Hey there, 👋 Mo here.

I’ve been getting some emails and texts who follow the newsletter to underwrite a deal and give my thoughts.

“Let the people have what they want”

The Process:

I have relationships with brokers who will send me deals on their email list. I buy in North East Ohio.

In order to make an offer on one property, you have to underwrite 50-100 to get an idea of the market.

You also have to do research on local markets.

Research:

For simple research, I read quarterly broker reports of multifamily volume.

I have access to Costar reports so I will frequent those and pull individual reports of properties. Costar is expensive, so this is meant only for professionals.

Calling the cops: I tend to call the cops (non-emergency) number to get a lay of the land of crime. I ask several things

• How many times have you been called to the property?

• What kinds of crimes happen there

  • Property crimes/vandalism I can overlook

  • Violent crime is where I stay away (I’ve learned that lessons)

• Are they able to give me past reports?

• Would the cop themselves live there?

Tools:

You need a brain, Google Sheets underwriting template, basic math skills, a phone, a computer and a lot of patience to buy a real estate deal.

Strategy

Assume we are using a traditional value-add buy and hold method. Assume we are spending $4200/unit to renovate with paint and some new flooring.

This is cheap, but I’ve been able to renovate some C-/D+ apartments for about $3-5k/unit.

Live Example:

This is a 12 unit apartment located at 563 E 118th Street in Cleveland, OH.

Here is what the executive summary is:

High level facts:

1. Asking price of $495k

2. 12 unit apartment building = $41.25k/door

3. 3 fourplexes

4. Brick exterior, vinyl siding

5. 10/12 units occupied

6. Gross annual income is $68.7k

7. Expenses are $25.1k

8. NOI = $43.6k

9. It’s being valued at a 8.82% cap rate

10. Unit mix is 8 1/1’s and 4 2/1’s.

What sticks out is the fact that is was renovated in 2019, which is good to see the owners putting in some time into it.

I see from the map that the property is near the really nice area, but everything in Cleveland is street by street.

Map View

Google Maps is one of my tools in the toolbelt.

I take a look at it and go into street view. The road seems to be all multifamily with the apartments being on a corner lot.

The front of the property on the street view points out a few obvious problems. The apartments look decent, but a couple of the walls in the front are leaning and there’s some damage on the balcony of a few of the units.

The damage on the balcony dictates that there might be more damage on the inside or deferred maintenance, which SCREAMS red flags and $$$$ bills.

The Operating Memorandom (OM)

The OM is where the broker puts together their package to show to prospective buyers (us).

It says that the property is all market rate and no subsidized. That’s good news – if we wanted to put section 8 (good program), it wouldn’t be an issue.

TLDR:

2 beds are going for $600, 1 beds are going for $550. Market rents are much higher than what is in-place.

Assume my strategy here is to place section 8 here. Let’s go to HUD’s database of Small Area Fair Market Rent (SAFMR)

SAFMR is a database from HUD that gives an estimate of top end rents from HUD by zip code and bedroom size.

From left to right it is: studio, 1 bed, 2 bed, 3 bed, 4 bed.

So from this, top end of rent roll would look like this:

($660×8)+($810×4) = $8,520/month. This is HUD and for the top end, so I would assume you’d knock off 10-15%.

10% = $8,196/month

15% = $8,034/month.

Not bad…

However, the broker’s pro forma seems to be less than cheery. I know the area and the 1 beds would probably rent for $650 and 2 beds maybe $750 max.

Local property managers and Rentometer.com would also be great tools to check local rents.

I pull up some comps of apartments for 1 bed and 2 beds…

They seem… to support our thesis with $695-950 on the high end. Make sure you click “exact match”

NOI

Assume 50% of expenses.

Reminder: NOI = Revenue - Expenses.

Att $8k/month in gross rent, you’ll receive $4k in NOI.

Annualized, it’s $48k.

This hasn’t factored in exact taxes + insurance. calculate the new taxes at tax rate (3.5% in Cleveland) and 20-40% higher insurance than current. 

Free cash flow

Free cash flow (FCF) is NOI = mortgage - capex

NOI = $48k

Loan

Assume we put 30% down ($150k) on $495k. Loan is 70% LTV, 8% interest rate, with loan fee rolled in. The lender charges 2% origination point.

Amortization is 30 years (the loan is paid down over 30 years, bulk of the interest is paid up front).

Balloon payment is due in 5 years.

My monthly payments would be $2,600.

NOI = $4k/month

Mortgage = $2.6k/month

Capex = $4.2k ($350/unit/month).

FCF = $4k-($2.6k+4.2k)

FCF = -$2.8k/month or -$33.6k

*$350/unit/month in capex might be light. This is a D class neighborhood and your tenants might run through the property. I would rerun the numbers at $400-450/unit/month.

The final verdict

I would RUN from this property. It’s cheap and doesn’t cash flow in today’s markets. The location is bad so I would factor in higher management figures than what’s quoted in pro-forma and the rents might not be achievable.

Factors

Crime

I’d call the cops – I know this is a bad area, so your copper pipes might get stolen. Your contractor’s car or tools might also get stolen.

High interest rate

I’m running this at 8% assuming long term loan and 2%, you are able to negotiate this. If interest rates were closer to 6%, you may have been able to make it work, but this is how high interest rates are affecting everyone…

High capex

It’s an old building, it will need to be upgraded. You can tell from the photos that at least 2-3 of the units will have damage. I am not accounting for any roof, plumbing, electrical problems at all.

Accounting for this and the deal wouldn’t make any sense regardless.

Management intensive

D area, not great. It’ll involve a certain type of manager who has experience with this property type. Not everyone is willing to take it on.

Not much upside

Frankly, it’s priced too high for the area. $41k/unit is very high for this area and the buyer of this is probably some out of state California person.

You’d need to buy this at 50-60% of asking price for it to make any sense. I’m being very conservative, but this is probably best served by someone local and a knack for handling this tenant class and section 8.

Final thoughts:

Thank you for reading this article! This was a fun article to write and I hope it was educational.

I hope you enjoyed this exercise and are able to apply some of the lessons. This was a very broad brush and quick back of the napkin.

Do this 100 times and chat with brokers and you’ll have an advantage in the marketplace.

Tell me if you’d like me to go over other property examples and if it helps you get a knack for underwriting.

If you’re interested in chatting, respond to this email.

Thank you,

Mo