The other day, I did a talk about forcing appreciation and I mentioned how I only buy for cash flow. This led to a barrage of questions around buying for appreciation. So, I thought I would answer it here.
As a recap, there are two basic ways a multifamily deal makes you money: 1) Through Cash Flow and 2) Through Appreciation. Before I go on, I’ll color in some details of each.
In a cash flow deal, there is typically good net cash flow when you walk into the deal. In this type of deal, you are basically looking for income from rents and other income minus expenses to have cash at the end of the month. Expense items include insurance, the mortgage, taxes, any utilities and other costs associated with the property. We are always looking for this number to be trending positive on a month by month basis, but sometimes there are negative months or you just break even. This could be indicative of other problems, such as you have an overrun on expenses or you are just not collecting enough income. I covered ways of addressing both scenarios in my other podcasts, so be sure to check them out. Regardless, in negative and zero situations, you want to get that handled because if there is no cash flow, it makes for unhappy investors and unhappy owners.
In an appreciation deal, you are relying on drivers outside of your control to bring up the value of the property over some long period of time. The thing to note is that it may be subjective and even speculative. These deals are banking on the local area to drive the overall value of the property. Maybe there is a new revitalization happening like a new arts and entertainment district, there is limited space to build in a hot area, or there is an economic driver that increases the demand of the area. The appreciation strategy is driven by the region and market you are buying in. Meaning, not every market will appreciate. The most extreme places are New York City and Los Angeles, where the cap rates are very low but people buy anticipating that in 5 years from now, that $1MM triplex will be worth $1.4MM. In these cases, there is very patient money and these investors are looking to park their money in the hopes to score down the road.
With that out of the way, the reason to buy for either cash flow or appreciation depends on your motivation. As I mentioned, if you are looking for a long term gain, appreciation is your best path. If you are looking for cash in the short term, month over month, you need to be targeting cash flow.
If you are syndicating deals and the objective is to make money in the short term you need to be investing for cash flow. The property needs to be cash flow positive and in a position where you can bring up income and reduce expense to maximize the net cash.
But, if you are looking to invest for appreciation, then the strategy is much different. In this case, you are looking for an asset where there is a great deal of change and improvement. If you are using investor money, they would understand the strategy and get on board. If there is some cash flow, you can always provide some very small return, but the score will be on the back end when you go to sell the deal off.
And this is the part where things get risky. Because appreciation is based on speculation, that big score when you sell it is not guaranteed. If you are putting your investors’ money into a deal, you better make sure you know your market and what goes on in that market. That is why places like New York, Los Angeles, Chicago and more recently, Miami have turned into appreciation markets. Buyers in those areas KNOW it will appreciate over time and will go without cash flow – or even negative cash flow – for a score at the back end. If you plan on applying an appreciation play in markets that have not moved all that much, be careful. Your job as a syndicator is not to lose money.
These days, the focus of my partners and I is cash flow. We may expect some appreciation, but we do not bank on it. We bank on running the property well, making improvements to drive income and doing a refinance to pull money out of the deal to return to investors and pour into the next deal. There is nothing wrong with buying for appreciation, it’s just not what we do.
Anyway, what strategy do you prefer? Let me know in the comments. I’d love to hear from you.
If you liked this, go ahead and give it a thumbs up. 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.
As value investors, we are always looking for multifamily deals we can get into, improve and drive revenue to increase the net operating income. This is referred to as ‘forced appreciation’, when you, as the investor, are actively working on the property to improve cash flow and reduce expenses.
This is different from ‘natural appreciation’ where the market is driving the increased value of the property. Basically, you are selling the property for more than what was paid. You have no control over this type of appreciation and it is not always guaranteed.
Forcing appreciation in a big way, such as installing new low-flow toilets to drive down water expenses (if you are paying for water) or increasing rents is not always possible. Perhaps you don’t want to invest in the plumbing work or you are already close to market rents and can’t push them higher. Regardless, there are still ways you can improve NOI and force appreciation in other ways and reserve the cost intensive tactics for later.
