Welcome, to episode four of the Real Estate Ride Along Show!
This property is a six-unit building with four large 2-bedroom/1-bath units and two 1-bedroom/1-bath units.
This building was initially attractive to us due to its proximity to a previous property that we had just sold one block away. That property happened to be a 22-unit apartment building which we did particularly well on so we had good feelings about the location.
This made us especially confident that we could renovate to the same level, fetch the same rents, and expect to lease it up in a similar time frame to what we had done before. It makes our planning underwriting of the numbers much easier because we did not need to repeat a lot of the rent comps and study as we normally would on a new project.
We like this area as a rental property because it’s off of Broadway, a major thoroughfare in Denver, and it’s surrounded by multiple shopping centers, restaurants, and grocery stores. This Denver suburb is very popular and makes for a great rental area
We found this deal through our network, as we typically do in a hot market like Denver. A friend of mine knew the owner, who lives in Greely and was tired of self-managing the building from 60 miles away.
The owner requested that we make a decision quickly or he was going to take it to market the following week. Given our prior history of investing in this location, it gave us a leg up on the competition to move quickly. The owner had actually signed a listing agreement with a broker to list the property, so we knew that we were under the gun to make a decision quickly.
Being that this was through our network and we were able to meet the owner’s needs, we were able to acquire the building off-market for $845,000. Recent comps in the area are over $975,000 for this same type of building. Since we purchased the subject property back in November, our neighboring building, which is made up of mostly 1-bedrooms, also six units, recently sold in April 2020 for $1.05 million!
The Game Plan
While this building is mostly all outdated from a cosmetic standpoint, during our property inspection it was a pleasant surprise to learn that the previous owner had installed four new furnaces in the building, new water heaters in every unit, new electrical panels, and four new washer/dryer units.
If you have watched any of our previous content, you already know that having a washer and dryer in the units is very valuable.
What we learned by renovating the 22-unit building down the street is that we can get about $100 more per month if there is an in-unit washer/dryer and forced heat, so having these updates already in place was a huge bonus.
Our plan is:
- Do cosmetic updates to the interior of each unit one by one as opposed to clearing the entire building.
- Put on a new roof and replace the windows.
- Update the swamp coolers to AC units.
- Lease to market-rate tenants once renovations are completed.
- Sell to a buy and hold investor looking for a turnkey property.
Once all the updates have been completed, using our finished 22-unit building as a reference, we expect to see rents jump from their current rate of $950 per month on average to $1,300 per month + RUBS.
Most of these units were occupied by tenants, so we had to come up with a workable timeline to rehab each unit while keeping the tenants in mind. In December of 2019, there was one unit that was vacant so we started rehabbing that unit. One the last day of the month, we served one of the tenants, who had the lowest rent and unit that was in the worst condition, a 30-day notice.
This gives the tenant 30 days to find another apartment, during which we chip in to help with any moving expenses or manual labor associated with the move in order to make the process as smooth as possible for all parties. By serving the 30-day notice at the end of the month we are able to plan our construction process knowing that we will be able to start construction on the first of the next month, once that unit is vacant.
By starting construction in February, it gave us a better chance of being able to achieve max market rents by leasing closer to the spring as opposed to the middle of winter. Over time we have learned that leasing in spring and summer months from March to September increases rental income by 5-10% depending on the location and unit mix.
Five to ten percent in additional NOI over hundreds of units is worth millions of dollars in backend value. So when we are planning construction we always try and schedule renovations to end as close to March as possible so that we can capture this incremental value based on seasons in Denver.
This particularly matters when raising money from outside investors for a project. In the past when I would do projects like this with my own personal capital, I would most likely clear the entire building for convenience and speed. However, since we have limited partners (outside investors) on this property, it greatly increases their returns to have three or four units filled at all times and collect this additional $30,000 in rental income over the course of construction.
Funding the Project
For this deal, we were able to get a loan from a bank that loaned us 80% of the purchase price at 4.4% and interest-only for two years. As I mentioned above, we plan to sell this property before the two-year mark, but if for some reason we don’t, we can refinance into a longer-term loan or the bank will restructure our loan with new terms and a new interest rate.
We anticipate bringing a 20% down payment, all closing costs, and our rehab budget, which we have budgeted to be about $150,000 for all updates. As mentioned above, in past deals I would normally fund a smaller project like this with private money, but since we have investors, it makes the returns higher and lowers risk by taking bank debt at lower interest and lower LTV.
Walkthrough
With this building being in more of a suburban area rather than the heart of downtown Denver, we will still update everything cosmetically to look very fresh and clean, but we won’t need to spend extra money to do those high-end finishes as we won’t see the return on them.
You typically don’t see higher-end finishes in suburban neighborhoods like this one because there isn’t same the demand to pay proportionately higher rent for higher-end finishes as you see in trendier urban neighborhoods.
Interior Renovations
- Add light fixture to living room
- New paint to brighten it up
- New flooring – LVT
- New vinyl double-pane windows
- AC units – forced air
- Add new furnace to units that haven’t been updated ($1,200-$1,400)
- Add new water heater to units that haven’t been updated ($800)
- Cut out part of the wall between living room and kitchen to make it seem bigger/more open and add natural light to kitchen
- New lower cabinets in kitchen ($400-$600)
- New shelving to replace upper cabinets in kitchen
- Granite countertops in kitchen
- Custom backsplash in kitchen
- New stainless steel appliances in kitchen
- Add dishwasher (plumbing + dishwasher = $500)
- New light fixture in bedroom(s)
- New tile flooring in bathroom
- New tile on walls in bathroom
- New tub in bathroom
- New plumbing fixtures in bathroom
- New vanity in bathroom
- New toilet
Anticipated bathroom rehab costs will be about $4,000 per unit. We expect the bedrooms to be about $800 per room to update. The kitchen will be about $3,000. We hope to update each unit for under $12,000.
