Apartment Investing

[SteveO]

I fondly remember the subordinate that used to work for me. I was attempting to coach him in his development as a technician. He told me that if I was going to make his job "not fun" that he would quit. I asked him why and he told me he did not need the money.

I changed my approach and started asking him questions. He told me about the apartments that he owned.

For the next few weeks I started reading books and asking him more questions. I repeatedly asked him how to get started. His only response was "just go do it" or "just go buy something".

Well, I learned how to evaluate a property and estimate income and expenses. Then I got listings of every single property in town. I drove past most of them to get ideas and narrowed it down to certain areas. Then I started tossing out offers. Most of them were refused because I was looking for a seller carryback of 10-15%.

I did not have a lot of money to use. Fortunately, I had a house and was able to take a third mortgage (that is right, I got a "third loan on my house").

I found a seller of a 4-plex in Carlsbad, Ca that had an ocean view. The seller was tired of operating this property and gave me the seller carryback. I negotiated the asking price down from 230K to 180K.

There was one vacant unit when the transaction closed. I remember standing inside of this unit, looking around, and thinking "what in the F*ck did I get myself into. It looked like so much work.

I got the unit ready and rented it. Never had another vacancy with this property for the remaining 2 years that I owned it.

 

[SteveO]

Feel free to ask any questions that you may have with regards to investing in apartments. Keep in mind that there are some limitations with regards to local income and expenses in your particular market that I may not be familiar with.

 

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[IceCreamKid]

sorry for a layman's question, but to clarify- your business plan for apts is to sell in 5 years after purchase? Sorry if I misread something.

Steve, with your permission may I give a breakdown of a simple reposition deal? I think it will help many understand the basic foundation of the process. I will delete this post if it conflicts with your investment strategy...not trying to steal your thunder here, my friend!

• Assume you get a chance to purchase a 40 unit building for $1M that you buy at a 12 cap. The owner is old and not interested in pushing rents at all so the units are renting at $500/month which is $50 below market rent. The property is 100% full and operating with expenses at 52% of PRI
• Let's see what happens to our investment if we get rents to market levels and manage our leases to get a 3% increase per year over the next 5 years. Let's also assume that we can manage expenses to be no more than 45% of PRI
• $50 per unit per month increases NOI by $24k/year
• 3% annual increases will drive market rents up 16% or an additional $88 per unit by year 5, or another $42,240/year. Rents would average $638 starting year 6
• Dropping expenses from 52% to 45% and holding them steady adds an additional $21,400 to NOI
• These three steps add over $87k to NOI which is enjoyed over the life of the project.
• Assuming the cap rate remains stable this would create appreciation of $725k at sale
• If you purchased in the path of growth and created a more stable project the cap rate could go down, at a 10 cap this increased NOI would generate $870k of appreciation

 

[SteveO]

When you say exit the business, do you mean exit the process of repositioning apartments? In other words, you will just buy and hold these 100-200 unit buildings after they are paid off?

Yes, exit the repositioning process. In terms of cashflow, I can get by on $50K per month.

 

[G_Alexander]

@SteveO

Have you ever purchased a building that was fully vacant and in need of rehab? This scenario does not allow the use of traditional bank leverage on the front-end (due to the obvious lack of cash flow generation at acquisition) but is an attractive scenario if you have the equity investors available to stake you. This is not revolutionary, but wanted to hear your thoughts as I know you have done syndication (just not sure if it has ever involved a vacant project).

Theoretical example
Property: 15 units
Asking Price: $450,000
Vacancy: 100%
NOI: $0
Purchase price: $300,000 Cash
Closing costs, rehab, and lease up (6-8 months): $175,000
Total project costs: $475,000 Cash
Gross Rental receipts: $15,000 / mo ($180,000 / yr) -- ($1,000 per unit avg., assumes no laundry or vending for simplicity)
Net Operating Income: $105,000 / yr
Cap Rate: 10% (more of a "fringe" neighborhood)
Net Value end of Year 1: $1,050,000

Refinance, pay off the equity investors their $450,000 plus a preferred return of 12% as well as 50% NOI split post lease-up to sale.

Cash out at Refinance: $787,500 (75% LTV)
Cash to investors: $532,000 + 17,500 (4 months, $4,375 a month after lease up)
Total Cash to Investors: $549,500
Cash Received: $238,000
Remaining Net Equity: $262,500 (25%)

We have just created $500,500 in value to ourselves. We hold the property at 75% LTV post-rehab after paying all investors off and realize both long-term cash flow and substantial liquid equity for our next project. We have also now established a track record with investors who are begging for more 12% preferred returns all without involving banks until we get to the long term hold period period.

