We just walked through an abandoned 18 unit apartment building.
Even though the broker listing had A LOT of disinformation, we will be bidding on this property at Auction.
I’m going to go through everything we discovered during our walk-through and how I quickly underwrote this property to come up with my Max Allowable Offer.
BEHIND THE SCENES – ABANDONED 18 UNIT PROPERTY
Today, I want to bring you behind the scenes of my very first time bidding on a property in an online auction. It’s a vacant 18 unit multifamily building in Burlington County, NJ. This place was ABSOLUTELY DISGUSTING!!!
- There was black mold along the walls everywhere you looked.
- The subfloors were rotten.
- The roof was caving in on itself.
- The bathrooms and kitchens had this mossy green texture growing everywhere.
A few years ago, all of this would have scared me away. Now all I see are dollar signs.
During our site tour, the broker told us he showed this property over 30 times in the past 60 days, but only 3 people have signed up for the auction. This asset is not for the faint of heart.
Let’s dive in!
Site Tour
First, I want to talk a little bit about the importance of going to see this property.
Usually, I don’t take the time to walk a property before making an offer. I typically put enough contingencies in my offer so I can walk away safely if something is seriously wrong. However, this is an AS-IS, WHERE-IS sale through AuctioN so I don’t have the luxury of backing out without losing my deposit on this transaction.
I’m really glad I went to the property, because the listing is riddled with disinformation. It wasn’t until I met the broker face to face that I started to get some real answers.
I’m going to my best Maury Povich impersonation while going through the listing document to show you just how egregious it is.
Here I have the official offering memorandum. OK here we go….
The listing says “the building offers 30 surface parking spaces for residents.”
The lie detector test determined THAT was a lie.
The 30 spot parking lot next to the building belongs to the state of NJ as a park and ride for public transportation. There are actually zero dedicated parking spots for this building. The only parking available for tenants is street parking.
The listing goes on to say all 18 units are one-bedroom units.
The lie detector test determined THAT was a lie.
At least half of the units were studio apartments.
The listing also identifies this property as a “Value-Add Opportunity with tremendous upside via lease-up of vacant building.”
This building is not just vacant, it’s a gigantic environmental hazard.
For the record, there are typically 3 types of investments in the multifamily space.
First, there’s a CORE investment, which is a turnkey asset with a stabilized tenant base. It’s where people park their money for returns that match or slightly beat inflation. This strategy is for investors more interested in preserving their capital as opposed to growing it.
Then there’s the Value-Add investment. This is where you can make slight improvements to the property like refinishing bathrooms and kitchens to yield an extra 10% in rental income. This strategy works well when you buy a really large asset like 200 units or more.
Then there’s the Complete Repositioning / Opportunistic investment, which is when you take a frog and turn it into a prince. I’d argue this investment is even riskier than your standard opportunistic investment. This building is a dead, poisonous frog. And we’d be lucky if we are able to turn it into the prince’s balding brother.
Hahaha.
OK… moving on.
The listing’s stabilized pro-forma computes a vacancy rate of 2.5% for the submarket.
According to the US Census Data, the Camden County, NJ vacancy rate for the first half of 2021 is about 6%, and can be as high as 8.5%.
The listing’s stabilized pro-forma computes a property management fee of 3% of gross collected rent.
No decent property manager would touch an 18 unit asset for less than 8% of gross collected rent unless they were awarded equity as compensation as well.
The listing’s stabilized pro-forma has an expense ratio of 25%.
The lie detector test determined THAT was a lie. Minimum spend on an asset like this will be roughly 50% of gross potential income. If you’re spending less than that, you’re just building up deferred maintenance and today’s cash flow becomes tomorrow’s capex.
Finally, the listing made zero mention of an underground oil tank.
The lie detector test determined that was a lie…of omission. When we walked the property, we noticed a fill pipe sticking out of the ground. Upon further review, an environmental study was done to determine there IS an underground tank and the seller will NOT be removing it before the sale takes place. Depending on the size of the tank and the remediation required, this could be close to a $50,000 expense.
When I asked the broker if this property is actually in an Opportunity Zone, like the listing said it was, he shrugged his shoulders.
I wish I could be upset about this, but I’ve come to expect this type of behavior from middlemen with very little skin in the game. Their compensation is tied to their ability to sell the property, but so often they’re just not willing to be properly informed.
