February, 2024

I watch for new builds closely.

It’s easy to see when they’re going to hit the market because once they’re under way and progress is visible and their development schedule is easy to determine. It’s public information and Costar shares this.

Your buildings are class C and this new one is class A. No threat, right? Wrong. Good renters have good jobs, they take care of their units, and want to live in a clean, safe community with amenities. They will move up if they can. Renters in a class B property will move to the class A and class C to class B. Not all of them, of course, but enough that it will impact your property.

But building is cyclical. We have been in a period where a lot of new building was started. Interest rates were low, vacancy was low, and rent growth was through the roof. Who wouldn’t want to build new apartments in that kind of market.

We’re seeing them come to market in a big way now. RealPage reports that apartment supply jumped to a 36 year high in 2023 when you measure the new product coming to market as a percentage of existing inventory. Even more apartment units are expected to be delivered in 2024.

Where? Right where you’d expect. DFW, Houston, Phoenix, Austin, Charlotte.

Are you buying now or can you hold for a few more years? The pendulum is swinging hard to the other side. Again, predictable. Census Bureau data shows multifamily construction starts down 12% year-over-year as of late 2023 but Jay Parsons, Chief Economist for RealPage, distills data around new buildings being designed, projects being delayed, and banks willingness to finance these projects. He’s saying the drop in starts is more like 40% for these reasons.

The demand for housing is not going away, not even declining. It’s still on the increase and will continue to be. Now we are seeing that over the next 3-5 years supply not begin to keep up.

If you own, hold. If you don’t, buy. The best is yet to come.

Market update
Tucson, Arizona
– Do you like the sun? Come to Tucson, 350 days of sun a year, the sunniest city in the U.S. Who would want to live there besides those of us who love the sun? Birds do. It’s home to more bird species than anywhere on Earth except one – the Amazon rainforest.

What else is Tucson known for? A recent designation as a Top Ten Digital City by Government Technology magazine. AARP’s designation as one of the top destinations for retirees.

Tucson also had a Forbes designation over ten years ago as Best City for Renters. That may not be so true any more as now it is recognized as one of the highest rent-growth cities in the U.S., with 2.9% year over year growth.

Tucson’s population of 543,000 grew about 11% over the last 20 years. Job growth has kept steady at 2.2% in 2021, 3.2% in 2022, and 1.4% in 2023. People and jobs are still moving in, at a time when most major cities are moving in the opposite direction.

One of the biggest long-term issues Tucson faces is water supply, but Tucson has commendably managed its supply more successfully and sustainably than its bigger neighbor, Phoenix. Groundwater supplies are at or close to steady, as they replenish nearly all that they pump out. Their source is the Colorado River, which has been running dangerously low in recent years but adequate for Tucson’s needs.

Most importantly, Tucson’s conservation regulations allow growth. The welcome mat for new residents and companies is open because there is room to grow and a sustainable infrastructure.

Who are the big employers? University of Arizona for one. Universities, of course, are one of the most desired attractors for lifestyle-driven population growth. UA has all the right attributes. Then there’s Raytheon, one of the top defense contractors in the U.S., Walmart, Freeport McMoRan who mines copper and gold, the Border Patrol, and the normal major employers which you find in every metro – the City, County and State governments, Tucson School District, U. of A. Healthcare Network.

One of the main draws of Tucson has always been its access to markets in Mexico. Container terminals all around the U.S. have been expensive choices for major importers so massive amounts of goods enter North America through Mexico and travel through cities like Tucson. When manufacturers decide to move production over the border, their preference is to keep it close to the border. Tucson is 65 miles from the border, and a major highway makes this an ideal transportation route.

Tucson experienced massive rent growth, up 30% from 2021 to 2023 according to RealPage. That reflects population growth but also an inability to buy houses and a supply that could not keep up. While Phoenix saw rents decline year over year by 4.7% through June of last year, Tucson continued its growth at 0.8%. Costar reports rent declines through end of 2023 although that more likely reflects new supply coming to market.

Supply is growing in Tucson, but as we noted above, supply growth is likely to slow down after this year because builders don’t want to pay these outrageous interest rates.

Two trends that aren’t stopping any time soon are the southward population movements and company and employer migrations to lower tax states. Tucson will benefit from both, despite the temporary slowdowns we’ve seen recently.

