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JustAskBenWhy

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Therein is the rub... you're right. The larger deals and properties are not for small investors. People who have the money to invest will go for the tax benefits -- especially business owners who aren't as limited to take advantage of those benefits. But, the small investors will try to play the game with the big boys and quickly get their wing trimmed.
I am saying this influx of renters will create a lower and mid-level market. That movement will bring out the marginal investors who think they can get rich quick. Those investors will create a "shake-out" market when they actually are faced with the hard day-to-day truths.
(I have known a few people with money who followed these hapless investors around to pick up the windfall deals. And, yes, the money guys did quicky make pretty good profits.)
We saw a mini version of this type of market in LA at the end of the 1970s, the mid to late 1980s and the first part of the 2000s. Everybody wanted to invest with OPM (other people's money) and get on the bandwagon. It ended badly for them as a group in each one of those cycles.
The basics have never really changed.
I don't buy into any of that argument too much. The "get rich quick" idiots have been around this game for as long as I can remember. They were getting burnt in good cycles and in bad.

What people don't understand is that the money is in the delta, and you have to underwrite the delta. Capitalizing value on an NOI, while not technically wrong, is not the right way to underwrite. This, however, is what is taught in the mainstream, and therefore it's what everyone does. And with this approach, you'll lose money in good cycle and bad...
 

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WJK

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I don't buy into any of that argument too much. The "get rich quick" idiots have been around this game for as long as I can remember. They were getting burnt in good cycles and in bad.

What people don't understand is that the money is in the delta, and you have to underwrite the delta. Capitalizing value on an NOI, while not technically wrong, is not the right way to underwrite. This, however, is what is taught in the mainstream, and therefore it's what everyone does. And with this approach, you'll lose money in good cycle and bad...
Most people don't know what the "delta" is. You're talking over their heads.
 

JustAskBenWhy

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Most people don't know what the "delta" is. You're talking over their heads.
But now they have a reason to do some research :) I am not in the business of spelling things out. I see teaching as a process of triggering thought and curiosity, and developing in folks an ability to read between the lines. The rest is up to them...
 

JustAskBenWhy

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Here's a lesson:

Everyone always thinks that the only way to get a deal is to find a less sophisticated owner. And, in some ways, this is true. However, for the same reason that the building is not operating at capacity (because the owner is unsophisticated), the financials will look like hell a well. The less sophisticated owners don't know how to do it any better or different...

Now, this works the same way with a duplex as it does with a $10M deal. I am going through this as we speak. (hopefully you didn't imagine that unsophisticated buyers don't exists in large deals) Anyhow, the challenge is this: do you know how many hoops we're having to jump through for the bankers? They need certain reports, broken down a certain way, and it's simply not there because the seller just didn't keep those records...

Unsophisticated sellers - there are benefits, but there are very real challenges as well.
 

WJK

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Here's a lesson:

Everyone always thinks that the only way to get a deal is to find a less sophisticated owner. And, in some ways, this is true. However, for the same reason that the building is not operating at capacity (because the owner is unsophisticated), the financials will look like hell a well. The less sophisticated owners don't know how to do it any better or different...
Now, this works the same way with a duplex as it does with a $10M deal. I am going through this as we speak. (hopefully you didn't imagine that unsophisticated buyers don't exists in large deals) Anyhow, the challenge is this: do you know how many hoops we're having to jump through for the bankers? They need certain reports, broken down a certain way, and it's simply not there because the seller just didn't keep those records...

Unsophisticated sellers - there are benefits, but there are very real challenges as well.
And regardless of the owner's sophistication, are any existing records correct? Do they pass the "smell test?" In my commercial RE appraising practice, I saw a lot of double books, no books, and scummy lies.

Although it works the same with a duplex, the small unit information is easier to obtain or estimate. And because of the margin-of-error factor, those deals are a lot more forgiving.

