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Real Estate Apartment Appreciation Targeted

Discussion in 'Real Estate Investing' started by SteveO, Sep 10, 2007.

  1. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    Some of you may have read this article as I have posted it before.

    Game Plan - Appreciation

    So many people discount appreciation as a viable way to invest. Targeted appreciation can work if you have a game plan. I am not talking about investors that buy non-cashflowing deals in California because property values always go up there.

    The following is the basic recipe that I use for apartment investing. Single family homes do not track on the same cycle and do not fit into this model.

    Start with the cap rate:

    Cap Rate = Net Operating Income (NOI) / Price

    (Annual) NOI = Gross Income - Expenses (Not including debt service)

    My plan involves finding areas that have been overbuilt with apartments and/or have had some temporary loss of jobs. So basically, these areas have high vacancy rates as a result. If an area is performing well, builders come to build and money pours into the area for development.

    If a location has job growth targeted in large amounts and high population growth, this vacancy issue will fix itself.

    Owners on the other hand are struggling. Offering rent specials and reduced rents to entice more business. Renters are now moving because the rent specials down the road are worth the extra work. The increased turnover is now leading to higher expenses. The bottom line continues to shrink. In these cases, a vacancy rate of 10% can easily be 18-20% rent loss due to concessions, non-pays, and vacancy.

    So, assume that your Gross Scheduled Income is at 290,000 per year and you have 18% rent loss. This would leave you with 52,200 loss and a total Gross of 237,800.

    So if your expenses are at 120,000. This would make your NOI at 117,800.

    The area is now undesirable due to the rent loss so the cap rate has gone up. Let's assume it is at 8% for example:

    price = noi / cap rate

    Price = 117,800 / .08 = 1,472,500

    Now is the time to buy in this location. Let's say that we buy at full price for the sake of the example. I think many investors may not but the example will still be relevant.


    So now we are a couple of years down the road. Vacancy has improved from 10% to 6%. Rent loss has gone from 18% to 7% (the ratio gets smaller as the rental market tightens). To top it all off, rents increased by 3% the first year and 5% the next.

    The initial GSI of 290,000 has now gone to 313,635. Rent loss is now at 21,955 and the Gross is now at 291,680.

    Taxes, insurance and labor (hourly rate) have gone up but maintenance, turnover, total labor, and marketing have gone down. So we will keep expenses where they were originally at 120,000.

    Our new NOI is 171,680

    Because the area is now more desirable due to better financials, the cap rate has gone to 7.2%.

    What has this done to our value?

    Price = 171,680 / .072 = 2,384,444 A gain of 911,944. !!!!

    If I put down 294,500 (20% of the price) that would be a gain of over 300%.



    What happens when we add in undervalue component where there is mismanagement going on. The initial price may have been more like 1,100,000 and the seller might have even carried back 5 or 10%. Do the math, it is incredible.

    Clearly there is a macro economy at play here also. The example only deals with the micro cycles of a given metropolitan area. If you catch the macro cycle on the upswing, the numbers would be better. On the downswing... well, you are hedging your bet by using a process.

    I have given a number of presentations showing real life examples. I went into most of them expecting 3-5 year holds but many ended up being 1-2 years because things went well. I have had a number of deals with returns over 100% per year. I have had others with no down that have returned over 1M in 2 years time.

    An area is not ripe for these returns just because it has high vacancy. Some areas do not recover well. There has got to be circumstances that cause the vacancy with something on the horizon that is going to remedy the situation. Once the area has improved, the building will pick up again thus renewing the cycle. The prime time to sell is just before this building occurs in most cases.

    There are really 3 parts to RE gains: casflow (gotta love it), appreciation, and value added. The value added part comes from mismanaged properties. This is not so visible in a market that is well occupied but it shows up clear as day when there are vacancy issues. The appreciation and value added components each will typically far outweigh the cashflow returns if the process is done correctly. The money from the gains can be rolled into a larger deal where there is more potential for higher cashflow returns and again.... appreciation.

    It is a process that I got right out of a book. I thought it sounded too simple.
     
  2. Bilgefisher
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    Bilgefisher Bronze Contributor Read Millionaire Fastlane

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    Steve,
    Thank you very much for this. I will be referencing this post often.
    speed+
     
  3. ProInvestor
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    ProInvestor New Contributor

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    Property management is crucial IMHO.

    SteveO any thoughts on property management for units. I have some but have a NNN lease so tenant issues aren't really a worry, but I would like to move to apartments/Multifamily.