Here are 5 affordable ways to force appreciation in your multifamily deal:
1) Install Coin Operated Washers & Dryers: If your multifamily deal has a basement or storage area that is not in use, install a coin operated washer and dryer. It is not only a huge benefit for the tenants as they won’t need to go to a laundromat, you will also benefit from the income on the machines. If you have a small multifamily apartment building, something less than 30 units, you can probably get away with installing your own units and having the management company pick up the coins on a regular basis. Reach out to a few of your local laundromats and ask them if they are willing to sell their used machines. Depending on where you are located, you can charge $2/cycle on each. If you have enough tenants, it can add up quickly.
2) Offer Doorside Trash Valet: Depending on the asset and the market, you can consider either having your cleaning people put this in place or bring in a company that does this on your behalf. Not only will it keep the hallways clean, tenants won’t need to walk their trash to the dumpster on those cold, late nights. Many outsourced companies will split the profit with the property owner, so the barrier to implement is low. Again, this will vary depending on where the property and where it is located.
3) Add Storage Units: Tenants are usually short on space and will often pay for additional space if you offer it. If you have a dry basement, you can put up walls and doors and rent the space to the tenants. If you have space outside, you can have a steel structure put together on the premises. There are professional companies that put up prefabricated storage units and they are not expensive. Tenants have been known to pay an extra $30 to $50 per month for each unit – and all that cash goes straight to the bottom line after you cover the build cost.
4) Install Energy Saving Systems: Aside from LED lighting and motion sensors, you can also install systems for your furnace or boiler that will only activate depending on the temperature outside. There is usually some cash to kick up for the install, but it will pay for itself in two months if you are providing heat for your tenants.
5) Install Security Cameras: While this is not an income-generating investment, it does increase the overall value of the property. The active cameras will keep an eye on your investment while giving the tenants some peace of mind. In some cases, they may even make the difference for the tenant to move into your building versus one that doesn’t have such a system.
Anyway, what are some low cost or affordable ways you are driving income or reducing expenses? Let me know in the comments. I’d love to hear from you.
If you liked this, go ahead and give it a thumbs up. 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.
We are in a competitive market today. When you are preparing an offer on a deal that you want to buy, you need to do your best to be easy to work with, aggressive and able to close. This means handing over a Letter of Intent that is strong and has the best chance of winning. Doing the homework ahead of the LOI is important and this info applies whether your deal is $100,000 or $10,000,000.
Ultimately, you are looking to write the LOI the way the seller and broker wants to see it, complete with the price and terms that will get the deal done. But before you get into that, you need to prepare for writing up the offer. Here are the three things you need to do before you actually write the LOI:
1) You Need to Ask Questions When you call the selling broker and introduce yourself, tell them about your background, team and what market you are buying in. From there, you want to express your interest in the property and ask questions about it.
– How much are is the seller looking for? – What due diligence period is the seller looking for? – How much earnest money is the seller looking for? – What is the most important thing to the seller, besides price? – How would the seller like the LOI written?
Maybe the broker that is selling the deal is also the one that sold it to the current owner. Ask the broker, “How was the offer written previously?”, “What did it sell for last time?”, “Why are they selling today?”.
You see, when you get to the point of preparing the LOI, you can write it the way they want to see it, and you have a better chance of winning the deal. Because you wrote it the way they want it, they will agree with your price, due diligence and down payment. You want to give the seller what they want.
2) What Price and Terms are Acceptable to the Seller During this conversation, you want to go into a deeper dive with the broker around what they believe the deal will be worth to the market. This info is typically backed with data that supports the price. On larger deals, the broker will forward a ‘Broker’s Opinion of Value’, also called a BOV. This is prepared by the selling broker after they inspect the property and pull the recent listings and sales nearby. Make sure to pull your own data to make sure their opinion isn’t skewed. It is very easy to do as certain properties in better condition will get a higher price.
After you get an idea of what they are looking for in terms, continue to ask questions. – Who is the decision maker? – What’s their story? – What price will this sell at?
They may tell you that “this deal will sell for over $5MM”. Keep that number in mind and wait it out a bit. You don’t want to offer too much too early. Often times, brokers will inflate the prices and they will get a bunch of lower offers. If your analysis can support a $5MM price, send it over and call the broker to verify receipt. Ask them how your deals stacks up. Ask them how many other players there are and how many offers they have. The point is, go in strong with your best and final bid so you can lock the deal down.
