Our apartment investing industry has shaken a lot of people out. They couldn’t get started buying apartments, or they bought something and it lost money. Some extremely competent people have had these experiences. The market over the last three years has been brutal. Multifamily assets have declined more in this down cycle than in the 2008-2010 downturn.
Those of us who buy and operate apartments are using all of our creativity to hold occupancy, not expecting rent growth or surges in demand. That will return but it’s not here today.
So when I talk to syndicators who are looking for others to partner with them, it is astounding when they are not enthusiastic, positive, informed, and humble.
Many are apathetic or even worse, entitled. Look at our performance, they say. Time’s up I need to go, sometimes they might say. This shocks me.
We have been seeing that interest in apartment investing has declined. Meetups are not being attended. Conferences have half or less the attendees they used to have, and many of the bigger ones in the industry have put a pause on future conferences. Like the political candidate who’s down in the polls, they are “pausing” their candidacy.
If you’re building a business based on attracting partners, you have to first believe in your business. It’s your cause, your mission. Then second you have to communicate that belief through enthusiasm and facts, not just perpetual optimism.
Why is today an opportunity to buy? Wasn’t it a good opportunity last year, the year before?
We also need to remind ourselves that real estate is a long game. This moment in time might not turn out to be the very best time to have invested, but it will be close. Maybe recovery is delayed, and yes it could get worse, but three to five years from now will it be worse? There’s no reason to believe it will.
Cycles happen and the obstructions to improvement will fade. They always do.
Real Estate Gone Wild
The path to real estate wealth is not always a straight line up and to the right.
The 40-unit apartment complex I own I bought with funds from a 1031 exchange out of a 15 unit, the 15 unit I did a 1031 exchange from a 4 unit
And the 4 unit almost broke me.
I rented to a tenant who I did not do a good job of screening. She had a plugged toilet, I brought in my favorite plumber, he ran his scope down the drain and let me know of all the things in that drain that shouldn’t have been there. These problems kept occurring, my plumber kept fixing them, and I kept warning the tenant.
Then there was a water backup onto the floor, into the carpet. Clean water, fortunately, but a mess nonetheless. I got someone there as soon as I could but the carpet took awhile to dry out.
Her disposition became bad, hostile, complaining constantly about everything. I was early in my real estate investing and wasn’t smart enough about how to deal with these personalities. I didn’t initially appreciate what they can cost you or how to be aggressive in solving the problems.
Then she started complaining about mold and her son’s allergies. These problems are real and under normal circumstances I am as concerned about them as the tenant is. Now I was highly suspicious of her motivations and wanted her out. Her next step could have been to get an attorney.
On one of my visits I walked through the unit. I discovered she had her brother living there, not on the lease. And I discovered a firearm on the dresser. That was it for me.
I explained that I was certain she didn’t want to be here and offered her cash for keys. She demanded a much higher amount than I anticipated, but I agreed to it so away she went.
In retrospect I got off easy. I often thought of what else that could have happened and still read the horror stories about landlords losing so much because of an experienced shakedown tenant like this person.
Now I settle problems quickly and am much better at screening and recognizing when someone with bad intentions slips in.
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Finer Points of Multifamily Properties
Deal Packages Contain Landmines
This little side of real estate investing is truly one of the most fun. It’s like your birthday. You know the deal package is coming because you saw the brief intro and pictures and you talked to the broker. When it arrives you’re opening it up just like a birthday present.
I want to get rich off of this one! I’d like it to soar in value. Let’s see how I can make that happen.
The broker projects impressive rent increases, expense reductions, talks about how pathetic current management is and how much better of a job you’ll do, and shows you your dream proforma.
Good so far?
Now you’re looking at every little unpleasant detail you find in that deal package and you are ready to rationalize it.
Insurance in this market? I’m sure it’s competitive.
Repair costs – a little higher than your rule of thumb.
95% physical occupancy but maybe a few delinquencies. And some recent new leases at a $25 increase!
You plug their numbers into your spreadsheet and you can see the returns they projected. That’s a good start, but then what do you do?
You discover that the few delinquencies actually show an economic vacancy of over 10%. That means a lot of tenants are not paying rent.
The property is 40 years old and clearly some expenses like HVAC repair/replacement are not showing up in repair expenses, and pictures show most of them are not new. They’re burying some expenses.
And those rent increases? They came at a cost. Concessions, move-in gifts, maybe even side agreements.
Now you’re concerned. Your assumptions may have to change, and when you change them, the returns are not so great.
These are obvious red flags, but not all red flags are obvious. If you want to understand a deal, focus on the assumptions:
> Rent growth projections – how fast are rents growing in this submarket, if you renovate your units what can you expect for rents
> Expense ratios and rules of thumb for the market
> Exit cap rate – if you keep it low your returns will look great, but who really assumes cap rates will drop? Not an investor.
> Renovation timelines – if you’re hiring a contractor, unless you know them and their availability really well, contractors can be a wildcard – unpredictable and unreliable. Hopefully not yours but it can happen.
Here’s the part most people ignore:
Small assumption changes lead to massive outcome changes. Stress test your assumptions. Create a sensitivity chart, something like this:
Your job as an investor is to pick apart the marketing packages brokers send you. Most brokers are very honest in my experience, highly credible, and I thoroughly enjoy working with them, but they will still show you the optimistic picture.
You need to test different scenarios, especially the gloomy ones, to see how the deal holds up when the sun is not shining.
“Three things cannot long stay hidden: the sun, the moon and the truth.“
― Buddha
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.