    Rgds.
    proInvestor
     
  4. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    Strong property management is the cornerstone of the business. If you go find the best deal in the area but don't manage it efficiently, you will be going backwards. Everyone wants to do a good job but there are a select few that actually carry it out properly.

    Make sure that you are in alignment on your goals with the management team. Always check references and review their track record.
     
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  5. gita73
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    gita73 New Contributor

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    Steve-

    What are some sources you use to research potential areas to invest in? For example, how did you narrow it down and eventually determine that TX, for the time being, satisfies all the criteria you look for in your apartment investing?

    ProInvestor -
    What are NNN leases?
     
  6. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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  7. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    The primary drivers are employment growth, population growth, vacancy rate, and new construction (partially tied to permits).

    There are some other factors most of which will be fully explained in Vollucci's book.
     
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  8. TNT
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    TNT New Contributor

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    SteveO

    As always a great post. You bring a lot to the table and I am glad you are willing to share it. Thank you!

    Talmadge
     
  9. Yankees338
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    Yankees338 Bronze Contributor

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    Great post, SteveO! Definitely loaded with a lot of info. I, too, will be referencing this often...at least until I get my hand on Vollucci's book!
     
  10. JesseO
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    JesseO Contributor

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    What a great, quality post to read. Thanks for taking your time to post this. :notworthy:
     
  11. andviv
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    andviv Gold Contributor Read Millionaire Fastlane FASTLANE INSIDER Speedway Pass Summit Attendee

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    Bump.
    Every now and then I like to go back to some interesting posts. This is one of them.
     
  12. badtzuman
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    badtzuman New Contributor

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    I realize I'm a little late in this thread...

    Prop Mgmt is KEY!
    1) The best way to find great Prop Mgmt is to find out if there is a local Apt Assoc and ask them. Prop Mgmt in itself is a subculture/community where it is likely people know of each others track record.

    2) In hindsight, I would have found 3 Prop Candidates, and taken some time to have them walk the property, and units (if not all units). Then asked is this a property they'd do. Some Prop Mgmt Companys will tell you. What I'd be looking for is a very straight answer. So I think he is over promising? How long does he project the rehab and eviction to 90% occupancy would take.

    3) Check all references, AND go to ALL of the properties that they manage.
    If you can, knock on several doors and interview people. You'd be surprised, you might get a little history lesson on past and present Prop Mgmt, neighborhoods, etc.

    4) I would ALWAYS consider replacing the standing Prop Mgmt Company right away.
    Maybe there are a lot of repairs & they just get dogged down. But it seems, some Prop Mgmt create crisises for themselves, or just 9-5 it. Give me a Prop with a clear system and is very straight with you on a property.
    a) When we bought a 140+ property (I get the economies of scale, but it can work against you), we kept the Prop Mgmt Co assessing they were taking care of things, and they just needed better owners (us). Actually, they had been working with the sellers to boost occupancy, and on the books where there were Occupied units, they really were vacant. The economic Occ was always a vague number (oh were still collecting rents 3 weeks late, etc.). Fraud. We finally caught on 4 months after the fact and the Prop Mgmt burned through our reserves because of 2 emergency rehab repairs of $50K+ as they did not do a thing about Code Violations.
    So find the best People for your Prop Mgmt, period.

    5) Find Prop Mgmt, that thinks outside the box. In the research and interview phase, a lot of Prop Mgmt Cos may use similar vendors, that can be good, or it could be just good Marketing by those vendors. A Prop Mgmt that has ways of cutting costs, but can preserve quality through individual smaller companies, is simply great. It may be a sign that this Prop Mgmt Co is a actively seeking ways to improve the other line, and keeping his eyes open for better alternatives.

    6) Find a Prop Mgmt way during the period when you are considering an Apt or area to invest in. They want your business, and they are likely to give you some info on the street-to-street micro-culturalpolitics of an area. Obviously, you can check their customer service skills.

    7) Does it pay to spend good money on great and active prop mgmt? YES.
     
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  13. Bilgefisher
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    Bilgefisher Bronze Contributor Read Millionaire Fastlane

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    Badtzuman, I know others and I would love to hear your story. 156 units is no small feat from where I sit.
     
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  14. Yankees338
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    Yankees338 Bronze Contributor

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    Agreed! I love to hear your success story!
     