Recent Articles Worth Sharing
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Finer Points of Multifamily Properties
Seller’s Financials Don’t Have to be Perfect
The first time I saw income statements and rent rolls sent to me that didn’t come from even a spreadsheet let alone professional property management system, I was put off. I had my standards, and I wasn’t going to indulge this amateur owner by responding to worthless reports.

I had been trained and knew what to look for. I knew how to categorize the seller’s income and expenses and my spreadsheet would tell me if it was a good deal.

But if I couldn’t trust the seller’s numbers, garbage-in-garbage-out as they say.

How many good deals did I miss with this “standard”? I couldn’t tell you, but that’s not my standard any more.

The world is full of people who don’t keep track of the numbers very well, yet their tenants know that when they have a maintenance issue, someone will fix it quick. Rents are going up only $10-20 a year. The staff is friendly when they come by. Utility bills get paid.

How much is the owner making? Enough to pay the property bills and maybe pay themselves a little after that. That suits them just fine.

So they decide to sell, you look at the property, you like it, then they send you something that’s handwritten. They even have a broker, but what’s a broker going to do about their mess? The best the broker can do is explain all of the other good qualities.

This does not have to be a deal killer. Look at their numbers, then use your other sources to fill in the missing pieces.

You want to know what rents are? Start with the leases. Are they signed? You work with the owner to get signatures on any that aren’t. You have to know what the tenants agreed to pay. That gives you gross scheduled income.

Get the owner’s bank statements. That tells you what the owner deposited over the last several months. Maybe not everything they were supposed to, so then you can figure out who wasn’t paying. When their systems are loose, they may have tenants who are delinquent. Now you can plan for having to get those tenants out after you take it over.

For each expense category, you’re going to use your own estimates based on other sources or rules of thumb.

Utilities – get the owner to allow you to contact the utility companies on their behalf, then request statements. You’ll need more than one month’s worth, ideally the last 12 months so you have heating and AC costs when the weather is cold and hot. Also, find out from the owner how occupancy changed over the last year. If it’s 95% today but was 75% last year, water usage could have jumped in that time.

Repairs – put your best asset manager on this task. You have to take into account deferred maintenance, the age of the buildings, what types of assets are on the property like pools, flat roofs, chillers/boilers, when were HVACs replaced. Getting Repair & Maintenance costs from the owner might be helpful but these are probably the least accurate of their financials. A rule of thumb is $500-700 per unit per year but you might make adjustments for deferred maintenance or if a major remodel was recently completed.

Property taxes – get an accurate number from the County. Call them if you need to.

Insurance – get quotes from multiple providers.

Landscaping, pest control – these are smaller expense line items than most others so you can estimate it, but unless there are no landscape items to maintain, they are not 0.

Marketing – you’ll need more than the free advertising services, plan at least $500 a month.

Property management and payroll – get quotes from your top picks for PM service providers in that area. For larger properties, payroll is usually $1,000 to $1,200 per unit per year, but this can vary too. If occupancy is low, you might need someone on site full time to fill up the property, but don’t need them full time after that.

These are the operational expenses, not the renovation expenses. You would be coming up with renovation costs on your own anyway, not asking the owner what he spent per unit on renovations, for example.

You are on your way but the biggest hurdle you have to overcome is your lender requirements. You should rest assured that lenders have seen all kinds of owner financials. They can figure out how to work with it. You have to be in touch with them, and get on the same page. When they tell you they need 12 months of utility statements, or two insurance quotes, or a third party repair estimate or roof inspection, get it. Follow their direction.

What you offer for this property should reflect the owner’s actual income and expenses as much as possible, but you have to account for an additional level of risk you’re taking by not having professional financials. However, the owner is old school, not naive, so low ball offers are likely to be ignored. The risk is you may discover issues during due diligence that were not disclosed, or there are tenants who won’t confirm their lease terms. Plan for the worst case, they aren’t paying, they won’t leave, or they pull out an older signed lease with a low rent and another 10 months left on the lease.

If you have to change your offer terms, then change them. The owner and broker won’t want this outcome and they may decline it, but if it’s the owner’s fault, the owner should understand.

When isn’t the market competitive. It’s extraordinarily difficult today because of interest rates, owner pricing expectations, insurance costs. You need every advantage you can if you want to buy apartments. Don’t pass up good deals for the wrong reasons.

    Who We Are

    Cardinal Oak Investments acquires, improves, and manages under-valued commercial apartments. We buy B and C class properties of around 100 units 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 contact us.

    Please note: Past performance is no indication of future performance.