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.
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When you are looking at long term real estate, you have to KNOW the area, going rate for rents, and improvement opportunities to improve cashflow. You will not only be making a commitment after you take it down, but you will also need to put a great deal of time in pursuit of the deal. With that said, underwriting the deal is very important.
When a bank underwrites a deal, they will determine how much exposure the deal will give them and whether it’s a risk the lender wants to accept. The great thing about deals in excess of $1MM, the property itself is used as collateral against the funds you are borrowing. The bank will look at you, your experience and liquidity, but the property itself is an important aspect to the loan. They know that if you or the economy falls on hard times, the larger deals will cashflow fine – as long as it’s being run properly.
I personally use a couple of models when looking at deals. I also leverage several underwriters at the bank when reviewing a deal so I can verify my worst case scenario and make sure the deal will be profitable. You need to remember that the bank is a partner on the deal and they want to see it succeed just as you do.
Before I even get into the underwriting, I ask myself three questions:
1) Do you really want to be stuck with this deal for the long haul?
2) Will it support my investor cashflow targets?
3) Can I exit the deal with profit for me and my investors?
This is just meant to be a short overview of what I consider. If you guys are interested in learning more about underwriting, please let me know in the comments by saying “Yes”. I can do a longer video on the subject.
Getting into your first multifamily deal can be exciting and nerve-wracking at the same time. If you do it right, getting into good multifamily deals will allow those involved to get closer to achieving their financial goals.
For some, realizing true financial freedom, is an illusion without the right way to get there. If you are serious about obtaining more wealth without the risk and hassle of building a portfolio one single family home at a time, then multifamily is the answer. When it comes to cash flow, multifamily apartments are by far, the most lucrative way to get that stream of income that is within the reach of private investors like you.
Here are my 5 benefits of getting into your first multifamily deal:
1) Steady Cash-on-Cash Returns
Higher cash-on-cash returns compared to single family homes make multifamily a solid winner. Getting $300 of monthly cash flow on a single-family home is a good starting point for many investors, but with multifamily investors can realize multiplied cash flows. This is you are multiplying the number of units. If one deal works, why not multiply it by 50 or even 100? Even owning a single multifamily deal with 12 units will put two or three thousand in your pocket. It may not be enough for some of you to change your life, but it would certainly help cover some of your bills.
2) Plenty of Demand
In case you hadn’t noticed, the is a ton of demand for multifamily. Aside from Baby Boomers and Millennials moving to renting rather than owning, it’s less expensive to live an in an apartment than maintaining a single-family home. For investors running their properties correctly, it means high occupancy. The large cost of multifamily deals compared to single family homes are enough to keep many investors away. So this market has considerably less competition. For those that are not afraid of the numbers, they are charging ahead.
3) Low Risk
If you are familiar with how banks lend on multifamily, you know that their rates are usually low and have a high degree of flexibility and leverage. This is because they see multifamily as a low risk investment. If your single-family home goes vacant, you need to worry about having cash reserves to sustain it. If you have a mortgage on it, you are pulling that cash out of your personal reserves. The benefit of having many units in one building is that if one goes vacant, there is still cash coming in from the others to keep it running. If banks like low risk and you can leverage their money, you should take advantage of it.
4) Leverage Professional Property Management
The cash flow of a properly run multifamily deal enable you as an investor to hire professional property managers to handle maintenance, tenant concerns and problems if they arise. The incoming cash flow generated by a multifamily property allows you to use your time to source more deals or spend it on what you enjoy doing. What’s more, having a professional property manager will allow you to scale your business if you like as you can lean on their expertise.
5) It’s a Business
Many investors favor multifamily properties because of the consistently strong market and the significant return on investment. So, like any business, there are many tax benefits and ways to increase cash flow. Aside from depreciation and interest deductions, other expenses like insurance and ongoing maintenance are spread over the number of units in the deal. You can force appreciation and Net Operating Income in more ways by offering benefits to your tenants. This drives valuation up and creates value in your multifamily deal.
Anyway, this is just an outline for you to consider the benefits of multifamily properties. What do you like about multifamily deal? Let me know in the comments.
Getting into your first multifamily deal can be exciting and nerve-wracking at the same time. If you do it right, getting into good multifamily deals will allow those involved to get closer to achieving their financial goals.
For some, realizing true financial freedom, is an illusion without the right way to get there. If you are serious about obtaining more wealth without the risk and hassle of building a portfolio one single family home at a time, then multifamily is the answer. When it comes to cash flow, multifamily apartments are by far, the most lucrative way to get that stream of income that is within the reach of private investors like you.
Here are my 5 benefits of getting into your first multifamily deal:
1) Steady Cash-on-Cash Returns
Higher cash-on-cash returns compared to single family homes make multifamily a solid winner. Getting $300 of monthly cash flow on a single-family home is a good starting point for many investors, but with multifamily investors can realize multiplied cash flows. This is you are multiplying the number of units. If one deal works, why not multiply it by 50 or even 100? Even owning a single multifamily deal with 12 units will put two or three thousand in your pocket. It may not be enough for some of you to change your life, but it would certainly help cover some of your bills.
2) Plenty of Demand
In case you hadn’t noticed, the is a ton of demand for multifamily. Aside from Baby Boomers and Millennials moving to renting rather than owning, it’s less expensive to live an in an apartment than maintaining a single-family home. For investors running their properties correctly, it means high occupancy. The large cost of multifamily deals compared to single family homes are enough to keep many investors away. So this market has considerably less competition. For those that are not afraid of the numbers, they are charging ahead.
3) Low Risk
If you are familiar with how banks lend on multifamily, you know that their rates are usually low and have a high degree of flexibility and leverage. This is because they see multifamily as a low risk investment. If your single-family home goes vacant, you need to worry about having cash reserves to sustain it. If you have a mortgage on it, you are pulling that cash out of your personal reserves. The benefit of having many units in one building is that if one goes vacant, there is still cash coming in from the others to keep it running. If banks like low risk and you can leverage their money, you should take advantage of it.
4) Leverage Professional Property Management
The cash flow of a properly run multifamily deal enable you as an investor to hire professional property managers to handle maintenance, tenant concerns and problems if they arise. The incoming cash flow generated by a multifamily property allows you to use your time to source more deals or spend it on what you enjoy doing. What’s more, having a professional property manager will allow you to scale your business if you like as you can lean on their expertise.
5) It’s a Business
Many investors favor multifamily properties because of the consistently strong market and the significant return on investment. So, like any business, there are many tax benefits and ways to increase cash flow. Aside from depreciation and interest deductions, other expenses like insurance and ongoing maintenance are spread over the number of units in the deal. You can force appreciation and Net Operating Income in more ways by offering benefits to your tenants. This drives valuation up and creates value in your multifamily deal.
Anyway, this is just an outline for you to consider the benefits of multifamily properties. What do you like about multifamily deal? Let me know in the comments.
