5 Multifamily Strategies to Cope with a Recession

 

I’ve been tracking the U.S. economy for some time. Most everyone from economists to multifamily real estate experts agrees that a recession is coming. Billionaire hedge fund investor Ray Dalio agrees that a recession is likely, we just don’t know when.

As of today, mid-April 2019, I would venture to guess that we are one to two years away from a market correction. According to a recent article in the Wall Street Journal, job growth in early 2019 came in below expectations. U.S. Gross Domestic Products growth has been fading since that article, with an annualized rate in excess of 4 percent in the second quarter of last year, and has fallen just a bit. The Federal Reserve Bank forecast suggests that the first quarter of 2019 annual growth rate may fall below 1 percent. I personally believe this to be cyclical, but when the Federal Reserve sees these numbers, they will pull back on their plan to aggressively raise interest rates and shrink its balance sheet.

The thing is, there is no way to know whether to wait 2 years or 8 years; it’s hard to predict. Rather than sitting on the sidelines, my team and I are staying active in the market, always looking for deals. We are tracking prices, looking for the asking and selling prices and watching for how long they are on the market. The best suggestion I give to others is to not overpay just to get into a deal. Buy on actuals and never on speculation or a broker proforma. Rather, be prepared to act quickly; Make certain your equity or down payment lined up, your banking relationships are ready, your credit score is good, and you convey your ability to close.

Here are five strategies to make sure your investments are protected when there is a correction or an all-out recession. These strategies will be good for 2 years or 20 years. They will always be relevant:

1) Always Buy “In Demand” Locations – As long as there are people, there will be a need for housing. When there is a market slowdown, friends and family will move in together to save on living costs. They will likely want to have access to public transit and highways, close to amenities like grocery stores, retail, malls, and hospital and safe neighborhoods. We personally like B- value-add properties that have a lot of nearby commerce, jobs, and population growth.

2) Keep Up With Maintenance – Because people will move in together to save on housing, some owners may see their vacancy rate creep up. Inventory will be on the rise and you will be competing with other landlords for tenant dollars. You will want to make sure your units do not look old, dated and worn out. The competition will be heavy. I would even say that if you are turning units and you are able to put in better materials at a reasonable price, do it while the market is strong so you can recoup your investment faster. I’m not saying to “over-renovate”. Rather, if you are able to get a deal on ceramic flooring for a property that would usually call for vinyl, and the cost is marginal, go for the ceramic.

3) Set Up a Reserve Account – Knowing that a recession is coming, make sure to build up your reserve account to make up for any upcoming vacancies, repairs, and other expenses. If you set aside 7% of the total rent every month for 12 months, you will have one month’s rent saved up in your reserve. If you don’t use it, you can deploy to your investors or make a major improvement that will drive NOI.

4) Have Liquidity – This strategy is related mainly to new deals; Lenders will be hesitant to lend during a slowdown or recession and sellers will be on the lookout for cash buyers. During a recession, the loan to value numbers we see today (75% or 80%) will certainly be much lower. Some lender may not lend at all. Having cash at your disposal – either liquid or lining it up from investors today – will be important to taking down deals when the economic storm comes.

5) Know Your Numbers – Calculate and track your net operating income on a regular basis and know where your break-even point is. Meaning, know what the bottom line number is to cover the mortgage, property management, taxes, insurance, and other expenses. You also want to know what other landlords are renting their units to understand how the market is trending.

If you buy and manage a good property with good strategies, you will always win. Yes, it would be great to pick up deep discounts if you manage to time things perfectly. I believe there is always a deal out there; You just need to work harder to find them. If you are waiting to time the market, you are foregoing the all the gains from today plus cash flow for the coming years. Like all investing, it takes patience and confidence to build success. Ultimately, you will have to make the call yourself on when you’re ready to take on a deal. Regardless, it’s been proven time and time again that getting into long-term, well-positioned and well-managed multifamily will deliver substantial inflation-beating returns.

Anyway, do you think there is a recession coming? When? Let me know in the comments. I’d love to hear from you.

If you liked this content, go ahead and give it a thumbs up and share it. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.

