Nine of eleven tenants are under market. Do you wait for the units to empty or push?

Question

I have been underwriting an 11-unit for three weeks and the whole deal comes down to one decision I keep changing my mind on.

In place: eleven units, average 810, comps support 1,000 to 1,050 on a turned unit. Nine of the eleven are month to month, all long tenured, all paying on time. Two are at 975 because they turned last year and those are the only two I can point to as proof the market rent is real. Historic turnover in the building has been roughly two units a year, which means natural vacancy alone takes four to five years to reach the rent roll I am paying for.

The case for waiting: no relocation cost, no vacancy loss, no reputation problem in a small submarket where I would like to buy again. Paying tenants are the cheapest tenants you will ever have. The building is 1978 vintage and the money I would spend pushing turns could go into the roof and the panels instead.

The case for pushing: the value is in the NOI, and NOI I have not captured is value someone else's cap rate gets to price. If I serve notice on four of the nine over the first year and turn them at 1,000, I move gross rent by about 9,100 a year on those four alone. My lender sizes on trailing income, so the sooner it is real, the sooner a refinance is real. Waiting also means paying today's expense growth against yesterday's rents.

There is a middle version where I raise the nine toward 900 without turning anyone, accept that two or three leave on their own, and turn only those. I lose the last 100 to 150 a unit but I keep the building full and I spend almost nothing.

Rent increase notice periods and what you can do with month to month tenancies vary a lot by state and sometimes by city, so assume the legal mechanics here need local counsel. I am asking about the strategy, not the notice form.

diane_kowalski · Answer

Before the strategy, what did your lender underwrite? If they sized the loan on 810 average and you are paying a price that only works at 1,000, the gap is being financed by your equity for however long the turns take. I would want that timeline written into the model as a cash cost, month by month, because four to five years of natural turnover at 1978 vintage expense growth is a different deal than the one on the broker's sheet.

karen_whitfield · Answer

I hold things for a long time so my bias is obvious. Nine tenants who pay on the first are an asset that does not show up in your NOI line. Every one you replace, you are trading a known payer for an unknown one, plus a turn cost, plus vacancy, and you find out in month fourteen whether the new 1,000 tenant is actually a 1,000 tenant. The compounding argument for pushing assumes the replacement performs. Sometimes it does not.

tylerbrooks9 · Answer

The middle version is the one I would pick and I do not think it is a compromise. You get most of the money, you keep the building full, and you do not spend a year as the new owner who emptied the place. In a small submarket that reputation follows the building, and your next seller hears about it.

renee_dubois · Answer

I tried @orchard's version on an 8-unit and it cost me. Six tenants at roughly 180 under, two units a year turning, and after two years I had captured a third of the gap while taxes and insurance took the rest. What worked was moving everyone to a lease at plus 8 percent, which sounds gentle and is not, and being ready to turn the two who walked. Three stayed, two left, and one negotiated, which I allowed. What nobody puts a price on is your own capacity. Four simultaneous turns in year one on eleven units while you are also learning the boiler is a lot, and if the money is going to be spent badly it will be spent badly in month three.

Nine of eleven tenants are under market. Do you wait for the units to empty or push?

4 replies