How to underwrite an 88 unit apartment complex

Hey, what's up guys? So the team just locked in an 88 unit apartment complex. And today I want to walk you through step by step, how it was underwritten, how it was analyzed so that you can know how to get through your leads quickly.

Okay?

And this is the part where it led to submitting an LOI letter of intent. Okay. The biggest thing needed in getting into commercial real estate, into apartments or something, scaling your apartments is first off, lead generation. Many people think it's funding, but I promise you it's lead generation. It leads trump the funding, the deal trumps the funding. Because if you find a good enough deal, I promise you, you just reach out to me, I promise you we'll get your deal filled up.

Okay?

But second thing you need, okay, is analyzing the deal conservatively, analyzing it well, but then analyzing it efficiently and fast.

Ok?

You only have so much bandwidth through the day, you can only analyze so many deals through the day. So you need to make sure you have processes in place to get them off your debt, the time wasters off your desk and get to the good deals quickly. And so today I want to walk you through step by step and what I'm going to do is share with you a video, a call that we just did in our mastermind where we help people scale into partners. Well, we all just jumped on a call and Larry, my partner just went through our new spreadsheet that's called the deal analyzer 2.1 and it is going to make your job a lot easier. Okay? And again, this is a deal that we just locked in. It's past due diligence. It's actually in the phase of bringing investors in. I think we're, we're just about it capacity but either way. Yeah. So again, just a preference. This is the stage before or after you've already done like a preliminary just, you know, 25% rule. Like you just want to get your unit mix your market rent, your renovation cost and your expense ratio. If you can get those four metrics, then you can just analyze that within 60 seconds to five minutes at most and just decide are you anywhere near the sellers asking if you're within 25%. We say, all right, let's move into this next phase where you factor in debt, you factor in the investors, you factor in a few more things, you get a little bit more precise numbers and so then you can accurately and confidently put in an offer. So without further ado, let's get into that, let's jump in analyzing this 88 unit deal.

So we'll kind of try to go by the instructions here that we created. So first thing you want to have is T12 rent roll for the subject property. You need market rate rents. You need your kind of idea of your repairs then your market cap rate. Then you want to save a copy because you don't want to mess the sheet up for everyone else. But let's correct the spelling as we go, huh? Analysis. So first thing we'll do is enter the name, the number of units price and then get the unit mix properly. This was a Summer Hill Apartments, 88 units Proposed price quoted, you know by the broker for the, for the net analysis for me and dollars a unit mix. I'm on, I'm on cheat here. We got. Instead of doing the unit mix well we'll go ahead and do it. We got four one bedrooms.

And this.