Thankfully the state of NJ has a mapping tool where you can simply enter the address of a property to see if it falls within an Opportunity Zone. Thankfully, this property IS in an opportunity zone.
BACK OF THE NAPKIN MATH
The broker for this property recently sold a 40 unit building down the street at 50% occupancy for $115K per unit. Based on that one comp, we feel like we can achieve a minimum value of $100k per unit here. If we manage to keep the building 18 units, I don’t think it’s far-fetched to achieve an After Repair Value of 1.8M.
Now Let’s see if a quick income analysis supports that valuation.
Based on the existing floor plan, we feel we can achieve the following gross rents.
- According to HUDuser.gov‘s Small Area Fair Market Rent tool:
- Each studio unit will rent for $1,010
- Each 1 bed unit will rent for $1,150
- According to Rent-o-meter:
- Each studio unit will rent for $1,195
- Each 1 bed unit will rent for $1,300
Based on a drawing my architect friend made, we’re going to assume our floor plan consists of four studios and two 1 bed units per floor.
That means our gross potential rental income is $19,000 per month.
That’s 12 units at $1,010 per month and 6 units at $1,150 per month.
Let’s assume 50% as our expense ratio, leaving 50% in NOI.
To be clear: that 50% expense ratio includes vacancy, property management, insurance, taxes, licenses, repairs, maintenance, capex reserves, contracted services, common space utilities, and whatever else you can think of.
So 50% NOI on 19,000 per month in revenue comes out to being $9,500 per month or $114,000 per year.
This property will likely have a cap rate anywhere from 6% to 7%
At a 6% cap rate, we can compute a value of 1.9M.
At a 7% cap rate, we can compute a value of 1.63M.
As you can see, our 100K per unit number lands right in the middle of these two valuations.
DETERMINING MAX ALLOWABLE OFFER
As you can see, our 100K per unit number lands right in the middle of these two valuations.
So how do we get to our Max Allowable Offer?
It’s quite simple if we keep this to back of the napkin math.
Let’s take the average of our 3 valuations to determine a potential ARV of 1.77M.
Let’s take 80% of that number to build in 20% equity off the bat.
That brings us down to 1.4M.
Then we take our best guess at how much money it’s going to take to turn this property around.
I think a new roof, new fire escapes, and removing the underground oil tank are going to easily cost $50k a piece.
Then I think our contractor is going to charge us $150 per square foot for the buildout.
The exterior dimensions of the building are roughly 75 feet by 25 feet. That’s a footprint of 1,875 square feet per floor.
Let’s increase that number by 10% and say there are roughly 2,000 square feet per floor to be safe.
At 6,000 square feet of livable space, the buildout cost should not exceed $900,000.
So our Max Allowable Offer is……..
1.77M * 80% – $150K for the roof, fire escapes, and underground oil tank removal and then another 900K for the buildout.
So all of that equals $366,000.
GOOD NEWS & BAD NEWS
Now there’s good news and there’s bad news.
Let’s start with the bad news first. The bad news is according to the auction platform the opening bid for this property is $325,000.
The good news is all hope is not lost. Since our back of the napkin math came in higher than the starting bid, I feel like it’s worth spending more time digging into the numbers here.
NEXT STEPS
The first thing I’m going to do is call my oil tank removal company and ask for a conservative estimate on a job like this. Then I’m going to find a fire escape vendor and ask what it would cost to install completely new fire escapes on this property. Lastly, I already had my contractor walk the property so we’re just waiting for them to come back with a bid on the roof and the buildout.
In a last minute attempt to gather more information, we submitted an OPRA request to the township clerk.
If you’re unfamiliar with the acronym, OPRA stands for Open Public Records Act.
In that form, we always ask the following 5 questions:
- Are there any open permits?
- Is there any record of an oil tank or septic tank historically or currently on the property?
- Are there any existing health, environmental, or code violations associated with the property?
- Are there any outstanding tax, sewer, water or other liens associated with the property?
- Is a property card and/or green card available?
Although I already know the answers to some of these questions, it doesn’t hurt to ask because the township may be able to provide some more insight.
For example, I know there’s an oil tank, but they might have a record of it being decommissioned properly.
On the other end of the spectrum, we might also discover a bunch of outstanding liens or code violations that need to be rectified, which would ultimately increase our startup costs on this project.
I’m looking forward to crunching the numbers further and ultimately bidding on this project.
