December 11, 2019

JF1926: How To Underwrite A Highly Distressed Apartment Deal | Syndication School with Theo Hicks


We’ve covered underwriting for more “normal” value add apartment syndication deals. Now we’re going to hear the differences between underwriting those deals, and underwriting highly distressed apartment communities. Theo will cover how you should underwrite highly distressed deals. If you enjoyed today’s episode remember to subscribe in iTunes and leave us a review!

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Joe Fairless: There needed to be a resource on apartment syndication that not only talked about each aspect of the syndication process, but how to actually do each of the things, and go into it in detail… And we thought “Hey, why not make it free, too?” That’s why we launched Syndication School.

Theo Hicks will go through a particular aspect of apartment syndication on today’s episode, and get into the details of how to do that particular thing. Enjoy this episode, and for more on apartment syndication and how to do things, go to, or to learn more about the Apartment Syndication School, go to, so you can listen to all the previous episodes.


Theo Hicks: Hi, Best Ever listeners and welcome to another episode of the Syndication School series, a free resource focused on the how-to’s of apartment syndication. As always, I’m your host, Theo Hicks. Each week we air two Syndication School episodes on the best real estate investing advice ever show podcast. You can also watch them in video form on our YouTube channel. These episodes focus on a specific aspect of the apartment syndication investment strategy.

For the majority of these series we offer some sort of resource. These are PowerPoint presentation templates, Excel calculators, PDF how-to guides, things that accompany the episode or the series. And of course, these are free for to you to download. All of these free documents can be found at, as well as all of the past Syndication School episodes.

This episode we are going to talk about how to underwrite a highly distressed apartment deal, today’s episode, and then the next Syndication School episode is gonna be focused on underwriting.

When you are underwriting your normal value-add or turnkey apartment syndication deal – we’ve covered that already in Syndication School. In fact, we did I believe a six-part series, or maybe even an eight-part series on underwriting… So if you want to learn how to underwrite those types of deals, go to, or just go to, type in “underwriting”, and then you’ll see all of those Syndication School episodes where we went over in great detail how to underwrite deals, we gave away a free simplified cashflow calculator, as well as some other documents to help guide you through the underwriting process.

This process is a little bit different. This isn’t an actual calculator. You can technically use the cashflow calculator that we provided, but you need to make some manipulations, just because when you are doing a highly-distressed deal, the upfront assumptions of underwriting are gonna be slightly different.

So we’re gonna find a highly-distressed deal that is something that has a low occupancy rate, so something that’s not stabilized,  so below 85%, but it could as low as 50%, or it could be completely unoccupied. It’s also something that has a lot of deferred maintenance; this isn’t a deal where it’s already got the deferred maintenance cured, and your plan is to either go in there and just continue to operate how it currently is, or if your plan is to go from that foundation and implementing some value-add business plans like renovating the units, adding some exterior amenities to increase the rent. This is different; this is when those things need to be done, obviously, but there’s also the added thing of a lot of deferred maintenance. Another example would be thing that have very big tax liens on them.

Basically, this is a deal that requires a lot of upfront capital to even get it to the point where you can start collecting money. So when you are underwriting a distressed property that fits that criteria, rather than just starting right away with “Okay, all my cap-ex are gonna be to add value”, you need to take a different approach… And we have a formula for calculating the max purchase price; the formula is going to be the stabilized value, minus the deferred maintenance expense, minus the stabilized expense loss, minus contingency, minus an equity fee, minus other expenses. I’m gonna go ahead and define all those, obviously, and then we’re gonna give away this document that I’m using as a guide for this for free, just so you can have that without having to have an audio form… So you can just be like “Alright, I’ve got a highly-distressed deal. What do I do? Oh, I’ve got this document in handy, that walks me through that entire process.”

So let’s go ahead and define the inputs and the outputs of this formula. Obviously, the output is the max purchase price. That is what you are calculating, and that is going to be the maximum amount of money that you’re willing to pay for the property. So what is the highest purchase price you’re willing to offer for this highly-distressed property? That’s number one.

The next thing – this is really the only positive input, which is the stable value of the property. This is gonna be the value of the property when it is fully operational. So you’ve addressed all the deferred maintenance, all the other issues… It is stable, so you’ve got an occupancy rate that’s at least 85%, and to calculate this number you want to divide the stabilized net operating income by the market cap rate.

