Hey guys, Mo here

Long time no talk. I had a 162 unit cross my desk. I think it’s quite interesting, so let’s analyze it without further ado.

This is not a solicitation for money and just to convey my thoughts of how I think about a deal like this.

The Deal

It’s a 162 unit “value add” pitched from a big brokerage in Phoenix, AZ. Whisper price is $19mm or “price of debt” according to the broker. The existing lender is willing to stay on and work with the new buyer.

The building was built in 1969 as a 165 unit condo project. 162 units are being sold with majority HOA control.

It is marketed as a “value add opportunity”.

Location:

It’s in a C+/B- neighborhood. It’s in the path of progress – close to the Phoenix medical corridor.

This might mean the average occupant might be either a young professional, traveling medical professional, or a college student who wants cheaper living than on-campus.

Unit Mix:

This is an offering of 162 units total out of 165 units in the complex before. This would mean you would have to try to buy out the existing 3 owners not part of the HOA.

This makes it tricky if you’re selling it as an apartment complex since you don’t own the entire condo. This becomes a fractured HOA situation, so you have to price that in.

Out of 162 units for purchase, 158/162 are studios (98%). 4/162 (2%) are 1 bedrooms.

The average square footage of these is about 415 SQFT. This seems a bit small for the submarket and amenities may not be up to snuff.

In Arizona, I’ve come to realize most renters prefer larger spaces, more amenities, and things like washer/dryer in-unit. Part of the value-add pitch is to add washer/dryer to the units.

You would need to factor in the cost for appliances, installation, and hookups and to see if it would be worth a $100-200/unit premium.

Tenant Mix

With such a small unit footprint, my red flags would be wavering. With 1 beds and studios, you generally have single occupants or on occasion, a couple.

This indicates it’s going to be higher turnover than an apartment complex with 2 or 3 bed units because 1 bedroom or studios are usually occupied by younger people who want to move. They might move in with a S/O or be a little bit more transient.

With single occupants in units, especially at a cheaper price point, you may have to factor in higher turnover and capex costs.

Rents

According to the OM, the average rents for studios are $1027 or $2.50 PSF. For 1/1s, $1275 or $2.26 PSF. The blended rate is $2.49 PSF or $1033.

The units are being marketed as 20% under market per the broker.

Renovation Schedule

Per the OM, 52/162 units are unrenovated and can be renovated for a bump in income.

As a potential investment, I am afraid of over-renovating the units. The risk would be spending too much money in capex and not being able to justify the asking rents.

I would be weary of what renovations were done and how much they had spent on interior vs exterior.

The owner has invested significant amounts of capex into the property like bocce ball courts, new pool decks, renovated clubhouse, new package lockers, and interior renovations like LVP, stainless steel appliances, and new paint on cabinets.

The questions I would be asking myself are:

• Would potential renters be willing to pay a premium for these apartment upgrades?

• How much does it cost to renovate a unit? (My guess is $10-12k/unit)

• How often do renters actually use these amenities?

Supply And Demand Concerns

Phoenix has a huge supply coming online.

Per Kidder Matthews, the average vacancy rate for apartments is 10% and average rent is $1500.

Per KTar News – 2400 units are being built in Downtown Phoenix “putting the submarket in danger of being overbuilt”. Northmarq is predicting 20,000 new units are going to be put up in 2024 across the region.

Buying an older apartment building (1969) means you’ll need to compete with new buildings that are being put up. All these newer buildings are going to offer concessions as a part of their lease up plan.

Concessions = things like free rent or offering money to refer other renters so you would need to factor that in.

A 10% vacancy assumption would be apt, perhaps even 15% during your “midway” column during acquisition.

Aging Building

The building is a 1969 building and it seems like the previous owners had put in a good load of capex. The question that I would be asking is where did these capex dollars go?

From the pictures and the OM, the dollars went to mostly exterior and interior modifications. I would be questioning when the last time major infrastructure upgrades occured.

These would include:

• Roofs

• HVAC

• Pipes

• Electrical

• Asphalt for parking lot

• Concrete for pool decks

It seems like the roof was replaced in 2023. The parking lot seemed like it was a little cracked and would need new asphalt resurfacing.

The building is turning 60 years old in the next 5 years so pipes, HVAC, etc might be up for replacement. Labor for installing these heavy duty items is also aging out so labor costs may also be very high.

Back of Napkin Math

So from the T-3, we’re looking at top line of $1.925mm with a slight increase for T-1 at $2.08mm.

Controllable expenses had gone down from $907k to $707k within the last 2 months. It seems like most of the cuts had come from $50k from payroll (layoff), $20k in marketing cuts, $75k from general & admin expenses, $18k from cleaning.

In non-controllable expenses, your insurance & property taxes would probably significantly shoot up so factor that into your underwriting. I am also curious what the % basis is for management and what duties does management actually perform.

As you can see, the expense ratio has trended down from 60 to 45%. This indicates the value add component could be because of managerial improvements.

My Thoughts

I think at $19mm, it’s priced far too high. That comes out to $117k/unit which does not match the 1% rent to price ratio that I like to seek.

I would assume $1000/month in rents. So $1.944mm in top line revenue (162 units $1k/month * 12 months).

Expenses at 45% for a building this size might be apt, but I am not sure how it is given any looming capital expenditures. I would increase this to about 50%.

So $1.944mm top line * 50% expense ratio = $972k NOI.

I think this deal is worth doing around $14-15mm.

A mid-high 6% cap rate is what I would be willing to pay MAX for this thing.

Main Concerns

The main concerns I have is looming oversupply market for short term and how will you compete with newer buildings.

Debt is also at extreme highs, with agency debt going around 6.5% interest. If you acquire this at anything below a 6.5% cap rate, you will probably have negative leverage and likely not pass DSCR lending tests. The way to offset this would be to put more cash down.

Deferred maintenance would be something I’d be weary of for balconies, pipes, and HVAC. Phoenix gets HOT during the summer and I’m not sure of how many AC units are there and how often they get serviced.

Summary

This would be a good property if you can acquire it for a good basis and be conservatively levered around 30-35% down.

I am not sure if it would be a great cash flow play, but I am bullish in Phoenix in the long term.

Therefore, I’d probably start my offer with low $14mm and see if they would play ball. Given the whisper price of $19mm, I doubt they would give me time of day.

Thank you for reading this. If you’re curious what property this is, email me and I’ll send you the OM. If you’re interested in investing, please email me so we can set up a call.

Looking forward to seeing other deals!

Thanks for reading.

-Mo