Be great.

Why Are People Overpaying for Multifamily Deals?

 

After the 2008 crash, the world of multifamily real estate has exploded mainly due to the low cost of capital by lenders and by individuals flush with cash. Sellers of multifamily understand that all this cash is looking to be put to work and this is driving prices to new heights across the U.S. Reports published by Black Creek Group show that almost ALL the 54 Metropolitan Statistical Areas they monitor are either currently in or about to be in hyperinflation.

This explosion is not just limited to appreciation markets like New York or Los Angeles, but tertiary cashflow markets alike. My partners and I are shocked at the prices that the asking and sale prices for some of these apartments deals.

Some of this heated market is commercial brokers inflating prices to get an institutional or foreign investor to overpay for deals. What’s more, many of these people are coming to the table with up-front non-refundable deposits before due diligence plus a 15% premium. Bear in mind that this was for a C-Class portfolio in a market that usually sits at about a 10% cap rate. They paid a 5.5% cap. Unless they are only worried about parking money, it will be hard to get a decent return on that investment.

To me, it seems that these investors are going ahead and overpaying for deals and ignoring the fundamentals of this business such as cash-on-cash return, cash flow, and ROI. But why are they doing it? Here are some possible reasons:

1) Individual investors have 1031 exchange funds that need to be put into real estate to avoid being taxed by the IRS. Because there is a tight time constraint of getting those funds into another real estate deal, they are willing to take a slightly lesser return than have it taken by the IRS.

2) Institutional investors are lowering their bar and going after smaller deals. They used to just look at deals exceeding 250 units – usually 500+ units. There are so few deals out there that they are now going after smaller deals. They are willing to take the smaller returns to put their cash to work.

3) Out of state investors are not seeing the returns in their local markets because their respective markets are way too expensive. They look to the midwest and are attracted to a “cheap” cost per door. International investors want to put their cash into a stable and strong U.S. dollar and see the same cost per door as an easy way into the market. In both cases, they are still paying a premium as the buyers in the local market won’t even touch that deal.

4) Buyers and Syndicators believe that ALL markets are appreciation markets and will sacrifice a lower return for that they believe will be a huge boost in the sale price down the road. This is not the case in many markets. There is nothing wrong with buying for appreciation, but people need to understand what they are buying.

5) Buyers and Syndicators are bending their conservative rules and taking reduced cash flow and returns to get into a deal. They assume the market will continue its climb for the next 20 years with no economic disruption while tacking on rent increases of 4% to 6% a year in their financial models.

6) When these same Buyers and Syndicators perform their underwriting, they assume that bank interest rates will be as low as they currently in 5 years from now. If you look at the trend of the Federal Funds Rate Historical Chart, it’s on the way up. I’m willing to bet it will continue to climb.

7) That broker on Loopnet ACTUALLY returns a buyers’ call and tells them about a sweetheart, off-market deal that they just can’t pass up. However, they need to pay top dollar to win it. So they accept the broker’s proforma as truth and buy the property. The broker then takes that comp and puts it on the next deal they are peddling.

I’m not saying that anyone making deals today doesn’t know what they are doing or that any deal trading today is overpriced. The buyer may have access to an off-market deal or there is a true value-add play where the rents are 30% below market and occupancy is at 78%. In this case, you and your team are adding value by stabilizing the property. Regardless, the investors in these deals make sure it meets their minimum investment criteria and do not deviate. They also adjust the model to the work involved to stabilize it to the level of risk.

I am a believer in buying for cash flow. My partners and I stick to the numbers and leave the broker’s opinion and pro-forma out of our decision-making process. Unless you are getting into a big turnaround situation as I described before, your best bet is to apply conservative underwriting to your deal based on actual performance. If the deal performs well and you can still build in reserves while still satisfying your investment criteria, then you take that deal down. This means you will be analyzing a boatload of deals, but it’s the only way you won’t crash and burn on a deal.

Anyway, is there any situation where it’s OK to overpay for a deal? When would you do it? Let me know in the comments. I’d love to hear from you.

