The exit assumption is carrying my whole model on a 12-house package

Package came across from a retiring owner. Twelve houses, all within about nine miles of each other, built between 1958 and 1979, sizes from 1,050 to 1,480 sq ft. Asking 2,640,000, so 220,000 a door. Current in-place rent across the twelve is 21,300 a month, average 1,775, and he's about 8 percent under market on eight of them because he hasn't pushed renewals in years.

T-12 gross is 251,000 with about 96 percent collections. Operating expenses as he reports them are 87,000, giving NOI of 154,000, a 5.8 cap on ask. His expense number excludes management, since he does it himself, and his maintenance line is 4,900 a house which for that vintage I don't believe for a second.

My rebuild: add 10 percent management on collected, bump maintenance and capex to 1,700 a door annually against roll, add a real vacancy factor of 7 percent rather than his 4. That drops NOI to about 122,000, a 4.6 cap. Push the eight under-market units to market over 24 months and I get maybe 14,000 of additional gross, call it 133,000 stabilized, 5.0.

The uncomfortable part is the financing. Debt at 65 percent, quoted around 7 percent on a five year term, is 5,600 a month or so on 1,716,000. Coverage on 133,000 is about 1.18. It clears, but barely.

The model only produces an acceptable IRR if I exit at a cap at or below entry in year five. Every basis point of cap expansion eats roughly 26,000 of value across the package. Fifty basis points of expansion wipes out the entire rent lift and then some.

So the whole thing rests on an exit cap I have no ability to forecast. I know that's true of every deal. It's rarely this naked. I'm trying to decide whether to price it as a 4.6 today and offer accordingly, which means about 2,400,000 and a seller who probably walks, or pass.

2 replies

1mikeoconnell7SP2APRO6

The operational side of twelve scattered houses is not twelve times one house, it's worse, and I'd want that in the expense line explicitly.

You've priced management at 10 percent of collected. On a scattered portfolio of that vintage most managers I've talked to want 8 to 10 plus a leasing fee per turn, and at twelve doors with 1970s houses you should assume four turns a year. Four leasing fees at half a month each is roughly 3,550, which isn't in your 122,000. Drive time between nine miles of houses is real too, and it shows up as slower turns rather than as a line item.

The under-market renewals are the other thing. He's 8 percent under because he never pushed, which usually means long tenants who will leave when you push. Every one you push is a turn you're paying for, so your 14,000 of lift comes with maybe 8,000 of one-time cost and a month of vacancy each. That's still worth doing. It just doesn't land in year one the way a model wants it to.

The exit assumption is carrying my whole model on a 12-house package

2 replies