Is a low income housing tax credit property. So the rents are capped there. There's rent limits by the that are established. So these are those rent limits which basically is our market rate rents. See there's 44 in my way 44 two bedroom units, 760 and there's 40 three bedroom units at 870. That gives you a total gross potential rent of 849,696. Our capex. I'm on cheat here too. Instead of doing the breakdown it was 225,000. Just going to enter that in the total instead of worrying about the breakdown. So that populates the gross potential rent there and it should have populated our capex down here in this cell which it did. Going back to the instructions we've done the unit mix, we've done the capital improvements. So now we want to enter our variables for the income and expenses and we've got some notes here that you know the current expenses for the property can help you with that because obviously you want to know what the taxes are, what they're currently paying in utilities, what they're currently paying for maintenances gives you a good idea of what you're going to be having with property. Other income. And then as you've probably seen on the sheet there's some guidelines that kind of tell you where you need to be. Other income, 2 to $400 per unit. I think we had 225 lost at least 3% vacancy rate, 5% delinquency 5%. And this is very conservative. I mean the loss to lease is the amount below what you've projected your market rates to be that you're going to be at. So if you Think you're going to be at those market rate rents and you're doing a pro forma. You could easily leave that at zero or just leave that column out. But again, you got to keep in mind this isn't what we're furnishing to a lender, to somebody to pitch the deal. We're trying to decide what I can pay for it to be a good deal. So you want to be more conservative. Same with delinquency. This is assuming vacancy rates are pretty standard and they're 48%. Delinquency varies greatly by the type of the property, how well it's managed. That's assuming we're only going to collect with a 5% delinquency rate. We're only going to collect 95% of the rent each month for this, for the year. Basically. Insurance 550 per per unit. Taxes on this property is about 1.2% and this is where you're going to want to verify. You can't just go by the taxes that they're paying because it's, it's going to be based on your new purchase price. But what you can do is go to the county tax website for that property and if, and take the taxes currently being paid by the tax value of the property and get a percentage and then just plug that percentage in here. Utilities 7 so 800 repairs and maintenance 10% management 4% payroll 8 to 1100 dollars per unit. Sears 900 total payroll is $79,000 which pretty much covers a manager and a full time maintenance person. General and admin. Excuse me. And this is a more condensed summary of if you have full expenses. You know some, some places you'll see, you may see on a T12 on marketing, legal and professional or you know, other things. But we just had to kind of have that all condensed into general and admin. Replacement reserves. I think we had a hundred on this deal. If you, if you're getting a Fannie or Freddie Mae loan, I think it's $200 per unit they require to, to come out of your, your money or part of the loan payment that goes into reserves. $200 per unit. But if you're getting just a local bank loan or something like that, you don't have to have that. But it's still a good idea to, to put something in. Depends on what you know. If you know roofs are going to need to be replaced in five years or something like that. You can have additional. We didn't have any other expenses on this one so we're done with income and expenses. Just that easy. Just from plugging in those, those variables. And that gives us an OI of 376,000. Now if you go back to the instructions, it tells you the calculated expense ratio should be between 45 to 55% for Class C properties. Really for most properties we look at, this says 35 to 45. For Class A and B properties, that. But that means nicer newer, which is really what an A and B is. But you know, a B minus probably would be more than that. 40 to 40, 55%. So that's just for like a, you know, quick double check. We're at 50.5. Very reasonable, probably conservative. Now we have to put in our all in our desired cap rate, which calculates our all in price. I think there's something on here about that to guideline, it says enter the desired cap rate. This should be higher than the market cap rate which provides you your discount. If you're all in at a higher cap rate than market. Basically that is your, your value add or your, you know, your discount. And it just gives you. Shows you how we're coming up with that. So if you got market cap rate divided by your discount percentage, that gives you your desired cap rate. So if your market cap rate 6% and the discount is 75% of the, you know, future value of the property, then 0.06 divided by 0.75 is a 0.08 cap rate. And it just says here, it's typically between. You want to be one and a half to three points higher than the market cap rate. So let's do that. And it says you will not have your maximum offer. Oh, I'm on, I'm on. I'm gonna go. I want a little bit better deal. So I put in eight and a.

Half.

All in desired cap rate. That gives me a all in price of 4.425 million. Taken back out, my improvement cost of 225,000 gives me a maximum offer amount of 4.2 and a cost per door of 47,000. 8. 40. I don't know, Jonathan. You want me to stop right there or keep going? That's.

Well, yeah, I think, I think. Do we figure out what we can make an offer on.

Maximum offer amount.

Okay. So yeah, that's the main thing is, is to be able to factor in the debt, factor in the, the investors share, and then know what we can confidently offer the investor, at least at this stage or the seller. Sorry. Okay, so then, yeah, that's that.

Then we Go from there, you know, to kind of put the rest of the numbers together on how much equity we're going to need and your funding and that kind of thing. But this really gets you to, you know, what, where you need to be on an offer amount. But I'll just keep going if you want me to. I just didn't know if you want me to stop there for any questions or clarification. But we'll go ahead. I'll go ahead and finish the sheet.

Larry, real quick. What? I didn't catch what the market rate was. What was the market cap rate?

Oh, I'm sorry. Yeah, skip that. I had six. It's pretty much six. You know, in the instruction example I had six. But yeah, this, this is a six.

Okay. Yeah, this part up to now what you've got is fairly straightforward. I can do this if given the numbers. If you get the income, expenses, you can get to that all in price. It's fairly straightforward if you're able to get the right numbers. Gets a little more complicated from here. So this is good.

Where did you place?

Right. And you can take, you know, you've got their T12, so you can take their current income and, and figure out what the in place cap rate is. But you know, depending on heavy the value add is, that may be relevant, it may not. I think I've bought properties that were at a negative in place cap rate but then you know, in two years it was a 9 or a 10 because they just weren't doing a, they were doing a very poor job managing the property. There was a lot of vacancy or whatever.

But where did you put in the cap rate? Right here, the, the market cap.

I didn't, I want to, I want it, I want to know where I'm going to be. Yeah, but that was this in the instruction. That's what this walks you through over here. You want to be 1, 1 and a half to 3 higher than the market cap. And I know, you know, some of the instruction you give it in the past was hey, you want to be all in at a 70 or 75% discount. Well, that's what this does. You take your desired cap rate divided by, I'm sorry, your market cap rate divided by the discount gives you your desired cap rate. You're just applying a discount. It's just basing it on, it's converting it to cap rate instead of discount. Because I mean that's what the language when you're talking to lenders, talking to brokers, that's what you're going to say I'm in place six cap. I'm going to be pro forma eight.