If you liked this content, go ahead and give it a thumbs up and share it. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.

Be great.

4 Powerful Tax Advantages of Multifamily Real Estate

 

Since we are now officially in tax season, I’m sure many of you are wondering how to protect your wealth from it being taken by the IRS. I have covered some of the tax benefits when it comes to multifamily, but I want to go a little deeper in the benefits and what it means to you as an active owner or a passive investor.

Before I go into the 4 most powerful tax advantages of multifamily investing, please note that I am not a CPA or a tax attorney. All this information is based on my personal experience and advice from my advisors on deals. Really, this is a birdseye view of the most powerful tax benefits that any passive investor should understand and you should talk to your own tax planning advisors and strategists before executing these tactics.

1) Depreciation
When you own or are invested in a multifamily deal, you are technically invested in a business. So everything related to that business, from paperclips to taxes, can be written off. One of the most powerful deductions you can write off is depreciation.

This is how a straight line depreciation schedule works: The IRS ruled that resident-occupied real estate has a lifespan of 27.5 years. The land the property sits on cannot be depreciated as it has an infinite lifespan. Let’s say you want to buy a property for $6MM and the land is worth $400k. Applying the IRS rule, you are able to deduct 1/27.5 of the $5.6MM, or $203,636 from income for each year. This allows you to show a loss on paper as the deduction may eliminate most or all of the income from that property. Even though you show a loss on your tax return, that money is cash in your pocket and that of your investors.

If you have a portfolio of other investments, you are then able to apply these paper losses to other areas of your portfolio. This means that your multifamily investment can lower your tax exposure on other investments you hold. Even as a passive investor on one of our deals, the depreciation in our multifamily deals flows through to our investors in proportion to their ownership percentage.

Keep in mind that I am not saying that it is not an entire elimination of all taxes. But there are other tools you can use to defer taxes indefinitely and even accelerate depreciation

2) Cost Segregation
Cost Seg is a great way of accelerating the depreciation of just about any commercial property – including multifamily. As I mentioned earlier, the IRS tax code says that real estate has a lifespan of 27.5 years. However, there are certain items that make up the building such as the plumbing fixtures to the cabinets to the appliances, that have a shorter lifespan.

When a professional cost segregation study is performed, an engineer will come on site and walk each individual unit. From there, they will separate all the items from the overall value of the building and present you with a schedule for those individual items. Many of those items, the IRS deems them to to have up to 7 years of useful life. The cost segregation study identifies these items.

In the previous example, I indicated that you would save $203,000 in taxes through depreciation. Let’s say that the cost segregation study of that $6MM property shows there is $5MM in building depreciation and $1MM from personal property appreciation. Your taxes look a lot different. We would take the ($5MM x 1/27.5 years) for $181,818 and ($1MM x 1/7 years) for $142,857, totalling $324,000 in annual depreciation expense – a significant savings over the $203,000 that we had calculated before! This will give you a great tax offset in income against other investment income.

The only caveat with taking this approach is that you could get hit with a higher tax bill when you go to sell the property down the road. As I mentioned earlier, there are ways of rolling your gains without getting nailed on taxes.

3) Qualify as a Real Estate Professional
For many people, real estate is a means to supplement their full-time job with some additional income. What many don’t know is that if you spend 750 hours or more annually in your real property business, such as managing rentals or turning units, you qualify as a Real Estate Professional. This means you are able to deduct 100% of your rental depreciation and ‘losses’ against any other income. This designation only helps you if you have ownership in a significant amount of rental property (i.e. more than just 1 unit) and you earn less than $150,000/year in Adjusted Gross Income. If you are an investor in one of our deals, you then have ownership and that may get you qualified.

4) 1031 Like-Kind Exchanges
Earlier, I mentioned depreciation as a way to increase your deductions and reduce your gains. A great way to defer taxes on your gains is by using a “1031 like-kind exchange” to roll your gains and avoid getting nailed in taxes for an indefinite amount of time. As long as that cash stays in the 1031, you can keep multiplying it without any tax implications.