On the larger MFRs, I spent a lot of time figuring out what the income stream and expenses should look like -- compared to the reported numbers. The ratios are pretty industry standard within known markets for different sizes and types of buildings. Anything out of those normal ranges raises red flags. Also, the different types of units-of-measure helped a lot too. (They went way beyond simply figuring out and analyzing the NOI.) Most were presented toe-to-toe in grid formats, making for easy comparison of projects. This was in addition to discounted cash flow analysis studies, rent-up studies, and such. Any matrix that was off required additional investigation and explanation. This was especially true in new construction, where the bank was financing the project.

The appraisal process for the larger projects goes way beyond the analysis done on small units and SFRs. Yes, we had a few buyers who weren't sophisticated, BUT my clients -- the banks -- and I worked together to made up for their lack of knowledge. The deals either worked or the numbers weren't there.

A significant percentage of these loans end up in the bank's portfolio or underwritten, so they have to live them for a long time. In the early 1990s, bad portfolio loans took down the whole Savings and Loan industry. It was lesson hard learned.
 

JustAskBenWhy

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And regardless of the owner's sophistication, are any existing records correct? Do they pass the "smell test?" In my commercial RE appraising practice, I saw a lot of double books, no books, and scummy lies.

Although it works the same with a duplex, the small unit information is easier to obtain or estimate. And because of the margin-of-error factor, those deals are a lot more forgiving.

On the larger MFRs, I spent a lot of time figuring out what the income stream and expenses should look like -- compared to the reported numbers. The ratios are pretty industry standard within known markets for different sizes and types of buildings. Anything out of those normal ranges raises red flags. Also, the different types of units-of-measure helped a lot too. (They went way beyond simply figuring out and analyzing the NOI.) Most were presented toe-to-toe in grid formats, making for easy comparison of projects. This was in addition to discounted cash flow analysis studies, rent-up studies, and such. Any matrix that was off required additional investigation and explanation. This was especially true in new construction, where the bank was financing the project.

The appraisal process for the larger projects goes way beyond the analysis done on small units and SFRs. Yes, we had a few buyers who weren't sophisticated, BUT my clients -- the banks -- and I worked together to made up for their lack of knowledge. The deals either worked or the numbers weren't there.

A significant percentage of these loans end up in the bank's portfolio or underwritten, so they have to live them for a long time. In the early 1990s, bad portfolio loans took down the whole Savings and Loan industry. It was lesson hard learned.
Yes :)
 

JustAskBenWhy

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Received today a proposed budget for Y1 from the PM. They are higher than us on the income, and lower than us on the OpEx. Thus, higher on the NOI by about a 5% margin.

Additionally, because of the CapEx we are doing up-front, they think we need about 50% of CapEx reserves out of the CF on an annual basis of what we Pro Forma.

Not adjusting out underwriting at this point, but if they are right, it's going to be a nice bump...
 

juggler619

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Kelley McEachern

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Congrats on the good news Ben. Hope it goes your way. Took my first action today. Filed my LLC and EIN for my REI business and have a good banker ready. Next week I start learning about financing and networking for a solid accountant, lawyer and private money options. My plan is to focus on locating my first rental. (baby steps) I have zero experience rehabing anything outside of my own house so I will cross that bridge when I get to analyzing the investment. I got a lot to learn but those in this community inspire me to face the unknown and conquer it. Thanks for sharing.
 

JustAskBenWhy

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So, they way I teach is by asking questions. Here we go:

What is the presumed relationship between the interest rates and the cap rates in an efficient market?

Go
 

Kelley McEachern

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Well, cap rate is the 1 year yield of an asset ( not including expenses) and can be used to compare property's (cash flow). Interest rates and cap rates move together in the same direction but it is not that simple. When you say "efficient", are you implying that market conditions are favorable for lenders to sell into market demands?
 

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JustAskBenWhy

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Sort of. Cap Rate is a market metric. Essentially it measures risk appetite in a given marketplace. And when I say efficient, I am referring to the efficient market hypothesis which stipulates that all participants in a marketplace are rational and base decisions upon an equally available set of data. In other words, if we all know everything there is to know, and we act rationally in response to that which we know, the market can be thought of as efficient.