  15. badtzuman
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    badtzuman New Contributor

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    Quite Honestly,
    My team/group is still in the process of working things out. I just know from recent experience that Prop Mgmt is a MAJOR factor. Short of calling any particular Prop Mgmt Co out, the previous Co and Sellers artificially skewed the occ, and blamed it on the Prop Mgmt Program (fraud). Later we find out by the previous onsite Mgr that she was directed to not kick people out until a new person applied for rent, thus keeping occ at least the same level. We thought we were walking into the property at 80% occ. Not so.

    Our saving grace is our Team committed to seeing the project through, our new property Mgmt company and the local relationships we've developed along the way.

    This story and its success is still being written.

    Appreciation is a viable means to wealthy, absolutely, but in many cases you have to ask yourself can you handle the negative cash flow?

    We are new to apartment investing and had been looking for a 40/unit Bldg with our investing friends. We did find one but our friends noticed a 120unit bldg from the sellers off the market. It was packaged up to a total of 156units at $26500/unit in an area that sells for 30k to 35k/unit. Sounds like a deal. An investor friend even passed it to Dave Lindahl to go over the numbers and check if it was good deal. He said it was. But honestly, not knowing all the critical factors that slip between the cracks could cost you, things that we didn't even hear about in class, even with a walkthrough by a bldg inspector like, or replacing AC units because of new laws, new local taxes because of the amount of cooking oil being dumped into the sewer. You don't want to be sideswiped (and you will), so you have to seriously ask yourself, could you and you as a team handle the negative cashflow between the time of that appreciation given a worst case scenario?

    Right now given the liquid cash from our group, we think we can pull it off, so that conservatively we are a break even by next year. But this will make things tight for this year. At this point we are lucky to have some business lines in this credit crunch. But I think a new investor coming into the fold would give us a nice buffer.

    Also another bit of advice. investing in a group and leveraging resources, people, brainpower, and money is great. But if you plan on investing on something seriously, then go Without your team/group/tour and visit the neighborhood for a good week or two. This way you are not necessarily influenced by anyone, but yourself. Get the straight story from locals, police, local library(excellent). Restaurants/waitresses and local businesses are great resources. Visit them, and find out what their hopes are for the area, or what they are afraid of. These are the people who would likely be renting from you anyway.
     
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  16. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    Agreed.

    Once you determine an area to invest in, you must spend time in the ground to understand it. I actually visit apartment communities that are not listed for sale. Leasing agents are sales people by nature. I usually tell them that I am in the area for a year of that I am shopping for my kids. There is usually a lot of information that comes out in these conversations. Sometimes, you can even get them to tell you the problems and challenges in the area.

    Don't forget that local investors are looking at these properties also. You need to understand the area well enough that you won't be taken advantage of.

    Hang in there.
     
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  17. Jill
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    Jill Silver Contributor Read Millionaire Fastlane FASTLANE INSIDER Speedway Pass Summit Attendee

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    Good stuff, Steve. I just spent this week re-reading Berges and Vollucci. Excited about pulling the trigger!! Speed++
     
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  18. bflbob
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    bflbob Bronze Contributor Read Millionaire Fastlane Speedway Pass

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    I went and looked at a 32-unit yesterday.

    The numbers on it are fabulous -- 44% COCR, 17% Cap (with 15% vacancy).
    Seller financing at 6.5%, 30 years, 80%.

    Solid brick building, excellent foundation, newer roof and boiler.
    There is one section of the place that needs jacking and support.

    Tenants are mainly minimum wage, welfare, or abuse victims.
    Tenants pay anywhere from weekly to monthly, depending on when they are paid.

    It comes with an onsite property manager.
    An old Italian guy who is tough as nails and soft as Charmin.

    He said that when he moved in, it was a crack house.
    First night there, he wanders into a bunch of guys doing drugs.
    Tells them to get the hell out, he's calling the cops.
    One guy blocks his way, and he tells him "Move it sonny, or you're going to get hurt."

    Shortly after he gets to his room and calls the cops, they kick his door down.
    He said, "If it was only two, I could've taken them, but there were four."
    So he jumps on his bed and curls into a ball and let's them beat him.

    The property owner offers to let him leave and return his rent.
    He says, "Hell, no! Just give me free reign of the place."
    So, now the place is drug-free, although there are some boozers there.

    The bad news on this place is that it is a slum house.
    Four single rooms share a kitchen and bath.
    It was pretty filthy, and looks like it hasn't been painted since the moon landing.
    The rooms are furnished with a bed, fridge, and a dresser.