The amenities we are adding are a huge draw for the tenants in this area. With the work done by the previous owner to install washer/dryers and forced heat, coupled with our renovations to modernize the look, add dishwashers, and add forced air along with exterior paint and improved curb appeal, we are able to make this building stand apart from the rest of the neighborhood where most of the buildings are older, outdated, and lacking any of these interior amenities.
Exterior Renovations
- Remove swamp coolers (eliminates not only an ugly unit but also maintenance to drain and winterize each year)
- Add brick where swamp coolers were
- Paint entire exterior
- Replace electrical boxes ($2,000 each)
- Expand common/sitting area for tenants
- Improved landscaping with new mulch and flowers
Another appealing quality that this building possesses is a few storage units in the back. We are able to charge extra for these, about $50/month.
The two biggest utility charges are gas and electric. Luckily, this building is already set up so that each unit has its own meter for electric and gas which makes it really easy for tenants and for us as landlords because we won’t have to worry about billing back tenants for these charges.
Services we will bill back to the tenants are water, sewer, and trash. For the 1-bedroom units it will be about $50 per month and for the 2-bedroom units it will be about $75 per month.
The Numbers
We purchased the property for $845,000. Instead of using private money as mentioned previously in the article, we used a bank in Iowa that we have a working relationship with who loaned us 80% of the purchase price at 4.4% with two years of interest-only payments. We were responsible for bringing the remaining 20%. With closing costs and a renovation budget of about $145,000, we will be into the project for approximately $314,000.
Unlike some of our other projects, we will have tenants in some of these units while we update the ones that are vacant. So we will have some rent coming in each month. All of the tenants are on month-to-month leases, so it works well that once we have two units completely updated, we can rent them out to market tenants, vacate another two units, and repeat the process.
This helps us offset our costs of carrying the project and we actually still end up making a few bucks each month by having tenants stay in the units.
Another option that we have given tenants is the ability to stay in their unit and we will update with appliances and some other items; the legacy tenants will then pay just under market rents. They can also choose to move into a newly updated unit and sign a new lease agreement at full market rent.
As we mentioned when walking the property, we will be billing each tenant back for water, sewer, and trash each month.
Another item we have to account for in this project that we don’t always have at our other projects is the grounds maintenance. There is some grass out front and they have a small parking lot, so we will need to make sure we address those items in our numbers.
We are in a good spot when looking at our total operating expense ratio. For a fully remodeled fourplex, we hope for around 23-25%, so we are in really good shape here.
The monthly NOI will be the same whether we keep it or a new owner buys it. The difference is the type of loan each of us has and the terms of that loan. With our bank loan of two years interest-only payments, we will cash flow about $4,162 annually. Not bad!
We always run a three-price exit scenario so we can know what to expect as we offload our projects. For this building, we realistically think we can get 5.5% as far as cap rates. This project was really a home run because the development was a lot less intensive. We didn’t have to deal with pulling permits from the city, it was mostly all cosmetic, and it ended up being a great return on investment for the time we think we’ll put into it.
We want to look at the numbers for an investor who will come in and hold this asset. We assume that we will get a 5.5% cap rate, that the investor will put about 25% down, that loan fees are about 1%, and acquisition costs are about $10,000. That means that a new owner could acquire this property for about $382,000.
We always like to look at the return on investment quadrant so we don’t get hyper-focused on cap rate and remember to look at the other ways we make money on our assets. We look at cash flow, appreciation, debt paydown, and depreciation/tax benefits.
For this type of asset, we are seeing between 3-5% is good for cash flow. Denver is an appreciating market so we usually expect at least 3-5%. Debt paydown is great because it’s your tenants who are paying this down. Altogether, for this project, these metrics give us about a 24% return on our money.
Taking a look at a five-year projection, we anticipate that rents will go up and expenses will go up, but the loan payments will stay the same. This gives you total equity of about $710,000 to tap into for other investing projects!
Tips for New Investors
One way to get involved is to find an operator such as myself and see how you can help and bring value. You can offer to help on the project during nights or weekends to either swing a hammer or manage the construction, which helps operators who manage these projects better and get things done quicker. You get real-life training and experience without having to put up the money.
Another way to think about getting involved would be to consider property management. You could negotiate a lower rent to be the on-site property manager for your building. Again, you gain knowledge and first-hand experience while growing your network.
Conclusion
Overall, this was a solid deal for us that fits our buy box perfectly: an outdated building, with a legacy property owner who has become weary of property management looking for a convenient no-hassle closing.
A bonus on this property that we do not typically see in outdated properties is having some of the expensive cap ex items already completed prior to closing. This allowed us to spend less on renovation and focus on mostly interior updates that will add 30-40% in monthly rents.
Being able to capitalize on updating for the area and tenant needs while keeping several legacy tenants in the building to still collect rents was great to help offset our expenses and made it an easier project to carry even before we increased to market rents.