To get the market cap rate you wanna talk to your broker, property management company… There’s lots of reports out there that talk about what the cap rates are for particular markets, but it’s gonna be pretty specific to what you expect the stabilized product to be; is it a class A, class B or class C market? All those things go into what that market cap rate is going to be, so it’s gonna take some research on your point, because I can’t just give you a general number and say “Hey, it’s gonna be a 5% cap rate”, because I don’t know where you’re investing, I don’t know what class the property will be once you’re done curing deferred maintenance and doing renovations… So make sure you have a conversation with your experienced property management company, the broker… They should give you an idea of what the market cap rate is for — not what the market cap rate is for the property in its current condition, but what’s the market cap rate for once this property is actually stabilized.

Then for the net operating income – this is why I mentioned that you can use the simplified cashflow calculator that we gave you, but there’s upfront work before you’re gonna input data into that. So once everything is stabilized, once all the deferred maintenance is cured, you can underwrite the deal like any other deal… And when you do that, you’ll have your one-year, two-year, three-year, four-year, five-year etc. income projections, expense projections, and then your net operating incomes.

And even when you’re underwriting a regular value add deal, you start how it currently is operating, and then you say “This is what I plan on doing, and based on what I plan on doing, this is the new income based on the rents and other incomes being collected. Here’s the new expenses based on how it’s currently operating and how I expect to operate it, and here’s my net operating income.”

So you wanna follow that same process to calculate what is going to be your projected net operating income once you’ve taken this property from highly distressed to stabilized. This is not a five-year NOI, this is — alright, let’s say for example the property is at 50% occupancy, and that’s really the only issue. Well, what’s the next operating income once you get it up to whatever your occupancy projection is?

If you project an 8% vacancy rate, then what is going to be the net operating income at 92% occupancy with everything at market rents, and the expenses being whatever you decide the expenses to be based on, again, how the property is currently operating and the conversation with your property management company and how they can operate it.

I go into a lot more detail on that in the episodes about underwriting a standard deal. You can use the advice I gave there plus what I’ve just said to figure out how to calculate that stabilized value. But overall, it is gonna be based on the market cap rate once that property is stabilized, and the NOI once that property is stabilized. That’s the positive input. Now, everything else is gonna be subtracted from that stabilized number.

First you wanna just subtract deferred maintenance. What are the costs to cure all the deferred maintenance issues, both interior and exterior? These are not going to be things that are value-add, these are things that are gonna be things that need to be done to get the property actually functional.

Maybe there’s a bunch of units that are completely down, that can’t even be rented. That’d be an example of deferred maintenance. Maybe half the roofs are really old and leaking. That’s deferred maintenance. Those are things that are required to be addressed in order to make the property livable. So tally up all those costs. Obviously, that requires going to that property, doing your due diligence… So you’re not gonna have an exact number upfront, but we’ve talked about, again, in previous Syndication School episodes on how to determine these things before you actually put the deal under contract.

That involves going to the property, talking with experts, getting some high-level quotes from experts as [unintelligible [00:10:10].11] having conversations with the property management company to figure out what these items are, and then what the cost of these items are. And then you can also ask the owner, but again, you can’t totally accept what they say to be true for deferred maintenance, because they might not necessarily be giving you all of these correct information, or all of the deferred maintenance issues.

So subtract deferred maintenance from the stable value… You’ll also wanna subtract what we’re calling the stabilized expense loss. Let’s say that it takes you one year after buying the property to get it stabilized, to actually start collecting rent. Well, there’s a lot of money that’s going to be lost during that time, so you can’t just start your proforma at end of year one; there’s a whole entire year of you paying insurance, of you paying utilities, of you actually using rental income that’s coming in. Not only are you not making any money, but you’re actually paying money. So you wanna account for all of those things  as well – all the rents that are being lost, all the income that’s being lost and all the expenses that are being paid need to be included in this formula. So you wanna also subtract that number from whatever that stable value is.

Next is contingency. You’ve got your deferred maintenance budget, you’ll also want to have a contingency budget, again, just in case you weren’t able to identify all of the deferred maintenance issues, because that’s going to be impossible until you actually get in there. Sometimes you need to actually break into walls and you realize “Oh my god, there’s so many more issues.” You hear stories about that all the time.

