A beautiful apartment complex, Craddock St Apartments, has recently come on the market in San Marcos, TX, home to the Texas State Bobcats. A group of investors are analyzing the property to determine if it would be a worthwhile investment.

Here are the facts as presented by the listing Real Estate Company.

Total # Units – 72 Asking price: $4,450,000.00

62 – 2 bedroom units @ $650 / month

6 - 3 bedroom units @ $1,100 / month

4 - 4 bedroom units @ $1,500 / month

Each apartment includes a stove, hood microwave, dishwasher , washing machine and dryer .

One of the 2 bedroom units has been converted to become the rental office, one of the 2 bedroom units is being used for storage and one of the 4 bedroom units is occupied by the apartment manager and her family. The apartment manager does not pay any rent.

The leases are typically one year leases with tenants responsible for paying their own utility bills, electricity and water. The refundable security deposit is one month’s rent.

The historical occupancy rate runs at an annual rate of 95%.

Approximately 5% of the renters do not pay their rents and are evicted after 2 months of not paying their rent. When evicted the renter forfeits their security deposit. It costs the apartment complex $200 in fees to evict a tenant.

Historically, Craddock St Apartments has been able to increase rents by 2% each year.

The owners of the apartment complex are responsible for paying all common area costs that include common area lights, pool maintenance, trash collection, pest control, landscaping & grounds maintenance. Currently the annual costs related to each of these is:

Electricity - $12,000

Water - $9,000

Pest Control - $16,000

Landscaping Materials & Supplies- $7,200 & $2,400 for Pool Supplies

Trash Collection - $4,800

The complex employs a full time grounds keeper / maintenance person for $26,000 per year, fully burdened. Additionally, the complex has a full time manager who is responsible for leasing all of the units. Due to the fact the apartment manager lives rent free, her annual salary is $20,000.

When new tenants move each apartment is “made ready” which usually cost $150 per apartment.

Due to the age of the appliances and the apartments the annual maintenance cost in materials, is $300 per apartment.

The property tax rate for San Marcos is 2.77% of appraised value, which is reset at the selling price, each time a piece of property is sold. The cost to insure the property is based on the value of the property and the annual rate is 0.7% of the value of the property.

The cost to maintain the rental office is approximately $2400 per year for telephone, key copying and office supplies.

Additionally, the owners like to keep a safety account of 2% of the annual rents, just in case of a major repair.

Since the investors all have students that attend Texas State they are very interested in looking at this opportunity. They plan to finance this purchase, using as much leverage as possible, to maximize the return. A preliminary look at financing terms reveals the following, Interest rate on a 15 year commercial loan is 6.1%, on a 30 year commercial loan is 6.5%, the interest rate and on a jumbo loan for 5 years with the balance of the loan being paid back in year 5, the jumbo loan rate is 4.8%. The projected interest rate in 5 years, due to increasing inflation is 7%. All banks now require a minimum down payment of 25% of the purchase price. One time closing costs are expected to be 2% of the purchase price.

Upon preliminary inspection, it appears that there is some deferred maintenance and to keep the property up to the perspective owner’s high standards, required maintenance in future years. They estimate that 10% of the units will require a maintenance investment of $5,000 each immediately, with the remaining units being updated at $5,000 per unit over the next 5 years, 20% of the remain units being updated each year until all the units have new HVAC, plumbing fixtures and appliances.

Upon looking at the rent rolls, the investors were pleased to see that due to the efforts of the apartment manager, 95% of the tenants paid their rent on time, the other 5% being the tenants that are evicted.

One area of concern is the large number of new apartments being built by both the university and private apartment complex developers in the San Marcos area. Over the next 5 years the number of available apartments was due to increase by 50%, while the student and general population was only expected to increase by 33%. This would mean a very very conservative estimate for appreciation of 1% and each apartment would have to be kept up to “Class A” standards to be competitive. To help the group felt that an advertising budget of $12,000 per year, for adds, signage and brochures would keep Craddock St Apartments in the public’s eye.

Because the investor group includes an accountant and an attorney no legal or accounting costs are expected to be incurred.

The investor group will require a minimum return of 8% to do this deal, but would prefer 10% if possible.

The investors were not sure how long they wanted to own the apartment complex if they purchased it. Some felt that they should sell it when their children graduated from Texas State. Those estimates ranged from 5 years to 15 years, so they decided that they should run the analysis for return and resale in 5 year increments. When they sell the property they will pay a 6% commission to a real estate agent.

Questions:

1. List all of you assumptions in doing your analysis.

2. Is this a good investment at the asking price of $4,450,000.00 in year 5? 10? 15?

3. If it isn’t a good investment at the asking price what should the offer be and why?

4. What are some of the risks to the investors if they decided to purchase this property?