This is one of the most powerful tools when it comes to deferring taxes and saving you a lot of money. The first thing to know about doing a 1031 is that when you roll the profits from your real estate project, it must be put into another real estate project like the one it was in previously. This means you cannot take the profits you made on that multifamily deal and roll it into a new pizza place you want to start up. You would need to roll that cash into a higher-basis property within a set timeframe. Talk to your CPA about lining you up with a professional 1031 intermediary.

Anyway, have you heard of these tax advantages? Let me know in the comments. I’d love to hear from you.

If you liked this content, go ahead and give it a thumbs up and share it. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.

Be great.

How To Protect Yourself At The Top of the Multifamily Real Estate Market

 

Everyone, from the major national mortgage brokers to Kiplinger Magazine, are all saying the same thing: 2019 is still a hot market. Cheap debt and plenty of investor cash looking for returns in the multifamily market have supported the increased property values in recent years.

If you are buying multifamily, you are probably seeing cap rate compression – where cap rates were usually in the high 7’s are now in the low 6’s – and deals are still selling fast. There is chatter of an economic slowdown, but we are not seeing it yet. I’m not sure about the exact “when”, but as long as you remain conservative in your underwriting and buy for cash flow, you should be good.

Regardless, it’s a good time to think about how to protect yourself in case your respective market is at its peak.This means, continue buying for cash flow and not appreciation as I have covered in my previous material, optimizing the cash flow of your existing assets and picking up major rehab projects that are not risky to you or your investors. Here are five considerations to think about:

1) Always Be Active: This means not sitting by the sidelines or waiting for the cycle to drop. It just means you need to look for deals that make sense. In every market, there are always deals. If you are actively engaged with local brokers, attending meetups, and talking to other real estate pros, you will find deals.

2) Focus on the Cashflow: As the economic cycle rolls off its peak and begins its decline, active investors will see the value of their property ratchet down. What you need to remember is that as long as you have annual leases and you are treating the tenants right, you should cashflow just fine. That paper loss is only experienced if you sell the property. Keep your operations tight, make sure you have good financing in place and make sure the deal cashflows.

3) Put Liquid Cash in Illiquid Assets: The wealthy know that real estate is a safe haven when a bear market hits. Like I mentioned in the previous point, the primary concern for investors is returns. Many of these investors understand that owning multifamily properties financed with fixed-rate debt and increasing rents over time will perform very well in an inflationary period. There has been case study after case study on how cash-producing real estate has outperformed the stock market. The point is, if you’re committed to a buy-and-hold strategy, investing in cashflowing multifamily real estate in anticipation of a bear market will protect your net worth. Just make sure that the property has a diverse employer base with some history of making it through previous economic slowdowns.

4) People Still Need Shelter: For those of you that have lived through a recession, you know that jobs and businesses disappear. It never hits just one sector. A local economy will contain businesses that are dependent on others for commerce. Meaning, a local 500-person call center has people that go to the local gas station for fuel, the restaurant next door for lunch and the electronics shop up the street to buy a new phone. When a recession hits, all this stops. The call center vacates and all those businesses are negatively impacted as well. But just because the businesses are gone, it doesn’t mean the people are gone.

Those people still need a place to live. As we saw in 2008 and previous recessions, people turn to renting to stay mobile and reduce their overall “real estate footprint” because of a job loss or their homes foreclosed on by the banks that actually stopped lending. It’s worth noting that during these recessions, multifamily real estate foreclosures were very low and occupancy was steady or even increased between 2008 and 2010 according to the U.S. Census bureau and DataQuick.

5) Cranes in the Air, Buyers Beware: This is in reference to the oversupply in a market. Rental rates and sale prices rise when inventory is tight. In previous U.S. recessions, new multifamily construction in many markets just stopped. So, new construction lagged behind population growth – especially since new construction is mainly Class A property in primary markets with all the amenities. With the market flooded with new supply, it’s clear that there is a supply/demand imbalance that will take years to be absorbed by the local market. Be aware of the rental rates these new units are commanding. If they are having a tough time filling them, it could be a sign of trouble.