3) You Need to Express Confidence to the Broker As you go after a deal, you need to know that you want to have it in the first place. Do you want to handle that property for the next 5 to 10 years? Are you sure you want to be in that location? Are you sure you want to take on the repairs and maintenance of that property? Are you sure the area will improve the way you think it will? These are all things you need to ask yourself.
With this out of the way, you then need to express confidence to the selling agent that you are the one that can close the deal. They need to have confidence in your ability to deliver. You want to express that you are super easy to work with. You want to pull them in and get the property under contract. You need to get control of the deal. But first, you need to get an LOI together.
Once you get through these three things, you can put your Letter of Intent (LOI) together. If you want any chance at winning, you need to be aggressive with your offer. This includes putting together the shortest due diligence you can do, going in at your highest and best price, and removing all the contingencies before you go to finance. Again, you want to be easy to work with. Do not include crazy stipulations or other types of unconventional clauses unless they asked for them and it’s what THEY want. I suggest using a broker that specializes in writing up multifamily deals. They will tell you how to write the deal up. Your broker may have even worked with the seller’s broker in the past and they know how they like to see the offer written.
Anyway, how are you putting deals together? What sort of questions do you ask? Let me know in the comments.
If you liked this, go ahead and give it a thumbs up. 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.
Here are the five things you will need to do to take down your first multifamily deal:
1. Find a deal — You need to network with brokers. When you do, you need to convey the confidence you can actually close the deal (and get the broker paid!) It doesn’t always need to be through a broker, but they are often the source of many deals since the better ones are engaged with the multifamily community. Note that this step is harder than you think! You will go through 100 deals before you find one!
2. Analyze the deal — When you are looking to buy a property, you need cash flow. Do you know what to look for to find the cash? Are expenses way out of the norm for the area? Is there an opportunity to increase income? Do you know the terminology?
3. Build your Team — Unfortunately, you can’t build a team by reading books. The only way is to take action by connecting with people and specialists in your local multifamily space. This may include other multifamily investors, commercial brokers, professional property managers, title companies, or real estate attorneys. Not all will want to talk to you or even help you, but you must stay strong until you find ones that are willing to open a dialog with you.
4. Financing the deal — While it is expensive getting into a big deal, don’t buy based on your budget. Larger deals (let’s say buildings with 50 units or more) are typically out of reach for most people. Many don’t have the liquidity or net worth by themselves. This is why you partner with others.
5. Manage the deal — When you first take over a property, it will have it’s fair share of problems. This step is important as you need to work with the property management team you vetted and help them make the deal perform to plan. Your partners and investors are counting on you. Make certain your team is solid!
Like anything, before you start calling on brokers, you must educate yourself. You need to be around others with the same mindset and expand your think. You can do this, but it won’t be easy – unless you build a team!
Evaluating a deal varies from property to property. My focus these days are Class C and Class B deals, so it really depends on the business plan for the property which drives the underwriting process. This includes gathering the expense and income data, building a financial model, performing rent and sales comps and in-person visits. All this can take anywhere from a few days to a week. Then, once you negotiate the fine points and get it under contract, you will have 30 to 60 days to perform due diligence to confirm your underwriting assumptions and build out your business plan according to what you find. When you consider the costs of both the underwriting and due diligence process, deal evaluation becomes an investment of both your time and money. So, the sooner you can find any deal breakers, the better.
Here are my 5 tips on potential deal breakers to look for when you are checking out a multifamily deal:
1) Mistakes in the Offering Memorandum
The offering memorandum is a marketing document created by the sellers’ broker that summarizes the deal. Note that I just said “marketing.” The purpose of the OM is to support asking price the sellers’ broker. All the photos will look very nice and the typesetting will be impressive. The intent is to sell the deal for the highest price possible – and yielding beefy commission check for the broker.
Typically, the OM will include a pro forma, trailing 12 month and a rent roll. You never use that data when analyzing a deal. At most, you should use it as a guide because most of this data will not be accurate. Sometimes they are even totally fabricated. Remember, this data is to pull in the highest offer.
