I always combine both methods when I am looking to purchase a property such as is described here.
I always figure it will take me a year to stabilize the property and I use the number of vacant units times their stabilized rent for a year. I take that figure, add it to the amount I decide it will take me to rehab the units and THEN I include those two figures to my estimate of value package I use to make my offer.
These kinds of properties can be a goldmine if you know what you are doing. They can be a disaster if you don’t.
This question is related to vacancy and how that directly effects the offering price and the NOI calculations. The last 13 unit complex I bought had a 5% vacancy rate and at the time of purchase was completely occupied. So calculations we strait forward.
I have looked at all ten units in this other building and some of them need repairs such as carpet and vinyl replacment but most of it is poor up keep. The majority of the repairs could be made in a couple of months. The current manager this individual has hired is 20 years old with no previous managment experience. I have no idea how he expects to run this thing effectively with this type of management.
The actual question I have is when calculating NOI do you do it based on a 50% vacancy rate? I know the cap rate I want so the purchase price can be calculated based on a 50% vacancy rate, but as your aware the price will be extremely low. Is this realistic, even though after I take over I could most likely get it occupied within 6 to 8 months.
I have never attempted to purchase an apartment when the initial occupany is very poor. I know this should directly effect the offering price but how dramatically?
In situations like this I like to ask how long the existing tenants have been in the building. If the answer is , this one 2 years, that one 3 years, the other one 10 years etc. then you know the building is desirable to tenants (or was, LOL) and that the problem is rotten management.
If the tenants have all been there less than 6 months it is a danger flag.
You have to figure out what is going to happen under good management (yours) and work out a value accordingly.Use a vacancy factor of 5% if your experience teaches you that is reasonable.
Now deduct the cost of putting the building in good shape. In fact whatever it cost, double it. You deserve to get paid for your efforts.
Now you have a value. You must buy for less than that.
The seller’s value could be much higher or much lower, because his price is a wild ass guess while yours is based on an objective analysis.
To answer your question, bad management and high vacancy drags down the value dramatically. But this is temporary. Your good management and rehab skill will turn it into a good building full of good tenants in a few months to a year. Then it will be a good building as long as you keep it up.
I assume the building is structurally sound, and in a decent neighborhood.
This is not an easy one to figure since you have not indicated what value you put on the cash you have on hand to do this deal. Since its only 50% rented the prospects are slim that a lender will do a loan on it. So you will have to figure the value on the current rent/expenses and use a market rent for the unoccupied units once the work has been done to them to figure your value. Then subtract the rent loss advertising and carring costs for 12 months subtract that from your value and you have a good idea of the asking price.