As a real estate owner and operator for more than 15 years who made his way through recessions, the strategy that served me well is to either buy or turn around existing properties in well-located areas targeted to moderate-income renters. I like to hold my real estate for the long term and implement the planned increases as I go, making adjustments as needed. This has served me well in the past and I expect the same in the future.

Anyway, how are you preparing if we have an economic slowdown? Let me know in the comments. I’d love to hear from you.

If you liked this content, go ahead and give it a thumbs up and share it. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.

Be great.

 

 

Service Animals: Not Knowing the Rules Will Cost You

 

For many families and individuals, pets are more than just companions. They are an extension of the family. Many multifamily owners and landlords recognize this and have shifted to more of a “pet-friendly” model. For other owners, they do not want pets in their units as they may cause damage or bother the other tenants. Prospective tenants will bring their pets along saying they are companion animals, leaving owners and landlords worried about fair housing issues if they don’t accept the animal in the unit. These days, it is now more important than ever to understand the fair housing rules around service and assistance animals and the potential problems for operators if they do not comply.

Not understanding the differences could result in you inadvertently discriminating a person with a disability and, in turn, violate the Americans with Disabilities Act (ADA). Here is the long and short of it: The rule states that people with disabilities have the same rights to housing as those without disabilities. As an owner or operator, it is illegal to deny housing to someone because they have a mental or physical disability. Before we go into the problems you can face as an owner or operator, let’s go into the two primary scenarios you could be faced with: service animals and assistance animals.

As I mentioned, service animals are covered by the Americans with Disabilities Act (ADA). A service animal is defined in the ADA as primarily a dog that perform tasks for a person with a disability. The tasks performed by the dog must be directly related to that person’s disability. The important thing to note here is that there is no proof required by the tenant that the dog has been trained or even registered with the government. You are not allowed to set up designated units for tenants with service animals out of consideration for other tenants as they need to have the same opportunity to be in any units for people without disabilities. This means no “pet-friendly” units. You are also not allowed to charge pet rent or fees. Like I said before, it is illegal for you to deny housing – even if you have a “no pet” rule – to someone that has a service animal.

Assistance animals are a little different. They are not covered by the ADA. Rather, they are covered by the Fair Housing Act (FHAct). An assistance animal may be a service animal, for someone that needs emotional support and alleviate their disability.

Unlike the ADA that limits service animals to dogs, an assistance animal can be just about any animal within reason. There have been people that say that their alligator, skunks, and donkeys are assistance animals. It’s also worth noting that there is no restriction on dog breeds. Like the ADA, assistance animals do not need to be trained as they may be helping that person cope with a condition like anxiety.

Any potential tenant that does not have an obvious disability and is seeking to have their assistance animal in the unit would make a formal request for accommodation. You are able to ask the person two questions regarding their request: if they have a disability and if there is a need for the animal. If your attorney determines that an accommodation request for an assistance animal is legitimate, then it cannot be treated as a pet. This means you cannot charge a pet deposit or pet rent.

Now, you think a new or existing tenant may be trying to get around your no pet rule and pet fees. What do you do when they say they want an accommodation but they don’t appear to have a disability? To avoid trouble, you need to follow the HUD guidelines.

You need to push back on the tenant and request a doctor’s verification in writing of the tenant’s disability and whether the animal is needed because of the disability. The letter should confirm that a disability been established and that the animal is needed for the person to cope or serve as treatment of that disability. To limit your risk, use a third-party assistance animal validation provider. There are several on the Internet and are little to no cost for you.

It’s worth noting that if you live on the property and you or a member of your family has an allergy to the animal, it may be possible to deny the service animal. Also, if the service or assistance animal shows aggression toward anyone, you can possibly deny that dog in your rental as well. It can’t be based on the breed or the size of the dog. It must be factual. Before you take that on either case, be sure to talk to your attorney and come up with an execution plan. When you are dealing with Federal law, you want to be careful.

Anyway, how do you stay in compliance when tenants ask about service animals? How do you mitigate your risk today? Let me know in the comments. I’d love to hear from you.

If you liked this content, go ahead and give it a thumbs up and share it. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.

Be great.