I've been getting questions on Multi unit properties (MUP) recently and decided to review the Las Vegas MUP situation. MUPs are quite different than single family homes for a few reasons:
Since the unit you buy today will eventually be sold to another investor who will evaluate it based on the return, you need to buy it based on the return as well. Below are the formulas I would use to compare properties. Note that these formulas depend on accurate vacancy rates, existing lease terms and other issues such as deferred maintenance. Since these factors are specific to individual properties I will not include them in the following. It is critical that you do.
Capitalization Rate = (Annual Net Operating Income)/(Cost or Value)
For example, suppose you are considering a 4 unit complex and the rents are $600, $600, $600, and $700 and the asking price is $190,000. (Here is the actual property upon which I am basing this example) Assuming 100% rental rate (a really bad assumption) you would calculate the Capitalization Rate of the building as follows:
Capitalization Rate = ($600x12+$600X12+$600x12+$700x12)/($190,000) or Capitalization Rate = $30,000/$190,000 = 16%
Looks great! However, while the cap rate is interesting (and in this case fantasy since 100% occupancy rate is not real), cash flow is reality. Trying to be realistic, assume 10 months of rent for all units and $5,000/year rehab/repair costs. Note, the following is how I calculate it; not everyone uses the same method but this has worked very well for me on my MUPs.
Pre Tax Cash Flow = (Rents Received) (Management Fees) (Repairs) (Debt Service) (Taxes) - (Insurance)
Rents Received = $600x10+$600X10+$600x10+$700x10 or $25,000
Management Fees = $25,000 x 7% or $1,750
Repairs = $5,000
Debt Service assuming 20% down, 7% interest (MUPs interest rate is typically 1.75% higher than for single family investment properties) and a 30 year term = $1,076/Mo or $12,912/Yr.
Taxes = approximately 1% of purchase price so about $1,900/yr
Insurance for a four-plex will be about $700/yr
So, Pre Tax Cash Flow = $25,000 $1,750 $5,000 $12,912 - $1,900 - $700 0r $2,738. So, Cash/Cash = $2,738/(20% x $190,000) = 7.2%.
So, on the surface, MUPs looks OK but it all depends on deferred maintenance, ongoing maintenance and keeping the units rented. A few other things to consider:
Association effectiveness - Most of the MUPs I've seen are in a community. For example, 50 x 4 unit buildings with ownership of the individual buildings divided among many investors. However, you need to check ownership records since there might be one investor who owns many units and effectively controls the association. And, if you need something done and this major owner does not agree, its not going to get done.
Seller motivation Investors tend to sell these properties only when they are not making a sufficient return due to maintenance issues, excessive vacancy rates, vandalism, excessive rehab costs, financing issues, etc. So, you need to have at least 15 days due diligence and really check the units out.
Do your homework!!! As part of the purchase offer, include a requirement that the seller provide their books for at least the last two years. Have the books looked at by a professional. Also require copies of leases for all tenants.
Crime Check what is happening in the area. Walk around and talk to residents, the post person and, if you can, the beat cop.
Rental Fees Every time you need to rent a unit, you will incur a $300 to $400 fee from most property managers for advertising and/or commissions. If you have more than four charges a year, you greatly reduce your profit. For example, assuming $350/rental and the above example, your annual profit would decrease from $2,738/Yr to $2,738-(4x$350) = $1,400.
The Situation I bought a 4plex in Atlanta one time and with all 4 units rented. Things looked good. After I closed, I learned that 2 of the tenants were threatening to break their leases and leave due to the antics of one of the tenants. It took months to get this guy out and I had all sorts of problems with the other tenants until he was gone. The lesson here is talk to all the tenants during the due diligence period so you know the actual situation; don't just look at the books.
Contact me if you are considering buying or selling Las Vegas real estate. You will be glad you did.
...Eric
Eric Fernwood
RE/MAX CENTRAL
8400 W. Sahara Ave
Las Vegas NV 89117
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