I have looked at many deals where the rent roll in the OM and the actuals from the property manager were off by over $100 a unit. If you are looking at an 80-unit deal in a 9-cap market, it could mean the value is pumped up by $500k to $1MM. They also had occupancy at 100%. As soon as you see anything ending in a zero, you know it’s bull – especially when you see the rent roll historically showed 87%. I can assure you that they are not chaining tenants to the refrigerators! You must always use actual historical data and a current rent roll when looking at a deal.
Another time, I found they didn’t add the expenses up property and it made the deal appear like it had a higher cap rate. Other times. the internal rate of return was wrong. And other times when someone transcribed the rent roll from an 86-unit deal from paper to Excel and the numbers were all wrong. I know that people may make mistakes, how can you trust the numbers if there are so many errors in the OM? Again, understand that these numbers are all for show. Use them as a guide only when underwriting.
2) Unrealistic Pro Forma
The pro forma contains detailed information of the financial performance of the property. Generally, when you are looking at a deal, the T-12 is used to see if income and expenses of the property is stable month over month.
Here is an example that happened to me recently: I was looking at a 150-unit deal. The financials showed gross income for the previous 5 years starting at $780k and increasing by about $12k annually, which seem reasonable. The pro forma showed gross income for the coming year to be over $250k from current and it showed 100% occupancy. Additionally, the expense ratio was at 39%. Even the very best run properties with little to no maintenance run at a 40% expense ratio. While it is possible, the property would be a very well-run machine and those tend to be hard to come by.
On another deal, I found the expenses were super low compared to what they should be in the area. For instance, the annual water and sewage bill for a 30-unit deal was about $5k and the property was sitting on 1.8 acres of land with a lot of grass. Just doesn’t seem right.
The best way to overcome an unrealistic pro forma is to base your analysis on how you will run the property. If you are leveraging partners – like a property manager – ask them to prepare a pro forma of their own based on the seller data and knowledge of the area.
3) A Bad Area
One of the factors that tends to be an automatic deal breaker for me is the area it’s located. I’m looking for good deals in good markets. If there is no demand for people to live in the area or there aren’t jobs moving in, it may not be for you. If you are not able to raise rents or you need to worry about appliances getting stolen in the middle of the night, just don’t do it.
4) Unethical Property Manager and the Owner with a Bad Reputation
Let’s say the financial data in the OM was done by mistake or it was created by an intern not familiar with the numbers. We already decided we will not take them at face value. But, there are things far worse than bad numbers in a document and that is people that purposefully cloud the deal to hide expensive problems or even flat out lie.
I hold events on a regular basis with multifamily investors. One of our attendees discovered that the property manager was forging rent rolls, leases and other important data. The property manager also said they had 91% occupancy when it was more like 80%. The only reason my friend caught the property manager in the lie was because someone inside the company forwarded an email by mistake. He would have discovered it eventually because the numbers would not have balanced with what was in the bank, but he would have been further down the road.
Another time, someone sent me a 200-unit deal. Doing a quick search for the address on the Internet to see what the residents rated the property, I came across a video on YouTube where the landlord was shouting at a news crew! They were accusing him of providing no heat for the many of the tenants in the middle of winter. Something about paying a bill or a not repairing the boilers. I know that kind of stuff can be fixed easily with proper management, but if this is just one indication of one problem, I don’t want to see any more.
Regrettably, people don’t always tell the truth. If you get an inkling that something isn’t right, you walk away.
5) Issues Found at the Walk-Through
Even if everything looks good on paper you need to do a walk-through of the property before locking it down. There can be plenty of deal breakers that you can only see when you actually see the property.
For instance, if I see a lot of cars in the parking lot on a Wednesday mid-morning, it could be an indication of high unemployment in that building. Or if the surrounding area around a very nice prospect looks bad and run down, it could be an indicator of for crime.
Performing a site visit may impact your repair budget. Recently, I went to visit a 4-story property that looked promising on paper. When we walked around back, it looked like the back wall was splitting in two. From the very top to about the middle was breaking apart! Clearly the sign of an expensive problem. That would have cost a great deal of cash to repair and it killed the deal.
What’s your biggest deal breaker when you are looking at a deal? Let me know in the comments.