Syndication is not a revolutionary concept, it just takes valuation skills, a track record (first deals can be family and friends), MARKETING ability (get people to rally behind you, and speak with their $$$$), a defined plan (entry and exit) and a little structure. The scenario I laid out is very rosy, but if you have cold hard cash banks will move mountains to offload "non-performing" assets to you.

I know that you will have some insight on this topic and figured I would ask this publicly so others can benefit.

Thanks again SteveO, not just for this thread but for everything you have done for this forum. I have said it many times before and I will say it again... @SteveO, @RealOG, @GLC65 and of course @MJ_Demarco. You guys are all the greatest bunch of RE mentors anyone could ask for and hold a special place in my heart!

 

[SteveO]

In all the years that I have been investing in apartments, I have never seen a real 10 cap. I doubt that I have ever seen an 8. Income and expenses are rarely reported in an honest fashion. A proforma is usually handed out to potential buyers. The income and expense numbers are usually estimates done by the agents or seller that grossly misstate the actuals. Actual numbers are frequently doctored also.

It is best if you have your own numbers for expenses and income. There is too much to this for me to go into right now.

 

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[SteveO]

What steps do you take to shield your investments? LLC for each property? One holding company?
Have you leveraged equity in your properties to do other deals? Is this worthwhile? Seems like a good way to increase speed?

I do use individual LLC's for each property. LLC's and inexpensive and easy to use in most states. I also have another LLC for my management company. This way, my management of the property and the actual property are operating separately.

I have leveraged equity in the past. It is probably better to sell the property with the equity and roll it into a larger one if your plan is to keep growing. If you find some fantastic deal and the only option is to leverage equity, then you have more to think about. Leveraging your equity means both properties are at risk if one has problems.

 

[SteveO]

Have you ever purchased a building that was fully vacant and in need of rehab? This scenario does not allow the use of traditional bank leverage on the front-end (due to the obvious lack of cash flow generation at acquisition) but is an attractive scenario if you have the equity investors available to stake you. This is not revolutionary, but wanted to hear your thoughts as I know you have done syndication (just not sure if it has ever involved a vacant project).

Excellent!!!!!!!
I really wish that I had your head at your age!

I have purchased vacant deals with investors. I kept them in the deal after the refinance though but based their return on what money they had left in the deal afterwards.

12% money is tough to find on something that has this type of risk. I was able to get that number to 8% on one deal by allowing the investor a decent share of the total project. They invested 100% of the money needed for the project. They got 75% back after the refinance. The remaining money gets 8% preferred with a 50/50 split after. On sale, the investor gets 35% of the profits.

You can expect some pushback from the bank if you try and refinance close to the first year. So allow yourself more time like 1.5-2 years.

Again, great plan!!!

 

[SteveO]

What would be the first steps an absolute beginner should take before he/she can get started in apartment investing? -From not knowing anything about apartment investing to getting that first apartment?

First you need to get yourself educated on how to analyze a property. You need to understand cap rates, NOI, cash-on-cash, etc. You need to understand your market and the sub-markets intimately. You need to have a plan for what types of properties you are going to want to invest in. Is it rehabs, straight cashflow deals, etc.

These are just the basics. Pick up some books and read them. They will help.

 

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[randomnumber314]

LOL - I'm chuckling here a bit after reading your low income property experiences in the rest of this thread or another. I went to look at this yesterday, just to see what you get for pennies. Holy crack house!!! (literally, supposed to be vacant... cars out front, loitering, etc...)

http://hotpads.com/real-estate/1731...se,medium,large,garden,&dupeGrouping=building

FWIW I know of a guy who bought all the houses on a street (one at a time, approached landlord owners) and then went through and remodeled each house. Took the average property values up, rent income up too. They did it because they grew up there or something and didn't like the drug haven it had become. So...if you're able to play the long-game you could flip an entire neighborhood.

 

[SteveO]

Do you mean that the best opportunities aren't available publicly?

Partially. Sometimes a great deal will come your way because you are in the right place at the right time. But mainly I mean that there is money to be made if you have the right process.