Cap.

Which is a 75 discount. Yep. Nice. I love that. Does that make more sense? I mean we could, you know you could certainly add something here to the formula and have you know, market cap and desired discount. You could, you could put, make that part of the deal. You know, several years ago you just knew the formula was you just wanted to be all in at a tin cap no matter what. Didn't matter. But those, those, not many of those out there. Okay. But after we got through taking this one all the way through full modeling, it ended up being about an in place nine and a half cap. I mean not in place. I'm sorry. Pro forma nine and a half cap.

Perfect. Yep. And so were there other instructions on this thing or there?

Yes, we'll see. We can keep going. I just want to stop there, see if there were any. I think the net income on this property right now is about 242 50. So you know, if you take 240,250 and divide it by this, you know the 4 million proposed purchase price. It's about us. Like I said 6 cap but it's, it's got value add potential. Cost of reps are, are so far below potential. But yeah, I'll just keep going Jonathan if you like.

Yeah, no, I think the basic thing is yeah, cover the whole spreadsheet and then you know from here we're going to just transition into the loi. Right. We want to basically submit that loi and then, and then we want to open this thing to questions.

Okay. So the next step of the instructions, it says number eight, you have your, you now have your maximum offer amount. Number nine, you can go to calculate your total uses and you know, if you don't know sources and uses, it's just terminology used for, for you know your capital stack. Your, your, your uses are all the money you need to close and fund the deal and your sources of where it's coming from. It's pretty self explanatory. So we'll go ahead and do that. Number 10 says enter the acquisition costs. Number 11, enter your reserves and then enter your acquisition fee. So this is kind of a fun part. You get to play around with the numbers. Acquisition costs, say 1%, operating expenses and cash reserves. I usually like that to be about 1%. Regardless. You can get a little bit more detailed with that calculation by getting somebody to model this out like on a monthly basis. Because if you think about it, if you buy a underperforming a value of property and you may not be cash flowing with the new purchase price and the new debt out of the gate. So you're going to need some reserves until you can get because you can't go. Keep in mind this is, this is a two year plan to get to these market rents is maybe two years. So you're not going to snap your fingers and be at these this noi. It's going to take time to get there. So during that time you've got still cover all your expenses. Acquisition fee we're using 2% right now. So that gives you total total funding needed. Uses 4.331 million. And then your sources are going to come from debt and equity. Basically in this example or most examples or all examples I guess debt and equity, I don't know where else it would come from. So 80% loan to cost gives you a loan amount of 3.328 million. And it automatically populates. The rest has to come from equity or capital. You're going to raise down payment, whatever you want to call it. So those two match your total funding from the uses matches total funding from the sources. And then your debt you would have to know, you know, depending on whatever debt you're getting. On this deal it was 6% interest rate and an amortization period of 240 months. We were able to get interest only. You should always ask for interest only. So this just shows you your payment with your amortization. Amortized payment, principal and interest versus just interest only.

So that's interest only for 240 months.

No, the loan term is 6%. 240 month amortization. So amortization, the loan's going to be due in four years, five years, six years where the bank tells you it's due but it's amortized to determine the principal and interest payment over 240. If you get an agency loan like Fannie or Freddie, it's usually going to be 240, 30 years.

Right.

But they will give you an interest only period. So for the first say year you're just paying interest. Okay, Easy to calculate. 6% times loan amount is your interest is your payment for the year interest only. And then after the year it'll convert to that 240amonth amortization with a principal interest payment. Okay, that, does that make sense?

Yes, it does.

So your partner equity is just here. Is just the equity required here because you're assuming, we're assuming you're gonna, you're gonna raise it all. Even if you're putting in 300,000 of your own money, you still want to consider yourself a partner and pay yourself the same returns you're paying everybody else. If not, you're kind of cheating yourself. So this way you put in the preferred return we're going to pay, and in this case it's eight and a half percent. So that gives you the annual preferred return. This is a little, I guess this could be confusing because we got the payment, the debt payments negative and the preferred returns positive. But there's still both money going out. But as long as you know that. So this gives you a cash flow with interest only or during interest only, then cash flow after. And we got a little problem with this formula I think right here. Fix that real quick. I don't want to cooperate.

