We’re never ready for Black Swan events, but here we are. We’ve finally recovered from Covid, don’t have to wear our masks everywhere, eviction moratoriums are gone, and finally got coffee bean grinders back at Costco (well, some of them). And now, another one.
No one could have anticipated the start of the current Mideast crisis, nor the consequences.
We started the year with growing optimism. Multifamily cap rates and borrowing rates were heading down. Buyers and sellers were returning to the market. Over-development was leveling off and the new supply of apartments units was getting absorbed. Inflation was very close to being in check. It was about time.
But now – gas prices up over a dollar in just one month. Ten-year treasury yields spiked nearly 40 basis points. Check the charts – when yields rise this quickly they take a long time to come back down. And very little oil is getting through the most important delivery artery in the world, the Strait of Hormuz.
We know what comes after this. Market activity slows. Buyers stay sidelined. Inflation picks up, because oil and gas prices impact supply chain and virtually every economic activity.
I would love to be wrong. Let’s hope for a quick end to hostilities but the wait for normalcy might be protracted.
Real Estate Gone Wild
The path to real estate wealth is not always a straight line up and to the right.
I bought a triplex, my first multifamily, after talking to brokers, analyzing financials, driving all around the county to walk properties, then finding one for sale by a bank. It was perfect. Fully occupied, in good condition, in a nice cul-de-sac, and in a growing area a half hour from my home. I went to the title agency to close, signed the papers, and then drove straight to the property.
I started knocking on doors to introduce myself. Hi, I’m the new owner. But door #1 was an empty unit. I could see through the window, nothing there. Door #2 was a family, a single mother and small kids. She was too busy to talk but hey, at least someone is there.
Door #3 was an angry tenant. He’d been having plumbing issues, water leaks, and had enough. I was friendly and he was trying to be but he got hot and said he was going to sue the owner. I said Waitaminute, I’m the owner! He backed down, a little, said I didn’t mean you, but then we got to talking.
He’d been having this problem for awhile. I said I’ll get it fixed. I definitely wasn’t prepared for all of this but I got back to the property the next day with my tools and fixed the leak.
Needless to say, he was moving out.
Leasing empty units was not on my day 1 action list so I was stuck. Fortunately, I had a great broker, helping me understand how to buy and manage apartments. I called her and asked the most basic of beginner questions ever, How do I find new tenants? She said, well there’s always Craigslist.
I immediately felt stupid because my day job was managing multimillion dollar IT projects. I should have figured this out myself but it took a common sense broker to say, John you know how to solve this.
This taught me that real estate problems have solutions, sometimes they are easier than you are making them out to be, and if you don’t know the solution, someone else does. From that point I placed the Craigslist ad, figured out how to write leases, interviewed applicants, and placed tenants before long.
I knew I would have challenges, but not starting the day that I took possession!
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Finer Points of Multifamily Properties
A Deal I Passed On
I passed on a $6,600,000 apartment complex in Kentucky. All of the pictures looked nice and I had a great relationship with the broker who brought it to me.
I analyzed the financials. I don’t usually draw conclusions like “Price is too high”. I just determine what the price should be, taking into account upside potential and deferred maintenance. Pretty straightforward, not a lot of emotional drama or complexity. I make sure my broker is on board and aligned with me so he or she can sell the offer. They need to know that I’m interested and capable of closing.
The deal had an NOI of $332,000 with a cap rate of 5%. That’s a low cap rate. I’m okay with buying at a low cap rate if I have confidence that substantial value can be added, but a low cap rate means low margins. If anything goes wrong, cash flow could go to zero or below and you might have to dig into your own pocket to pay for the normal expenses.
The property was located in a secondary market. The city was growing and had good job diversity and the property itself was a solid vintage: 1999. That’s where the positives ended though.
I flew from Seattle to Kentucky to tour the property. As I walked around I could tell the property was not as advertised. The pictures made it look much better than it was. It had tired exteriors, rough landscaping, and rippling parking lots.
The seller had owned the property for two years but hadn’t executed their plan quite like they hoped. Despite the shape of the property, the seller was expecting a high price.
In my assessment of the financials, the property’s condition, and the quality of their tenant base, their high asking price, it wasn’t worth the hassle of going back & forth.
When you see a property in poor condition, there are two things you can almost count on. #1, the tenants moved into this property because they got a deal on the rent. Maybe a concession, or maybe they’re not really paying what the owner says they’re paying. And #2, these tenants will need to be replaced when you buy the property.
The price has to be really low to accept this risk and level of work. The owner will have to have felt the pain for a long time to recognize the true value.
So I went home and told the broker we’d pass.
“Successful negotiation is not about getting to ‘yes’;
it’s about mastering ‘no’ and understanding what the path to an agreement is.”
― Christopher Voss, Author “Never Split the Difference”
Who We Are
Cardinal Oak Investments acquires, improves, and manages under-valued commercial apartments.
We buy A and B class properties of 100 units or more in the Southeast and Midwest.
We look for properties whose amenities, aesthetics, and appeal have fallen into obsolescence, whose care reflects tired management, and whose location is where a stable workforce wants to live.
And we partner with like-minded investors looking for stable assets that produce good cash flow and strong appreciation.
Founded and managed by John Todderud, Cardinal Oak Investments has acquired properties on both coasts and in between creating annual double-digit returns.
For more information, schedule time with me or send an email to john@cardinaloak.com.
Please note: Past performance is no indication of future performance.