I think you are sorta missing my point. That or you are separating the CAP rate as something different than the ‘net before debt service’. Yes, it’s good that he has actually been doing the maintainence and it doesn’t matter that there are no brokers involved.
He has had expenses for, as examples; plumbing repair, paint, carpets, landscaping. You will too. They are all part of your expenses. Since he hasn’t disclosed what those costs have been you don’t know how much they undermine the cap rate. You were listing as the total of expenses only the most obvious things like utilities and taxes. There are lots and lots and lots of other expenses.
Take the roof. you say it’s fine now. That’s good, but it won’t last forever. You should be taking x% of gross rents and putting it aside to pay for the roof it will need in 10 years. Or at least put it aside mentally. If a new roof would cost $24k and last 20 years, then you should be putting $1000 a year in the “roof fund”, regardless of the condition of the roof today. If you just call that $1k a year “profit” and spend it you will be very unhappy when it’s time to replace and you have to get an expensive loan to put it on. If you knew what the expense was and planned for it, it’s just a cost of doing business and it was already calculated into your NBDS.
The more you know about the real expenses, the more accurate your estimate of the cap rate is and the less likely you are to have negative cash flow
When calculating your NOI, make sure to include ALL expenses. All city & county taxes and assesments. Insurance. An allowance for future vacancies. How about maintenance and utilities (these should be available from the seller)? Budget something for AC/Heat repairs, stopped up drains, broken water heaters. Are you sure there’s no undone maintenance items? What about yard care/landscaping? Snow removal? (leave it to a guy from south Texas to think of that one!)
Be a devils’ advocate, deduct every expense you can dream up from your GOI. (pretend you’re doing your taxes!) Then, if you’ve still got a decent cap rate and enough NOI to cover debt service, it’s a good deal.
Only $12K a year expenses on an 8 unit building? Something smells fishy.
Assuming you already accounted for at least a 5% vacancy / credit loss in your $61K GOI, that means expenses are less than 20%. VERY unusual. Something around 40% is much more common.
Can you run down your detailed expenses? Something’s missing here…
I would check this one like a hawk for signs of maintainence that has been delayed. If he doesn’t have expense numbers for paint, carpets, amortization on a roof, etc. I suspect he may not have been doing that. If you have to make up for that all at once it could be deadly. Numbers look good, but I’d want to see a serious inspection clause in the offer.
Okay, it looks like you fried my fish. A few things I would watch for:
Property tax reassessment on sale, increasing that expense.
I’d assume at least a couple thousand in maintenance and repairs per year.
Your lender will plug in at least a 5% discount to NOI for vacancy.
No management expenses? I’m assuming you’re managing the place yourself. Despite that, your lender may want you to plug in 7-10% here. Won’t be a “real” expense, but it will move your debt coverage ratio a little. I wouldn’t worry about it, you’ve got plenty of room to give.
That said…congratulations, looks like you’ve got yourself a hell of a deal.
Carl
P.S.: What part of the country are you getting these cap rates? I’m jealous.
Gary,
All apartments have been painted, new carpet, even some “newer” fridges and stoves, as well as about 4 water heaters. All apts are in pretty good shape. Don’t know about the roof yet, but he also converted the electric heat units to one big baseboard furnace system, raising the rents and the cap rate at the same time.
My concern is really that he didn’t include those as expenses. If you are not including them as expenses then you are coming up with a cap rate that is not realistic. You are getting the sort of pseudo cap rate that realtors like to bandy about, but not one that tells you if you really want to do the deal.
This is a private deal, no brokers here. If the work is already done, the rate I will see may be higher than his since he’s put these fixtures in place. Unless I need to do some improvements, this cap rate is real. I know is seems unrealistic but maybe the rates are not as high where you are. Doesn’t mean they don’t exist.