    As long as the property manager hangs around, I've got no problems.
    He handles the 3-days, and says that only 2 have ever gone to court (in 8+ years).
    "Treat them with respect, and you've got no problems", he says.
    The guy is a peach. The local welfare office even sends him one tenant's check.
    The tenant is a drunk, and the PM makes sure he gets food and pays the rent.

    So, I want to get a feel from the folks on here as to if this qualifies as a Value Play.
    I'm buying at about a 60% discount based on typical CAP for the area.
    I figure I'll need about $50-60k to pretty the place up a bit.
    (New appliances, carpet, patching and paint.)
    Looking to cash out in about 18-24 months with carry-over seller financing.

    What are your gut feelings?
    Any other slum lords out there?
     
  19. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    What is the area like? Can you permanently fix the issues in the property? Can you modify the rooms with a shared kitchen/bath?

    Can you do anything to improve the value or has the last owner done that with his management.

    I have had a couple of manager get assaulted by residents in the past. This was difficult for me to deal with on many levels. My targets now are set primarily on functional "C" properties in decent or better locations.
     
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  20. bflbob
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    bflbob Bronze Contributor Read Millionaire Fastlane Speedway Pass

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    The area is mainly older single/2-family homes.
    Nicer working class neighborhood, generally viewed as a good area.

    I don't think much can be done to the rooms as far as layout.

    A LOT can be done in terms of curb/visual appeal.
    It really looks like the place hasn't been touched in 40 years.

    The outside could be prettied up with some shutters, new doors and paint.
    The interior is just dirty. Old stoves caked with food, and the walls to match it.
    While I don't see this improving to a 10 cap, I think a 12% is reasonable.

    If I had gone into the place and it was clean, with updated appliances, I'd have had a much better opinion.
    It's sort of like a stinky "Cat Lady" house.
    No one wants it like it is, but cleaned up it is worth something.
    And most of what needs doing is cosmetic.
     
  21. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    Sounds like it may be promising. Improve the property and tenant profile while increasing rents and income sounds like a grand plan. The ability to improve the value through income and compressed cap rate sounds like a potential winner.

    The other income properties in this area have better tenants than this one?

    I consider the shared kitchen/bath as being functionally obsolete. It may have some affect on the market value. It may also have an affect on the ability to attract better tenants.
     
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  22. bflbob
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    bflbob Bronze Contributor Read Millionaire Fastlane Speedway Pass

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    The other properties in this area have MUCH better tenants than this one.

    Most in the area either own their home, or have good jobs.

    This is filled with seniors and the unemployed.

    They need a place to stay, and can't be too fussy.

    To put it in perspective...
    ...the neighbors have SUV's and Hybrids...
    ...these tenants have bus passes.

    The place comes with an extra commercial lot for parking.
    There are only 3-4 cars in that lot.

    As for the shared rooms, I don't like them either.
    My original thought was to convert to student "suites".
    But there is no common livingroom, and the general feel is way below other student housing.

    My best hope is to improve the place enough so tenants will stay longer.
    There are a few multi-year tenants, but most are short-term.
     
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  23. andviv
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    andviv Gold Contributor Read Millionaire Fastlane FASTLANE INSIDER Speedway Pass Summit Attendee

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    well, my concern is, can you run this place without the current PM? It seems to me the place is running just because the guy is there. What if he decides to move?
    Also, what is the rent upside potential? Could you raise the rents? by how much?
     
  24. bflbob
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    bflbob Bronze Contributor Read Millionaire Fastlane Speedway Pass

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    Andres,

    Put it this way...I wouldn't WANT to run it without him.
    But, I talked him, and he has no intentions of moving.

    Rents could only be raised minimally in my mind.
    Right now, they are $325-365/month.
    Even if I rehabbed the place, I don't see more than $400/unit.

    My biggest gain would be from reducing the vacancy.

    Right now, the seller is using 15% for the rate.
    One unit is "office", which the PM says is just full of junk.
    There's plenty of storage space in the place, so I'd get that one rented.

    I think the rehab would reduce the vacancy more than increase the rental rate.
    As is, there is $18,000 in vacancies.
    Reducing that to $8-10k would add a lot to NOI and valuation.

    The PM indicated that the advertising has been spotty.
    He says, "If I get the calls, I can get it rented."
     
  25. SteveO
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    SteveO Legendary Contributor FASTLANE INSIDER Speedway Pass LEGENDARY CONTRIBUTOR Summit Attendee

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    There was talk in another post about forcing appreciation so I figured this was worth a bump.
     

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