So - if Cap Rate is a metric representing risk appetite, and the market is efficient, what should be the presumed relationship between the interest rates and cap rates?

Your answer is correct - they should travel in tandem.

Next question: while this is the theory, what's the reality? And if the reality doesn't conform to theory, what does this mean - is the theory wrong, or is the reality inefficient?
 

Kelley McEachern

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From what I can understand, cap rates do not necessarily have to move with interest rates/bond yields because rising rate hikes can signal strengthening economic factoring (such as job growth) that support/improve occupancy rates, NOI growth with no new construction impacts. I don't think it makes it wrong though, just a means of protection against it. It also depends on the timing of the cap rate change too (short term or long) which can be very different. I would say it is inefficient.
 

JustAskBenWhy

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So, if the market is inefficient, we've got a problem. We must, as investors, have a clear view of exit before we get in. Preferably several exits. What this inevitably means is that somehow we must establish with some degree of certainty our exit valuation.

In an efficient market this would be an easy enough proposition. But, in an inefficient market - what do you do?
 

JustAskBenWhy

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Should be closing this week. Only about 173 things have to happen in order for us to actually close, but should be this week.

Wish me luck!
 

Get Right

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In an efficient market this would be an easy enough proposition. But, in an inefficient market - what do you do?

Finance the project with a variable loan then hedge by selling interest futures of similar size. This should return your project to efficient.
 

Kelley McEachern

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In a inefficient market, I must have multiple viable exit strategies (at least 2) for any given project.
 

JustAskBenWhy

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A bit of an update:

After 2 weeks of ownership, the lease-ups are slow. It's 105 outside. And we are not spending any $$ on marketing, so it's just street traffic for now.

The lease-ups we are getting, though, are at a very significant premium to in-place and this is before the reno. 1x1 got an $80 premium, and 2x1 got a $150 premium. So there is definitely huge LTL in as is condition.

The bidding process for CapEx has been very robust. We are getting work done for 10% - 30% under budgeted amount in most cases. Everything seems to be either at projected or under projected budget. The only estimate where we appear to be under are the appliances, which following the tariffs went up about 20%. Instead of planned $1,350 per unit it looks like we may have to spend close to $1,600.

The exterior work should begin next week, along with 3 or 4 interiors.

Talk soon
 

Sauce

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The bidding process for CapEx has been very robust. We are getting work done for 10% - 30% under budgeted amount in most cases. Everything seems to be either at projected or under projected budget. The only estimate where we appear to be under are the appliances, which following the tariffs went up about 20%. Instead of planned $1,350 per unit it looks like we may have to spend close to $1,600.

I think you may be able to do better on the appliances. Work with your pro desk. This is a quote I got recently from Lowes, all black setup with an OTR micro (my rep was able to get those down to about $160 per so the quote should be about $60 less). Also, if you use the preload card, you can get an additional 5% off. So you are looking at about $1200 per unit, plus install. My guy is in NM, but he may be able to help you out.

upload_2018-9-5_9-44-37.png
 

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JustAskBenWhy

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Well, guys - wholesale reno about to begin next week. The exterior bids came in low by a good margin, but the interior reno will be tight. Naturally, some unforeseen issues are coming up...it's a good thing we are well capitalized!
 

JustAskBenWhy

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Ruda666

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Winters in Salt Lake City or Denver have become pretty mild. Very few days with snow on the ground in the city. You have to go up to the mountains to actually get snow and it's not always that great.

But now with housing becoming so expensive, people have to live where they can afford whether they like it or not.
 

biophase

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JustAskBenWhy

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Kind of ironic you pose that question and link an article citing that it’s the 5th largest city in the US.
Totally hahaha... It's interesting how illogical folks can get at times lead by the hype :) Priceless!
 

JustAskBenWhy

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Pete799p

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Research we've conducted indicates correlation between CAP rates and Interest rates is 0.7. So not 1 to 1 but there's a relationship there. Like all markets they're not perfect, fluctuations in supply & demand, tax structures, etc. all play into it.
 

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