Case Study: Don't Overlook The Ugly Ducklings.

Ugly Ducklings don’t always turn into Swans, and concerns over location, tenant mix and shabby conditions are usually valid reasons for a Buyer to pass on a property. Here, however, is another instance where an experienced and capable investor was able to accept a bit of a “project” in order to realize handsome returns.

The Property: A 4 level, 12 unit Apartment Block on a 33’ x 120’ RM-4 lot on Broadway near Fraser Street, in the Mount Pleasant area of Vancouver. The building is almost 9,000 sq.ft. in total area, and has “character” elements with high ceilings, wood floors and spacious suites (10 x 1 bdrm & 2 x 2 bdrm). It is fully sprinklered, with upgrades to electrical & plumbing, but had been quite neglected with obvious deferred maintenance, a leaking roof & 3 suites vacant due to extensive renovation and repair. The tenants were a mix of short & long term, and mostly low income persons.

The Revenue: At the time of listing, the “Year 2000” revenue was stated as $78,000/year, less vacancy of $5,640 and operating expenses of $20,713, for a net income of $51,647 giving a Capitalization Rate of 10.6% on list price. In fact, with the vacant suites and an adjustment for higher energy costs, the actual, annualized net income at the time of negotiation was approximately $20,000/year less than this.

The Buyer: After a number of offers for the property, a successful and determined buyer emerged. This person was a real estate professional and had, in the past, owned a building much similar in location, condition and tenant mix. Although he never said so during the negotiation of the contract of sale, the buyer was confident that he could overcome the shortcomings of the property and make it a smooth running and very profitable investment.

The Sale: The property was listed at $489,000, and it was assessed at $491,000. Because of the income, and in spite of the location and appearance, there were many showings to qualified buyers. The factors that caused most of these buyers to back off was the fact that the building condition and tenant mix were issues needing immediate attention. The successful Buyer carefully considered this situation and negotiated a sale price of $450,000, but made the sale conditional on an extensive list of due diligence items. Over a 30 day period, these items (building inspection, environmental assessment, City work order search, appraisal, etc.) were systematically satisfied and the subjects were removed. Even after this, though, there were a couple of last minute delays in completing the sale as “suprise” issues regarding environmental factors and building insurance coverage had to be dealt with.

The Financing: This was not a “slam dunk deal”. Even though the Buyer had a downpayment of $150,000, and was borrowing only $300,000 (2/3rds of the sale price), securing and finalizing the mortgage commitment was a laborious process. As mentioned, the lender looked for a very clean environmental report, and was very sticky regarding the building insurance. A mortgage was arranged at 7 3/8%, on a 3 year term, with a yearly debt service cost of $26,000.

Summary: The Buyer regarded the property as a project, and immediately began doing repairs and upgrades to the building, starting with a new roof and renovation of the 3 vacant suites. The building is heated by a natural gas boiler and hot water radiators, but every suite is also completely equipped with electric baseboard heaters tied into the electric panel in the unit. This allows the owner to convert (on a suite by suite basis) the heating system from gas to electric, and the utility costs from owner to mostly user pay! A vacant storage area (complete with its own electrical panel and plumbing) on the lower floor will become a coin laundry area for tenants. The Buyer expects to spend in the neighbourhood of $70,000 to $80,000 on the repairs and “beautification” of the property over the next 2 years or so. By doing this, he expects to achieve rents averaging $650/mo. for the 1 bdrms, and $800/mo for the 2 bdrms, for a gross income of $97,000/yr. Adding laundry income of approx. $2,000/yr, and reducing heating expenses by approx. $8,000/yr could allow a net income of $75,000/yr for a Capitalization Rate of about 14%, and a “cash on cash” return of about 25%! This “ugly duckling” might never be a swan, but it will likely be a “goose” laying golden eggs for its owner for a good long time!

Give me a call, Bob Bracken at 604-263-2823 if you would like to discuss this case study further or have any other questions.