Posted by ray@lcorn on May 21, 2007 at 19:32:42:
I don’t think there is a deal here.
A turnaround has to do two things…
First, you have to provide for carrying the property during the renovations. Numerous ways to do that… but most often it is some combination of existing cash flow plus any new funds needed to cover the amount of negative cash flow (deficit), including any debt service during the interim. The deficit funds are added to the hard reno costs, and that’s your total capital investment.
Second, a turnaround has to have an exit strategy that provides a return on the capital invested.
This deal sounded workable until I got to the last number… potential gross of $25T per month after rehab. That means the anual potential gross is $300T, and with normal 40% expenses the NOI would be about $180T.
If the end value is calculated on an 8% cap, then it would be worth somewhere around $2.25mm. At a 7% cap, $2.57mm, and at 6% about $3mm.
With an asking price of $2.9mm, rehab costs of $750T plus carrying costs, and mid-range estimate end value of say $2.6mm, there isn’t enough there to cover costs, much less provide a return. On that subject (which is why we’re all here, eh?;-), I look for 24% average annual return for this type of deal, with a three-year hold period. (Typically it takes about a year for the heavy lifting, a year to get the rent roll stabilized, and ready for sale in year 3.)
Guessing total capital investment of $850T (costs plus carry), I’d be looking for about that much profit inclusive of one year of positive cash flows.
Sooo… $2.6mm less sales expenses (~4% or so), less my profit and net costs of say $1.5mm, leaves about a $1mm sales price.
I doubt the seller is going to be interested in checking my math(!), but if I’ve assumed something I shouldn’t have let me know and we can reanalyze.
p.s. yes, that’s an aggressive return target, and it knocks me out of a lot of deals, and that’s okay with me. I’m at the point that unless I am going to be paid pretty well I’m not going to take on the project. Many folks accept accept less and do very well. It’s a personal decision, and has much to do with where you are on the curve.
p.p.s. At a 15% average annual return (which I think is the minimum anyone should be paid to take on someone else’s problems), the profit and costs would be about $1.2mm, leaving a present value of about $1.3mm, still likely a non-starter for the seller.