Larry, what's the purpose of the interest only year? Is that allow you value add time or is that.

It helps with your cash flow, just gives you money.

Okay.

I mean, look at it, that's an extra 80, what, $7,000.

Okay.

Or that year one, you would have to, to help with cash flow. Because keep in mind, I mean, out of the gate, you're, you're going to be usually hurting for cash flow.

Right.

That's what, you know, lenders are going to look at.

I gotcha. No, that's great. I just wasn't familiar with that, I guess yet, so. No, it makes sense. It definitely is a benefit. I just wasn't sure why that would. I guess it's a benefit to the lender as well, because they want to get that interest as well. So they're.

Yeah, they're watching. That's what this, I just calculated debt service coverage ratio. That's what I mean, all lenders are looking at, even if you just go buy a house. But it's usually not an issue. But on something like this, it can be. If you're doing like value add, you're buying something underperforming, you don't get it performing. That's definitely what they're looking at, that you got enough cash to cover the debt. And that's what the debt service coverage ratio is. Basically, it's your net cash, net operating income divided by the debt payment. That's what gives that ratio.

So, okay, that makes sense. It's just funny. I'm doing the same thing with my single families. I'm getting a year of interest only, but it's for a different reason. So I can either sell it or refinance Which I know you, you like to either sell it or refinance it as well after value add, period. But you're going to get to that in a minute and it's not necessarily after a year. So it's kind of a different purpose.

But yeah, you know, a lot of people, a lot of people say, oh, you know, I want to, I don't want interest only because you're, you're really causing your, you're costing yourself extra interest, you know.

Right.

People say, I want to pay it down as quick as I can. Well, you know, they'll still take your money if you send some money on the loan, but you just to make the, to get the loan approved even in order to make it work. But sometimes they'll scoff at interest only. You know, the lender may not want to. So it's kind of a balancing act, you know, because they get, they get a higher return on their money if it's not interest only. So, but, but it's kind of the norm if you go get a Fannie Mae loan, they almost expect you to take it. And a lot of the, like the agency debt on higher price deals is a lot of times it's three year interest only. I've got a friend who bought one right here in Columbus, like a $17 million property. He got eight years interest only.

Wow.

So it helps the cash flow, you know, a lot. But he's going to owe downside is in eight years he's owed what he owed when he started, you know.

Right.

But you're counting on the value of the property going up. So that's.

No, I get it. Cash is king. So paying that interest only if it saves you some cash, that's everything.

Yeah, yeah. And you can take that money and make more than the 6% interest rate, hopefully. So stabilized value moving along. So now you kind of see what your debt's going to be, that you're going to have a debt service coverage ratio that's acceptable. Usually it's 1.25 is what you got to meet. But again, let me go back to that because keep in mind that's after this thing is fully stabilized. It says debt service coverage ratio stabilized. That's not gonna be a 1.31 month, 1, 2, 4, 5, 7. You know, this is after it stabilized. But this is also based on the amortized debt, not the interest only. So just something to keep in mind. But going back to the instructions. Well, we don't, we don't have that in the instructions. I'm going to have to fill that in. Jonathan, this just shows you this, this is just kind of extra things anyway. But we got what we need to make the offer to talk to the bank. Whatever we need to do. This is just kind of show you where you would be on, on a return or what value will be created. So the stabilized value cap rate, we can use that 6%. So when you get through 1824 months with the value add, you don't know what it's going to be worth. So you put in 6% based on this net operating income property is worth $6.269 million. This is, this little section here is just for the purpose of a refinance. Let's say we're going to get 70% LTV 1% refinance costs paying off the underlying loan. We would have net proceeds of a million dollars. Now you got to keep in mind, you know you owe your partners got 1.003 but just coincidentally that's about what you proceed out of the refinance will be. So you can pay everybody off. Everybody's now in this deal with no money down and it's cash flow and say you want to sell it in 1824 months we'll use that same 6% cap rate sales cost of 2% and you have a projected gain of $1.8 million. And this is after paying off the partner capital 1.03. And if you want to know what that's going to look like for the partners if they're. If you gave them a 20% equity share of this deal, they would earn 362,000 would be their 20% of the 1.8. You would have paid them 170,000 preferred return. That's $533,000. So that's about a 26% annualized return. Any questions about those sections? I must have lost everybody on that. That.

No, just looking at it, it's just interesting. You know what would scare me there with that refinance option in 18 to 24 months, refinancing that loan, you've increased your loan amount by a million dollars which you've got to start paying on. So isn't that going to just change everything when you've got that larger loan and I mean with interest rates going up, planning on refinancing and adding a million dollars to your loan.