For this particular formula, we recommend having at least 10% of that deferred maintenance budget as contingency. Sometimes people do 50%, sometimes people do 20%, 25%… It’s really what you’re comfortable with, but the point here is to 1) actually have a contingency budget, and 2) have it be at least 10% of the deferred maintenance cost. So if deferred maintenance is $100,000, then you wanna have an extra $10,000 as contingency for a total of $110,000 between the deferred maintenance and the contingency expense.

You’ll also want to account for equity fee. So you’re putting in all this effort into turning around this property, and in return for the effort you should want to get paid for that. Obviously, you’re not going to be getting paid from rents, so the way that you recapture that risk you put into the deal is through an equity fee. This is going to be a percentage of the stabilized value. How much equity do you want to have built up in return for your efforts? …and you subtract that from your purchase price. So rather than paying a million dollars, if you want to have $100,000 in equity, you pay $900,000 for your efforts. So you’re getting in at a discount because of all this effort and risk that you’re putting into the deal.

And then lastly is other expenses, so really anything else. As I mentioned in the introduction, talking about what types of deals can be considered highly distressed, it could be things that have tax liens on them. So if there are delinquent taxes, then you’re gonna wanna go ahead and make sure that you’re accounting for  that in your purchase price. So if you have to pay $100,000 or $50,000 in tax liens, you’re gonna  wanna reduce your purchase price by that $50,000 number, so that you’re not actually paying for the mishaps of the current owner.

These could be also things like financing fees, if you’re getting a loan on the property and not paying cash, acquisition fees… The acquisition fee would be something that you would charge if you’re raising money for this deal, or it’s just kind of your typical closing costs; things you need to pay for during due diligence, any of those upfront costs that you need to pay to actually close on the deal. Those are pretty standard across really any apartment deal. The specifics here would be any sort of delinquent taxes or some other type of lien on the property that needs to be paid off before it can even be sold.

So again, the formula is max purchase price, which is the maximum amount of money that you can pay for the deal, equals the stabilized value, which is based off of the cap rate and the NOI, minus all deferred maintenance, minus stabilized expense loss, so all the things you’re paying for while you’re actually stabilizing the property, minus contingency, which is a percentage of the deferred maintenance budget, minus an equity fee, which is the amount of equity you want to make based off of your efforts and taking the risk, minus all other expenses, whether they’re liens or the standard closing costs.

Before we close, let’s just go over an example. This is not a real-life example, this is something to show you how to calculate what the max purchase price would be on a highly-distressed property.

Let’s say you’re looking at a 100-unit apartment community that is currently 50% occupied. And again, we’re gonna give this to you for free, so I’m not gonna bring out my calculator and show you all the math. I’m just gonna say “This plus this equals this.” So you’ve got a 100-unit apartment community, half the units are vacant. So 50% of the units have already been remodeled for $5,000 each, and they’re all rented for $100,000 per month. So half the units are all fully renovated, remodeled, renting for $1,000/month, and it costs $5,000 to renovate those units.

Of the 50 vacant units, half of the units are flooded, and you’ve determined the cost of deferred maintenance is $1,000/unit, plus the additional $5,000 in renovations required after the water damage to bring it up to that remodel level to achieve that $1,000/month in rent… So a total of $6,000 needs to be invested in those 25 units.

Then the other 25 units need just to be remodeled to get that $1,000 market rent, so $5,000 is required for those. So really only 25% of the units are actually messed up, 25% are just not renovated, so it’s more of like a value-add play… And then 50% are actually done, ready to go, being rented. Also, let’s say you calculate the exterior deferred maintenance. Let’s say maybe the roofs in these 25 units are all leaking, so you need to spend 30k to fix those roofs.

Then you spoke to your contractor, they said “You know, it’s gonna cost  you 30k, you’ve got the 5k costs for the renovations, it also costs 1k to fix those water damages, and  it’s gonna take us six months to complete.”

Let’s also say that the owner has 50k in delinquent taxes. Those are kind of all the inputs you need to know. Then you talk to your property management company, you talk to your broker, and based on current listings of a similar product once it’s stabilized, you have the market cap rate of 10%… Which is obviously pretty, but that just makes the math a lot easier on our end.

