Case Study – Apartment Fix & Flip

Background:

The client was a high net-worth individual who made his living by buying, fixing up, and flipping estate homes. He was interested in diversifying his portfolio to something that would be consistent and not require a lot of his attention. He also wanted some value-added opportunity with a property. He felt that an apartment building could be a nice solution. After reviewing dozens of properties, I found one located at a prominent corner in the Haight Ashbury district of San Francisco on Page Street.

The Property at Time of Acquisition

The property consisted of 9 residential units and 8 parking spaces. The ground floor of the property had 8 garage doors, each  leading into an individual parking space, but there were no interior walls between garage spaces, so no security for any of the spaces, if someone left a garage door unlocked. Also on the ground floor, was a traditional apartment building entrance, with an old security pad with electronic door release for the front door to the building. There was also a small laundry room on the back side of the building on the ground floor, which contained one washer and one dryer that were coin-operated from a third party vendor. Above the ground floor, there were three stories, each of which contained a large one-bedroom unit in the building corner overlooking the street, a studio apartment in the middle of the floor, and a one bedroom at the other end of the floor. One of the main issues with the property was the fact that it was on the Soft Story Retrofit list, which meant that the building would need to have substantial seismic work done in make it safer in an earthquake. At the time the property was acquired, it was a voluntary list for building owners, but it was soon to become mandatory to do this seismic retrofit.

 

The Tenants at the Time of Acquisition

The majority of the tenants had been in the property for 2-3 years. There was one long term protected tenant that had been in the property for over 35 years. Under San Francisco Rent Control, a protected tenant is someone who is over the age of 65, or has a disability, or several other qualifying factors.

 

The Price at Purchase

The building was purchased for $2.750 million, including some concession for the seismic retrofit that would need to be done. The buyer put down $1 mil and financed the rest at a market rate apartment loan.

 

The Potential Value-Added Opportunity at the Time of Acquisition

The following items were key potential areas for value-added upside on the property that we could see at the time of purchase:

  • Seismic Work and Pass-through. The estimated cost to do the seismic soft story retrofit was about $165,000 from a competent engineer. The cost of this work, once completed, could be petitioned to the SF Rent Board to Pass-through to the tenants, on a structured amortization schedule that would spread out recovery of the cost for some 10 years. But, since the value of an apartment building is based upon gross revenues, such a potential pass-through increase could result in an additional $700-1200+ per month for the building, increasing the building value by over $250K based upon this portion of new revenue.
  • Legacy/Protected Tenant. The legacy 35+ year tenant in the building occupied a large corner one bedroom unit. Her rent was $775 per month for a unit that had a market value of over $3000 at the time. If we could find a way to buy her out, fix up the unit and rent it out for that $3000 per month, the increased rent of $2200 per month ($26,400 annually) could further increase the value of the building by more than $400K, based upon its gross income. The question was, could we buy out the tenant, and at what cost?
  • Garages. The garages were renting out at about $150 per month. If we could add separating walls between the garages, so that they were secure and private, we knew that the market rent for a garage in that area was $300 per month. An increase of $150 per month times 8 garages would mean an additional gross annual income of $14,400, and a subsequent increase in the building value of over $200K.
  • Washer/Dryers. One of the biggest scams in the apartment business is the coin-operated machines on a shared rental basis. It’s too easy for the coin op company to simply keep extra cash. While no one likes to believe this happens, but isn’t it odd that for 3-4 months in a row that EXACTLY the same amount of laundry was completed by the tenants. It would be a miracle! The property was receiving about $125 per month in shared revenue. The opportunity here is to actually by a coin-operated stackable machine for $2500 and then to keep the additional monthly revenue. Assuming that the $125/month being received was 50% of the actual amount collected, that meant that an additional $1680 annually, increasing the building value by over $25K.
  • Normal Turnover & Unit Upgrade. As units turned over with new tenants, the opportunity would be there to improve the kitchens and baths of the units, further adding additional rent. A unit kitchen and bath remodel, with re-doing the hardwood floors in the unit and fresh paint would cost about $30K per unit, if done correctly. But that same unit, which had been renting for $1500/month, would now rent for $3200/month, an increase of $1700 monthly and $20,400 annually. This increase would drive the building value an additional $300K for each unit that could be upgraded.

 

 What We Were Able to Accomplish

Here are a list of changes we were able to accomplish with the property over the next 24 months:

  • Seismic Retrofit. The seismic upgrade was done and completed for a cost of $165K. The cost was indeed passed through to the tenants and rents were increased approximately $700 per month.
  • Legacy/Protected Tenant. The tenant was bought out for $60K in cash and two months free rent ($1550 in rent concession). Once she moved out, another $30K was put into the remodel of the unit and it was rented out at $3350 per month, for a monthly increase of $2575 in revenue.
  • Garages. The interior garage walls were installed as part of the seismic retrofit and at an additional cost of only about $3000 for electrical/lighting work. The garages were all rented out at $300 per month and a waiting list was established. So, monthly gross income was increased $1200 in garage revenue.
  • Washer/Dryer. The owner purchased a vertical new coin-operated washer/dryer for $2800. The revenue from the machine increased to an average of $265/month, for an increase of $140 per month in laundry revenue.
  • Normal Unit Turnover & Upgrade. Three units turned over during the 24 month period. The resulting increase, with very little improvements to the units was over $2000 per month. Units were not upgraded as originally planned, as the market did not require it in order to achieve the higher rent.
  • New Security Gate and Intercom. We installed a new security gate at the front entrance and a more modern programmable intercom system. Cost was about $5000 for both.

The Building is Sold

The building was sold for $4.4 million a little over 2.5 years after it was acquired. Here’s what that looked like from the investor perspective:

$ 2,750,000                        Initial Purchase Price

     $ 50,000                         Closing Costs

$ 1,000,000                        Down Payment Required

$ 1,750,000                        New First Loan

$ 1,050,000                        Total $ In at Purchase

 

Capital Improvements invested

$ 165,000                            Seismic Upgrade

$ 61,550                               Tenant Buyout

$ 3,000                                 Garage Improvements

$ 2,800                                 Washer/Dryer

$ 10,000                               Normal Unit Turnover

$ 5,000                                 Security Gate and new Intercom

$ 247,350                            Total $ in for Capital Imrpvements

 

$ 1,297,350                        Total $ invested in Property

$ 4,400,000                        Sale Price

$ (352,000)                         Commission & Closing Costs

$ (1,750,000)                     Loan Payoff

$ 2,298,000                        Net Sales Proceeds/Total $ Out

$ 1,248,000                        Total $ Profit Before Taxes

118.9%                                 ROI Before taxes

47.5%                                    Adjusted for Annualization of ROI

 

 

Closing Thoughts

It’s important to realize that the investor did no hands-on work to make this $1.2 mil and 47+% ROI. My team at Lion & Foster International and I did the heavy lifting, strategic planning and the day to day operations to achieve this outcome.

This is just one example of doing a Value-Add strategy with an apartment building. We use this sort of strategy in our newest investment opportunity called the Perotti Apartment Fund I LLC. More information on the Perotti Apartment Fund I LLC can be found here.

Cliff Perotti

Producer and Host of our radio show. Cliff is a 30 year real estate veteran with experience in all aspects of residential and commercial real estate. He is the CEO/Managing Broker of Lion & Foster International, Inc., an international real estate investment and consulting firm. Cliff works with real estate brokers, developers, agents and investors alike. Simply put, he is a real estate aficionado.