Master-metered 8-unit, owner pays heat and water, expenses at 52 percent. Do I underwrite the RUBS fix?

I model income property all day for other people and I've somehow never owned any of it. Now I'm looking at an 8-unit for myself and the utility structure has me stuck.

Building is a 1962 two-story, one gas boiler serving all eight units through radiators, single water meter. Owner pays heat, water, sewer and trash. Tenants pay their own electric. Rents are 775 across the board, gross 74.4k.

Seller's actual expenses from two years of returns: taxes 9.1k, insurance 4.4k, gas 11.2k, water and sewer 6.8k, trash 1.9k, repairs 5.5k, no management. That's 38.9k, so 52 percent of gross, and that's before I add management or reserves. NOI as-is is about 35.5k. Asking is 495k, so a 7.2 cap on numbers with no management in them, which means the real cap to me is closer to 6.2 once I put a manager on it.

The obvious move is to bill utilities back to tenants, a ratio system based on square footage or occupancy, which I've seen modeled plenty of times. What I don't know is anything about doing it in real life. There's no submetering possible on radiators without spending real money. And every lease is annual with staggered end dates, so I'd be phasing it in over 12 months while my utility bills stay the same.

Question for people who've done it rather than modeled it: do you underwrite that recovery in your going-in numbers, or do you buy the building at 52 percent and treat any recovery as upside you might never collect?

3 replies

1sonia_alvarez Get yoursPRO6

Underwrite it at zero. A lender sizing your loan will use the trailing expenses and add management and reserves whether you like it or not, so if your equity check depends on the recovery you'll find out at term sheet.

The mechanism worth understanding: value is NOI over cap rate, so if you eventually recover even 8k of the 18k in gas and water, that's about 115k of value at a 7 cap. That's a real prize and it's a reason to buy the building. It just isn't a reason to pay for it today.

Whether you can bill utilities back at all, how the allocation has to be calculated, and what notice you owe existing tenants vary by state and sometimes by city, and a few places restrict ratio billing outright. That's a question for a local attorney before you write it into a lease, not a modeling question.

1chriswalton8CC1CPRO8

The staggered lease ends are actually your friend, not a problem. You phase it in at renewal, one unit at a time, and each renewal is a separate negotiation where the tenant compares their new total cost to moving. At 775 in a market where I'd guess comps are higher, you have room. What kills these conversions is doing all eight at once in a soft leasing season and getting four notices back.

On the boiler: 11.2k of gas on eight units is 1,400 a unit and that's a 1962 system. Get it scoped. If the boiler is at end of life you're looking at a capital number that dwarfs the RUBS upside, and I'd want that in the price conversation rather than in the utility conversation.

2aaron_fitz10 Get yoursPRO6

52 percent with no management line is really 60 percent, and a 6.2 cap on a 1962 boiler building is thin. What would you pay?

Master-metered 8-unit, owner pays heat and water, expenses at 52 percent. Do I underwrite the RUBS fix?

3 replies