You calculate that the stabilized annual expense per unit is gonna be $6,840. So the expense per unit for this deal is $6,840, and times a hundred, overall that’d be about $684,000. So how do we calculate the max purchase price? Again, I know I went through all that really quickly. We’re gonna give this away for free so you’ll have all the information in front of you, so you can have an idea of how to calculate these numbers.

Obviously, I just said exterior deferred maintenance is 30k; there’s a lot more that goes into that than just pulling the number out of a hat. You have to go to the property, you have to talk to contractors, things like that. But we already talked about that earlier.

So the stabilized value is going to be the annual income, so you need to figure out what the annual income is first, then figure out what the annual expenses is first, and that’ll help you determine the NOI. So the annual income is based off of 90% occupied, times 100 units, times $1,000/month, times 12 months, is about one million dollars. So this is $1,080,000. That’s the total income once this thing is 90% occupied, and then you’ve got the units being rented for $1,000. The annual expense, as we’ve mentioned, is $6,840/unit, times 100 units, is $684,000; that’s gonna be your expense… So your net operating income is the subtraction of those two, so you’ve got $396,000. The stabilized value based on a 10% cap rate is 3.96 million, which is $396,000 divided by 10%.

So you’ve got your stabilized value of, again, 3.96 million dollars. That’s one input. Deferred maintenance – so you’ve got interior deferred maintenance on the 25 units that just had the water damage, which times $1,000 is $25,000. You need to rehab the interiors of those 25 water damaged units, as well as the 25 units that have not been renovated, so $5,000 times 50 is $250,000. You’ve got your exterior deferred maintenance of — I say 50k here, but it should be 30k… And then you’ve got the deferred maintenance, which is a total of all of those; again, part of that is value-add, but that’s $25,000 plus $250,000, plus $50,000 now for the exterior deferred maintenance (I misspoke earlier). So a total of $325,000 for deferred maintenance.

For the stabilized expense loss we’ve got the 50 units that are vacant, times the six months that they’re vacant, times $1,000, which is $300,000… So that’s accounting for the income that’s lost; we’ve already accounted for the expenses… We’ve got the contingency, so we’re gonna do 10% for this case. 10% of the $325,000 deferred maintenance is an additional $32,500.

Let’s say that I want 10% equity for all these  efforts, so take 10% times the stabilized value of 3.96 million dollars, so the equity that I want is $396,000. And then other expenses – you’ve got your delinquent taxes of $50,000, closing costs of (let’s assume) $50,000, and let’s say you’re raising money for this and you want an acquisition fee of $50,000… For a total of $150,000.

So the max purchase price calculation is that stabilized value minus all these numbers. So 3.96 million minus the 325k in deferred maintenance, minus the 300k in the stabilized expense loss, minus the 32,5k in contingency, minus the 396k in equity, minus the 150k in other expenses… Brings you to the max purchase price being 2.7565 million.

Now, just to maybe reiterate, or just to say that this is obviously a very, very high-level… So a lot of these numbers — again, I kind of just said “Hey, here’s an example”, but again, underlying those numbers is a lot of extra effort to get the numbers. And then obviously, once you’ve done all this, you’ll also want to fully underwrite the deal. “Alright, so it takes me six months in this case to get it stabilized.

Once I’m there – alright, how does this deal perform based off of this purchase price?” Then you could actually adjust that purchase price even lower from there. Again, this is a max purchase price… But at the end of the day the deal might not make sense at this purchase price if you start to underwrite it out fully, look at a five-year proforma, and have a specific return goal in mind for your investors, in that case. This isn’t really taking into account the ongoing ROI; that’s something that you wanna do after you’ve come to this conclusion for the max purchase price.  But this is a great place to start… Of course, all of these deals need to be underwritten on a case-by-case basis.

As I mentioned in the beginning, this document that I’ve used as an outline for this episode will be available for you to download for free, in the show notes or at, so definitely take advantage of that. We’ll be back tomorrow, or if you’re listening to this in the future, the next Syndication School episode is going to be talking about the sales assumptions when you’re underwriting a deal. So what to assume about your exit when you’re actually initially underwriting the deal.

Until then, make sure you check out some of the other Syndication School series about the how-to’s of apartment syndication. Make sure you download this free “How to underwrite a highly distressed deal” document. All that is available, again, at

Thank you for listening, and  I will talk to you tomorrow.

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