I like to use two avenues, value add and timing. Both are very viable and are where the real money can be made. Here are some old links to discussions on these topics.

https://www.thefastlaneforum.com/community/threads/apartment-appreciation-targeted.588/#post-4307

https://www.thefastlaneforum.com/community/threads/finding-apartment-deals.4321/

https://www.thefastlaneforum.com/community/threads/amazing-apartment-returns.7763/#post-26157

https://www.thefastlaneforum.com/co...-markets-due-to-overbuilding.5480/#post-18319

https://www.thefastlaneforum.com/co...d-other-value-play-investors.3774/#post-13697

 

[Windsurfer]

There are many victorian sized houses(4-5bdrm) in my city, occasionally some of them go up for sale in various levels of repair. These seem to provide an opportunity similar to what you have described in your previous posts, but on an obvious smaller scale. I am curious to hear your opinion on these. Thanks for doing this thread!

@smartman - Be careful on these. In many cities you have to get these buildings rezoned for multifamily - which can be a long and arduous process - not to mention expensive in potential legal fees. In Minneapolis where I am you better have a fantastic deal on a SF house if you want to make it worthwhile. I also know of another investor who bought a duplex without checking that it was zoned as a duplex. The city came in and said he could only rent it as a single family even though it had two distinct units. In other words, b-bye to 50% of your cash flow unless you pay a bunch to remodel it.

 

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[SteveO]

Do you end up creating your own itemized rules of thumb for your general area then apply them to the properties?

The advertised are not only easily faked.... they are faked. 99% of the time they are listed as proforma numbers and not actuals. You can get actuals when you get the property under contract but these must be approached with care as well.

I will get as many quotes as I can once the deal is locked-up in contract. Insurance can be quoted, taxes can be calculated, you can get a utility run or have the seller provide you with the bills, everything else can be estimated or quoted.

I use a preliminary expense number when doing a back-of-the-envelope estimate of $3000/unit/year.

ICK, it looks like you have done some looking at this. Some people try to use a percentage for expenses like 45%. These percentages don't work.

 

[CashFlowDepot]

Also i'd like to mention my income doesnt allow me to be able to get anymore financing on properties.

You can buy multifamily or commercial properties with seller financing. There are many different places to find these opportunities. One is to just ASK the seller. There are several multifamily properties advertised at www.GoSwap.org -- do a search for seller financing, multifamily to see what's available there. www.REE.com also has some seller financing properties advertised.

Even if the property is not advertised as seller financing, if the seller is motivated enough they will do the financing so you don't have to go to a bank for financing. Just ask.

You can also offer to master lease the property with an option to buy later. The owner gets a percentage of the rents, you get the rest. When it is time to exercise your option you can either negotiate to convert to seller financing or sell the property for a profit.

A joint venture were someone else (private lender) puts up the money, you find the deals and manage the property works too.

There are a lot of ways to buy real estate without getting bank financing.

 

[RealOG]

Also i'd like to mention my income doesnt allow me to be able to get anymore financing on properties.

Most commercial loans are based off the performance of the property, not the income of the individual. When you are borrowing large amounts of cash, the banks know your measly W2 job isn't going to cover the debt service.

Banks care about debt service coverage ($1.25+ of net operating income per $1 of mortgage) and they carry about how much the property is worth compared to how much they are lending.

One quick lending negotiation on a deal we're working:

We contracted a commercial property. It's 46% vacant, but the leases we have on it cover nearly all the debt. Fully leased, the property is worth $3.4MM. The bank is offering 75% LTV at 5.5% interest on a commercial property we have contracted for $2.3MM. They are holding back 5% and will release it once we lease the property. This means we need to come up with 30% down, plus all improvements (~$125k), plus fees ($25k), plus reserve funds ($50k) to close this deal. The bank wants to limit their exposure to 70% loan to value.

I focused on two things for the bank, their interest rate (minimum return) and their exposure (loan-to-value).

To balance this, I offered to keep their rate the same. In return I asked for lending of 75% of the entire balance of what was required to do the deal - the purchase price, improvements, and fees. This would be a loan amount of $1.82MM. We would $150k in an escrow account we would draw from for improvements and leasing fees (controlled by bank) and $50k in reserve account (controlled by us). This lowers the bank's exposure to 65% while allowing us to leverage more for the entire project.

They have tentatively accepted.

Bottom line: focus on solutions that meet the banks needs. Smaller banks are more flexible than large ones, start there. The better your reputation, the easier it will be - but we all started from zero so don't give up. Even if it takes 100 calls!

 

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[SteveO]

Have you ever considering going public via REIT?

I have raised money and done deals. I had over 900 units at one time.

I have looked into starting a reit recently. Check it out here. Still may do it. I would like to go back into retirement and this would not help.

