REAL ESTATE Question for SteveO and other value play investors

[Runum]

Hi guys. Been reading "Buying and Selling Apartment Buildings". Question, when you were getting the ball rolling on your early deals what money did you live on while you were negotiating and working the bugs out of the deals? Did you have other sources of income or were you counting on the profits for some of your future income? At what point did your value play become profitable enough to just focus on that? Thanks for everyone's input.:cheers:

Greg

 

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[SteveO]

It took about 2.5 years to build a large enough portfolio to begin living off the cash flow. That was when the challenges really started though.

Your concerns are thought out and valid. If you are purchasing properties that are not performing well, the cash flow may possibly be negative at times. There are instances where you can get the bank to fund the negative with interest reserves but this is difficult when you are just beginning. bflbob had success with this though. Hopefully he will chime in on this thread.

You will always need to have contengencies for plans that don't go as expected. Cash in the bank, lines of credit, or any other source of quick cash is important.

I like to keep funds working as much as possible and tried to limit how much money was pulled out of deals. If you have to ability to hold some cashflowing propeties while working the value play on others would be ideal.

It all takes time. If you pencil it out though, the challenges are well worth the effort.

 

[KyJoe]

I was slower. It probably took me 5 years to make anything. I worked a couple of jobs during that, and lived pretty cheap. Looking back, the problem was the type of buildings that I picked. Almost everyone was built around 1900. The amount of repairs ate everything. I also bought several major rehab projects. They were/ are great for increasing wealth, but not income.

 

[Wolfgang5150]

KyJoe:
Do you still own the 100 year type properties? Or did you use them to move to newer properties?
I own one, an 8 unit; and enjoy it alot. the area is appreciating and it cash flows well, so I'm monitoring it to see what my next step is.
Thanks.
Kevin S.
Orchard Park, NY

 

[KyJoe]

KyJoe:
Do you still own the 100 year type properties? Or did you use them to move to newer properties?
I own one, an 8 unit; and enjoy it alot. the area is appreciating and it cash flows well, so I'm monitoring it to see what my next step is.
Thanks.
Kevin S.
Orchard Park, NY

Yes I do. I haven't sold many through the years. It's like driving a Model T on a long distance drive every day! When they get this old, you will be replacing gas lines, water lines, rewiring etc. The flip side is they are going condos on a regular basis in my area. My next step is to sell off a pile of them, and buy (newer)bigger properties. I wouldn't mind building a complex really.

 

[JesseO]

KyJoe, isn't it more costly to build an apartment than to buy an existing property? Where would most of the profit be? I wouldn't mind seeing a thread started that shows the differences (pro/con) of building vs buying. I know development can be quite profitable, so would it be something like that in terms of an investment? Thanks =)

 

[SteveO]

Replacement cost of a building is a key metric for me. Existing commercial (including apartment) buildings are typically well below replacement cost during a down cycle. High vacancy and poor financials are usually the reasons driving these values. As these metrics begin to improve and values begin to approach the repacement cost, it is usually a signal for me to sell. This is the time that developers will start the building cycle all over again. I want to be out of the market before the overdevelopment takes place.

 

[KyJoe]

It is much more costly (at least at the present here) to build one instead of buying one. On the flip side, the maintenace is lower on new buildings. I have seen many build, run it for 5 years & then sell it, then do it again. One advantage is changing layouts/designs to what people are looking for now. An example is a taller ceiling than a 8'. The downside is you now have to get much higher rents because of the cost. Another problem is the high cost of land. I am looking for something that I can change the zoining on.

 

[Yankees338]

Aren't tenants typically looking for a newer complex to live in?

 

[SteveO]

I am looking for something that I can change the zoining on.

Finding an angle that gives you an edge...

 

[SteveO]

Aren't tenants typically looking for a newer complex to live in?

As a buyer of properties that are usually 25 years or older, I would say no.

If that was the case, why would all the older buildings have tenants at all?

When it comes to the typical renter, they are usually looking for a safe, clean, inexpensive place to live. It is helpful if it is close to work and/or family and friends.

Some people are very price sensitive. $20 difference in rent may be the deciding factor in where they live.

Apartment unit layouts and construction styles can become functionally obsolete over time. Bedrooms that are too small, kitchens/dining rooms that are completely closed off to the main living area, little to no insulation, no sound barriers between up and down units, etc... It is important to look for these things. I like a good layout in an apartment and there are plenty of older ones that are laid out well.

Many of the newer places that have more ammenities compete with the pricing of owning or renting a single family house. Many of these renters are here by choice rather than need.

The one key thing about the older less expensive apartments in the more centeral parts of the city is that they are not building any more of them. Newer properties in key locations are usually pricey.

There is a saying that I have heard and pondered many times. It is the 3rd owner of a building that usually makes the most money.

 

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[Wolfgang5150]

Steve - could you expand on this comment more?
'It is the 3rd owner of a building that usually makes the most money'

I have not heard that one before..............

 

[SteveO]

Like I mentioned, I have heard this and pondered it many times. Obviously, it is not a hard rule but more of a generalization.

The first buyer is usually paying replacement cost or retail for the initial building. The problem is that these do not usually cash flow with high leverage. The buyers may be REIT's or people that have a lot of money and want trophy properties. They put a lot of money down and sit on them for a few years.

While there is always development going on, the majority is usually happening at the top of the market. This is the time that it makes the most economic sense to the banks and builders. When too many units come online, the market begins to suffer. Over-supply will hit the class "A" or newer apartments first.

Somewhere along the way, these owners may wish to leave this market for a better one. REIT's like to focus on citys that are doing well and will tend to unload their under-performers.

The next buyer is still getting a high-end property with all the latest and greatest floor plans and amenities. The prices are still high though. Maybe they got a decent deal but rents for the high end properties are not climbing rapidly.

The next time this property comes up for sale, there are much newer and better equipped units out there with the latest and greatest appliances and floor plans. Now the market is soft and they can't sell to a trophy buyer.

The next buyer that purchases at the "near bottom" of the market and rides it up is the one that will reap the rewards.

There are all kinds of reasons that market cycles fluctuate. The properties with some age on them are the ones that really swing with the values during the ups and downs. I have seen incredibly nice properties with only 15-20% more income than some of the older counter-parts, selling at more than twice the cost per unit.

Newer properties may not need as many repairs but the expectations from the tenants are much higher. The costs will associated from insurance, taxes, higher expectations, etc. will keep the expenses high. Maintenance such as painting, roofs, parking, etc will still need to be in the budget for the future as you will need to build a reserve.

Purchase well below replacement cost. As vacancies tighten up and rents climb, monitor for a time to sell. Once the builders start going at it again, your older propety should be close to the top of the market. Sell as it approaches replacement cost in value.

 

[Wolfgang5150]

Steve-O; great information here. As always, thanks!
Kevin S.
Orchard Park, NY

 

[Runum]

Sorry guys, I just realized I didn't acknowledge your responses. I have been working just about all of my free time in rehabbing my latest purchase. Thanks for your responses. This information helps me get my time line in perspective. :cheers:

Greg