Let's meet back up in two years and I'll let you know. Yeah, that is a good point. But keep in mind this is short term debt. Local bank 6% don't like the 240 month amortization but that's just what takes to play ball with them. There's bridge debt. I can go to Lima One Capital right now and get me a loan and it's about 9% and probably about 3 points on the front end. And they'll do interest only probably two years. But it's a 9% interest loan. That's bridge debt, you know, bridging from to permanent. I could go get a Fannie because this property is 95% occupied. You can go with a Fannie, Freddie May, a Fannie or Freddie loan out of the gate. But it's going to have prepayment penalties. I got quoted I think 5.8 something percent seven year loan or Freddie but it's going to have seven years of prepayment penalties and it's going, you know it's a lot more hassle on the front end to get that loan. There's a whole lot more documentation, a whole lot. But it's non rec course loan so there's some something to be said for that. But because I know I want to refinance the property in two years to pull that capital out. I don't want to do that type of loan. So in two years that's the type of loan it would be and it'll be 30 year and you know, three more years of new interest only usually a lot lower, you know, lower rates. I mean you know year and a half ago it was 3.5% interest, you know on, on a loan like this. But just the 30 year AM the 360 month amortization is going to help you a lot. I just don't have all that calculated right here. You go ahead. You know I could have the you know, the new loan and loan payment amount calculated and the new debt service coverage calculated. But the, the NOI on this property is going to continue to go up. Right. This is just like what we're going to get to and you know, year one, two, year one and a half, two. So I don't know if that helps but you know pulling and again that's a different mindset thing. Pulling out as much equity as you can is a good thing. It may not be some cases, you know, you don't want to over leverage your, you don't ever want to over leverage over leverage your portfolio but as long as you're not pulling the money out to go buy, you know, buy some sports cars and a boat, you is different.

Right.

And you want to get the Cat, you know, the investors are capital back and that money's tax free. I mean, just say you didn't have any investors and you just had a million dollars laying around. You bought this deal and said, well, I'll just keep it in there and not refinance, and I'm getting a pretty good return, but why not pull it out tax free and take that million and go buy, do another one and then do it again and do another one and do it again, do another one with the same million dollars, you know. Mm.

And do you pay. I don't see where you've got paying off your investors there in the refinance option, are you?

No, no. That's what I was saying. You know, there's enough to do that. We could have done that. You could add a. You know, I modeled out a little further for that. Once you know, you're moving forward, you know, you would be like, model, model phase two. But this was. Again, just keep in mind, we're just trying to figure out what we can pay for the property, but then you can continue to. To go. So if you said best or capital.

Return.

Type that would be equal, or that was here, not much. $13,000. Yeah. Everybody go have a steak. But sometimes the exact model for this deal is there, was there. We're not showing enough. Something I left out of here. The lender required $145,000 of interest reserves that we have to put up. So that's another $145,000 capital we got to raise. And there's some. Some other costs we don't have. But my model doesn't show the investors getting all the capital back at refi. But we'll continue to pay the preferred return on that amount. They don't have it back yet. And then at some point it'll be returned either through the cash flow or the future sale of the property. But, but the way we would do it, just, just 13,000 will be distributed out, you know, the same percentage of ownership according to people's percentage of ownership. But it's. It's pretty hard to find deals now that you can, you know, back when things were going up so much and there were. When things were appreciating so rapidly, you could find deals, refinance everybody, you pull out money. And in addition to what every. Everybody's capital and this hard to find those.

Is that because prices have sort of plateaued?

Yeah, yeah. Well, there was just such demand. You know, cap rates got so compressed, interest rates were so low. It was on the front end of that, that, you know, as.

As it was.

Going up so fast, it was just easier to do, but. But they're still out there, just like this one, so.

Perfect.

So, any questions?

Yeah, yeah, let's. I like how we're already in questions. I know we were going to try and review a couple.

Perfect.

All right, guys, so if that helped you make sure you like and subscribe in the channel and this video. But then also, if you want to work with other investors, if you want to be able to jump on these calls or be able to work with us, we would love to talk with you and see if this is something that would be good for you. If that's you, click the link in the description. It should be a link there that allows you to book a call with us. So we'd love to help you out in that call and just maybe get. Maybe add a ton of value on that call, if anything. Best case scenario, we'd love to see if it's a good fit. We'd love to work with you. All right. God bless. We'll see you soon.