 

[SteveO]

I had a question regarding the renovation. I had brought an apartment in its construction stage at a low cost, the painting and flooring works had to be done. I have to do it in a cost down manner. My friends suggested me to do the epoxy painting for the flooring. But I love chess board designs, is it possible to do with epoxy? Do I need to shift to tile flooring? Which is cost efficient, tile or epoxy? I need shining and sparkling floor.

Flooring is one of the most MAJOR considerations. It is costly and will continue to be a high cost item as you move forward. It is a big deal to the renters and is subject to trends.

Research what the other developers are doing. Don't put something down that will be tough to deal with later. Are there any issues with tiling over the epoxy? Once you put tile down, it is expensive to replace.

One trend that I saw was simply staining the existing concrete. I really like that option and was happy to see that was popular. Not sure where the trends are heading now though.

 

[SteveO]

Putting it another way, does a 10% cash on cash return make you happy or are you looking for something like 15-20%

This is a tough one to answer. I don't even always give more than a glance at the cash-on-cash. I want to see what my anticipated 5 year return is going to be. There, I want to see 300% or more.

My primary goal is to force appreciation through upgrades and/or increased income. Both of which will lead to a larger net operating income (NOI). The larger NOI will lead to a higher sales price.

Houses and apartments don't always track on the same valuation curve. They did on this last big downturn because of the huge oversupply that was in the market. Apartment valuations basically track from rental demand. There are plenty of other factors as well but house values are not tied to this.

 

[SteveO]

Do you self manage or hire it out? Is there a reasonable way to estimate the time commitment on a per unit basis? Obviously a few rotten tenants can make your life a nightmare.

What areas do you target if any (ie; college, low income, etc.)?

I have hired it out in the past. Will not do that again. Good management is very difficult to find. They are never as interested in the property as you are. You can just add a typical management fee into your proforma for your time. This varies on the size of the complex. For 20 units, you would likely add 7%. Around 3.5% for 100 units.

Rotten tenants need to be removed. Just like cleaning out the fridge.

I target decent areas where renters want to be. I do not care for student locations or low income although I would look at either to evaluate. If possible, I like single stories with backyards and washer/dryer hookups. Does not have to have these but they are resident stabilizers.

 

[Pete799p]

@SteveO

Have you ever purchased a building that was fully vacant and in need of rehab? This scenario does not allow the use of traditional bank leverage on the front-end (due to the obvious lack of cash flow generation at acquisition) but is an attractive scenario if you have the equity investors available to stake you. This is not revolutionary, but wanted to hear your thoughts as I know you have done syndication (just not sure if it has ever involved a vacant project).

Although it was not personally my property, not my cash in, I have done a bunch of this, particularly in the "fringe" neighborhoods of Chicago, over the last few years across a number of different assets, for a few independent developers, and investors. We would even pull buildings out of demo court among other things. I also worked for a PE company that buys bulk REO portfolios and non performing loan portfolios, many of which where either completely vacant or filled with squatters and dealers that needed to be booted out anyways, fun stuff.

I have seen it work out really well and go really bad. One commonality I have observed with successful ones is you need to know your numbers, you have to be able to work a crew, and especially in Cook you need to have the funds to absorb the carrying costs. I have seen construction over runs eat up all the profit and then some and vacant properties sit on the books for years waiting for permits to clear. With the PE company we were able to get buildings done for ridiculously cheap because of the economies of scale and the economy. When you order appliances by the truck load, or have a painting crew do 100 units at a time you tend to get a discount, especially when there is no good custom home work. As a whole not every building was profitable at any given time, some ended up costing too much in reno, some where is terrible locations, but some were complete home runs, it usually balanced out in the end. Most of this was because the bank made us take it all, for better or worse. On the smaller scale we would put together our own crew of guys and run the job ourselves Be prepared for a lot of turn over if your working under a tight budget, many of your good guys will bounce when they get a better offer.

PS. for a project like your describing vacant is usually better then partially occupied, in my opinion. I found it easier to do the whole building at once then try to work around tenants and the eviction process can be a long, expensive unknown in Tenant Friendly IL.

 

[SteveO]

What's the worst that can happen on a small 4 plex if you have repair skills excluding HVAC? (just assuming you need either bankroll or sweat equity if shit hits the fan... I hear people talk about water heaters exploding - exaggerate much?? , roofs leaking, etc...)

If you are going to buy a property, understand how much life you expect from all the major capital items. How long before you need to replace the roof, parking, appliances, a/c's, paint, etc. Either get a credit from the seller or put some money into an account for capital repairs. Then you apply $250/unit/year into the account for future capital expenses.

