consider your time/sweat equity/additional capital to reach the potential upside you are expecting. \n\nThey absolutely shouldn\u2019t require a signed contract prior to showing it. An NDA for the financials? Sure. But not a full contract. Price and terms could change once you see the inside. \n\nYou also might want to bring a contractor to get an estimate on refurbishing them so you have a ballpark price on fixing them up to get higher rents, and can get a better idea of the NOI over time.", "replies": [], "depth": 3}], "depth": 2}, {"id": "gudr3vc", "text": "Good national tenant NNN caps are way lower. Insane compression right now with an over abundance of buyers. Source just sold a 7-11 for a 4.65 cap in Utah, a Panera bread Corp guarantee in NC for a 4.9 cap...", "replies": [{"id": "gudty0b", "text": "I know there can be lower, but I see 5-6%\u2019s PA-DE-MD-VA and nearby others pretty consistently. From dollar stores to auto related retail, restaurants usually on the low end of that, but still. \n\nWhen you can get a dollar general for 6% cap it\u2019s hard to justify the landlord headache at 6.5%. \n\nAlso OP is hoping for upside potential, but will still need to consider additional capital and/or sweat equity to get there.", "replies": [], "depth": 3}], "depth": 2}, {"id": "gujrxuv", "text": "I am not sure the question was ever answered on where (what State or part of the country) this property is located. To say 6.5% CAP is very low....I would have to say, you definitely aren't familiar with units in CA. Units are selling here for 3-4% CAP....I've seen deals as low as 2.5% CAP. I also am not seeing many NNN deals above 6.5% unless you are talking about Dollar General or non nationals. I was seeing QSR's in Oklahoma for 4%!", "replies": [{"id": "guluc36", "text": "I shouldn\u2019t have assumed locale. Mid Atlantic, 6.5 for apartments is low. But I know it\u2019s very different in CA", "replies": [], "depth": 3}], "depth": 2}], "depth": 1}, {"id": "gud42rq", "text": "For larger deals it's normal to require a signed LOI and demonstration of funding before due diligence. I don't have to tell you this but the offered CAP rate usually tries to paint a best-case picture and if it's based on Y1 projections may have some of your upside priced in. I recommend sharing the balance sheet with some local owners and investors to see if any line items are missing or appear incorrect. In your actual due diligence it's worthwhile to ask for some prior year and current invoices. This might seem nit picky but it's a good way to understand how expenses are trending and what can impact big swings. I'd stay away from percentages when underwriting vacancy/downtime and bad debt and use whole units in a deal this size.", "replies": [], "depth": 1}, {"id": "gud8idu", "text": "I was under contract for a similar property last year, but I terminated the contract due to a combination of consistent seller mis-representations and the lockdowns that were just going into effect.\n\nMy lessons learned:\n\n1. Don't trust any pro-forma numbers they give you.  While I knew this going in, the misrepresentation was shocking.  In my case, they represented property taxes at $4K/yr, conveniently ignoring that they had recently gone up to nearly $12K/yr.  Only trust source documentation for your numbers.\n2. Get to know the property manager currently managing the place (assuming there is one).  They'll want your business, and are likely to tell you more about the tenants and the building than the current owner is.  \n3. Start conversations with lenders and insurers early.  The deals you get will likely vary from what the current owner is paying.  The lending terms varied considerably between providers, and not just on the financial terms.  Would you rather have a 20% down loan that you're personally guaranteeing, or a 25% down non-recourse loan?  Start finding out what your structuring options are now and pay attention to the non-financial components too.\n4. Understand the insurance policy you choose.  All of my cap-rate assumptions were based on an insurance product that met the lenders requirements, but barely provided any coverage.  It may be worth paying more for better insurance protection.  Make a point to understand the trade-offs you are making.", "replies": [], "depth": 1}, {"id": "gudccbq", "text": "Wow thank you all for the feedback. I\u2019ll add some details for additional clarity. \n\nThis is located in the Northeast Ohio Market. \n\nThe 6.5% cap rate includes the costs of their property management company who said they\u2019ll stay on board if I\u2019d like them to. I\u2019d consider managing the property myself. \n\nSome of all your guesstimates are close. Asking price is 400K. \nAgree on the rent rolls. Even for single family I will be more conservative and typically have tenants stay much longer. \n\nThe building itself looks like it was pretty well maintained. 7/8 units have been recently updated. Can\u2019t comment on the other improvements needed until I get into the place.", "replies": [{"id": "gudn7da", "text": "When was the building built? I know NE Ohio very well. I used to own 400 units there. \n\nFrom everything you\u2019re telling me thus far, you\u2019re buying WAY over the market. At least 200 bps over the market. At least. \n\nYou need to budget $3,000 per unit per year in operating expenses. That may be high, but it\u2019s not ridiculously high. \n\nPlease, PLEASE, reach out to me before getting hurt here. I may know the asset, the market, and even the owner. I\u2019m afraid you\u2019re going to get really hurt on this deal because your assumptions are painfully in error.", "replies": [], "depth": 2}], "depth": 1}, {"id": "gudltrz", "text": "Lawyer here. We see tons of deals with money hard on day 1, it\u2019s a sellers market for good MF right now. But that doesn\u2019t mean this is a good one. Are you using a form PSA? Or custom?", "replies": [], "depth": 1}, {"id": "gudy6au", "text": "It is an advantage for you to be a licensed representative and to have knowledge of construction. I recommend you to do good research on credit. Being patient and analyzing the conditions well will bring success. Good luck", "replies": [], "depth": 1}, {"id": "gufkgph", "text": "I am not sure what State you are in, but here in CA, the only thing making an 8-unit apartment building different from a 4-plex is the loan (commercial loan). You should be able to get a 5 yr, 7 yr or 10 yr adjustable with 25 yr amort. Other than that it is really all the same. I doubt the lender will require a phase 1 (which is common on most commercial deals) and with the number of units, I doubt you are legally required to have an onsite manager. Main thing is make sure all improvements were made according to code. I sold a 15 unit complex in Inglewood and the presale inspection by the city flagged a unit as a \"storage room\", so the seller had to convert it back. Good luck.", "replies": [], "depth": 1}, {"id": "gufksjx", "text": "In regards to the \"low\" rents....if the property is in a state like CA, you are screwed as the State now has rent control for all buildings more than 15 years old. Different cities may have even more stringent rules. I would definitely verify city and State law regarding rental increases as well as eviction moratoriums thanks to Covid.", "replies": [], "depth": 1}, {"id": "gug0i61", "text": "You stated,**\" cap rate is about 6.5% but rents are low so you can improve that number a bit. \"**   All a 6.5% cap rate means is that the seller wants you to pay him $15.38 for each possible dollar of NOI.  It is a valuation metric, not a \"return\" so you will not \"improve\" that number!  But you need to know what similar properties have traded at.  If they have sold at a 7% cap then you are overpaying $1.09 for each dollar of NOI.  Is that a plan?  Sounds like you are going to be scammed on the purchase price.", "replies": [], "depth": 1}]