I am at the point where I don't feel that there is much short of a fire that cannot be handled internally. We do our own roof repairs. Water heaters are easy. I have had a couple of them bust loose and cause a lot of damage but this is rare. They don't cost much to purchase and are easy to install.

The problem that I least look forward to are plumbing problems under the slab. I have had to do some repairs that required jack-hammering up the slab and have also had to reroute water pipes. I have not yet had to tear up a major portion of a floor to replace drain lines. This seems like it could be the biggest issue if it ever came up. I have had a couple of times where I thought I might need to but managed to control the situation with drain tools.

 

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[SteveO]

Steve, I've come to the conclusion that I need $300k cash to get started in commercial real estate, specifically apartments. Is this a fair conclusion or am I missing something?

These are your own barriers. There are a lot of creative ways to do deals. First you should consider where to start and gain experience. I always feel that a four-plex is the best way to do this. You can usually get more aggressive financing with these smaller properties. Plus, you can use this as a springboard to jump.

I went from four-plex to a partnership that gave me about 33% of a 45 unit project. This took less than two years. After another two years we sold the property and I traded into 70% of a 52 unit project.

 

[SteveO]

Can anyone in the US advise the best place or website to source multi unit buildings for sale?

Try loopnet.com

 

[SteveO]

What do you think are the most important things to focus on when looking to buy an apartment, renovate it and sell it again for profit?

This is one strategy and one that I have used many times. The most important thing to look for is the ability to make a return. Sometimes you can find decent running properties with little deferred maintenance for a reasonable price.

The most important part for anyone is the ability to understand the income and expenses associated with the property. If there are repairs that are needed, that needs to be factored in to the cost. You can often get these repairs included into the financing.

 

[SteveO]

sorry for a layman's question, but to clarify- your business plan for apts is to sell in 5 years after purchase? Sorry if I misread something.

I pencil them out for 5 years. If they are ahead of schedule, I may sell earlier.

We are here to learn. There are no questions that are too simple.

 

[IceCreamKid]

My goal now is to get a building between 100 and 200 units, pay it off and exit the business.

When you say exit the business, do you mean exit the process of repositioning apartments? In other words, you will just buy and hold these 100-200 unit buildings after they are paid off?

If not, what will you do with the cashflow? Gotta keep the money moving to keep the tax man at bay.

 

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[SteveO]

@Swift T , I bumped an old article that gives a rundown of the calculations for evaluating apartments and it includes the cap rate.

You can find it here.

Most people that own these apartment buildings work real hard to hide their identity. If you can find him and catch his ear, that would be fantastic. You had better do some studying first. Read some books, talk to some agents about the market, learn how to find deals in your area and so on. No mentor wants to babysit.

I have had people that want to be mentored in the past. I do not have an issue as long as it does not take a lot of my time. The problem that I have found is that when people offer to help, they want to help on their terms. Apartment work is tedious and mundane.

I have also had people in the past that have offered to find me deals. What I end up getting is straight repetition of the deals that come into my email.

If you are going to approach an owner for mentoring, you need to figure out how you can add value to them first.

 

[SteveO]

Have you bought land with/without planning permission and built apartments yourself?

What are your views/reasons for doing it or not doing it.

I have bought land with the appropriate zoning and built office buildings. Not apartments. I made money on the deal but it was a major distraction which required a lot of attention.

It is tough in my area to buy small lots and do a 20 or so unit build. It costs more to develop these small units than they are worth. I am not inclined to want to practice on a 300 unit complex which is what it would take to make sense economically.

I am an apartment operator. Not a developer. I like to stay focused.

 

[SteveO]

In my pursuit of a first good buy, first thing I look at is a good cap.

I have used investors for the past few years. This has been the most difficult part of selling to them. Most people want to see a good cap rate. A good cap rate at purchase means less forced appreciation. This is where all the money is at. But be careful... Not all properties can be turned around for a profit.

 

[SteveO]

Can you recommend any books that help with negotiating terms?

If you can truly uncover the seller's motivation, you can determine the best terms for both of you.

There is an interesting book by Poorvu called "The Real Estate Game". It goes though a lot of interesting deals.

I don't know of any books (not a big reader) that focus on negotiating terms. Perhaps you could do a search on this topic.

Look at a lot of deals. Let the agents know what types of terms interest you. Ask, ask, ask. Ask your lenders about terms you are thinking of.