March, 2024

As you know, don’t look for political viewpoints here, just relevant opinions and observations.

We have about 10,000 migrants crossing the Mexican border each day who don’t live in the U.S. and most are asylum seekers. That’s the number that is most widely reported. So 300,000 each month, 4 to 10 million over just the last few years, and about 1 million new legal immigrants a year over the last 20 years.

How many is this? We only track legal immigration so we don’t know. But we do know they need a place to stay.

We also have a housing shortage of about 3 million to 5 million, and it’s not getting any better. What does this lead to? Only three things. We build more homes, or prices for existing homes goes up, or people go homeless. Clearly all three are happening.

Today, however, communities are making new regulatory controls over housing development, making it harder and more expensive to build. Or they are concentrating new development in urban areas. I saw a sign next to a small grocery store on less than an acre near downtown Seattle last week that said “This is the site of a new 71 apartment building to be built.” No parking anywhere in that area. Already a dense neighborhood, but soon there will be more housing.

Communities are also pushing back on homelessness. Most big cities experience it and have seen it become much more prevalent in recent years.

Has immigration driven this spike in homelessness? Very likely, but again, not a lot of data.

The third outcome is increased costs for homes. Single family homes and apartments.

It is not a great outcome for those on the lower income side of the scale but it is certainly an opportunity for investors to build, improve, and provide the kind of comfortable, safe housing that our growing population needs. Don’t look to government for these solutions. Motel, office conversions, ADU’s – our ability to be creative is unparalleled when we have our own money at stake.

Where are immigrants settling? Rentcafe says Texas, California, New York, and Florida are the biggest targets. They are more than targets, though, they are beneficiaries. The U.S. has had communities of immigrants from day one. Supportive communities are the reason new members of society thrive.

You might want to turn off the flow of migration into the U.S., or not, but we should be embracing those who are here, looking for ways to support them, and creating opportunities to build wealth through these opportunities.

Market update
Wilmington, NC
– If you’re willing to take a hurricane hit every few years, Wilmington has a lot to offer. Others must agree as the population has grown from 65,000 to 117,000 in just the last 20 years. It is picturesque, historic, artsy, and quiet. It isn’t in the Research Triangle Park so there aren’t the super high income residents and major companies located here. No, mainly just people who value lifestyle over workaholism. But they need places to live, and Wilmington is providing them. reports rents increased .2% over the last month although they were down nearly 2% over the last year., however, reports rents for Studios up 43% over the last year, with 1BR’s up 2% and 2BR’s up 1%. Does that tell us a lot of single people are moving to Wilmington?

It’s not a cheap place to live. Median housing value is over $334,000, compared to $236,000 for North Carolina. Incomes fortunately are higher, though, $61,000 compared to $53,000 for North Carolina.

It is also a city that is doing well controlling crime. The crime indexes have been falling over the last 15 years, a very favorable trend.

Job growth has been relatively strong, 5.1% in 2021-2022 according to Milken Institute, and 1.3% more recently. That’s not too stellar but that suits them fine. Most jobs are in healthcare and hospitality but there is a strong scientific and technical services base as well.

Wilmington recently earned the #1 top spot on Southern Living Magazine’s list of regional cities “on the rise”, which are qualities that make a big mark on visitors. Things like less crowded beaches, Riverwalk, majestic oaks that some say are more grand than Savannah’s.

And these days they’re calling it Hollywood East because it’s a favorite filming location for movies and TV shows.

These qualities add up to an attractive place to live, and that invariably leads to new job and investment opportunities.

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Finer Points of Multifamily Properties
How Projections are Juiced

Projections can be juiced, or inflated. You need to know how to tell when they are.

Underwriting a property is the process of taking financial reports that come from the owner of the property, rearranging that information so it fits into your template or model, and inserting your own assumptions and projections so you can see how the property will perform if you owned it.

The financial reports might come from the owner’s broker, and they might have been produced by the owner’s Property Manager, but still the owner had the final say on what got sent out to buyers like you.

You might have an elaborate system for transforming their numbers into your numbers, or a spreadsheet, or you might just do a visual inspection of their reports. Whatever your system is, it’s going to give you an answer that says keep looking at the property or pass on it.

When you underwrite a potential property you’re thinking of buying, one of your goals is to see what rate of return you will get. However you measure that rate of return, your underwriting should give you your answer.

Your rate of return is most likely based on two types of cash flow: distributions from rents each month, and proceeds from the sale of the property. You expect appreciation on the property. You expect it to sell for higher than what you bought it for.

How do we project what it will sell for? The same way you’re valuing the property today for purchase. Net Operating Income (NOI) and Capitalization (cap) rate.

You know the NOI today because it’s in the seller’s report. Sure, the seller might have left out payroll expenses, property management, even property taxes, but you can figure that part out. The true, actual cap rate accounts for all of the operating expenses that owner is experiencing regardless of whether they reported it to you.

You are also projecting the NOI for the years you’re going to own it. Ideally the NOI goes up!

Does that tell you the value of your property at the time you want to sell it? Not quite. You still need to use the correct cap rate.

Which is – what? The cap rate you use with your projected NOI determines the value of your property. It does this by a simple calculation:

      Cap Rate = NOI / Property Value

Therefore, if you know the NOI and the Cap Rate, you can get the Property Value:

      Property Value = NOI / Cap Rate

You need to remember that cap rates are percentages. An 8% cap rate is .08. When you make any change to a very small number on the right side of this equation, it will have an enormous impact on the left side of this equation, the Property Value.

You think the cap rate in five years will be 6%? Let’s say you’re projecting NOI of $500,000 in five years, so the equation is:

      500000 / .06 = $8,333,333

But how did you get the 6% cap rate? Is that the cap rate you’re buying it at today? No, you’re buying at a 5% cap rate. So why can’t I use 5% for my cap rate in 5 years? Then the value is

      500000 / .05 = $10,000,000

Yes, I think I like that much better. Higher valuation, higher returns, let’s go!

There you are. Want a better valuation, use a lower cap rate when projecting your sale price. This is called your reversion cap rate.

Would you like to know what number investors look at more closely than most any other?

The reversion cap.

Because it’s the easiest place for deception. How they choose that reversion cap rate is one of the most important decisions they make when underwriting. I’ve seen several different ways syndicators and sponsors present it.

Keep in mind it is a projection so it is guaranteed to be wrong, but it is an indicator of how cautious the sponsor is, how conservative their numbers are, and how good of a deal this is.

Reversion cap rates need to be higher than the cap rate you are buying at today. Maybe a lot higher, maybe a little. One method says add a tenth of a percent to today’s cap rate for every year you own it, so if you are buying at a 5% cap rate and selling in 5 years, use 5.5% as your reversion cap rate. Others use a standard practice of adding a full percentage point to today’s cap. These aren’t wrong. But you could do better.

What I try to do is understand where the cap rates have been in this market over time. Although I could write extensively about what cap rates really are, the best definition is they are the market’s perception about property values. They are different in different sub-markets, and with different property classes. A new property has a lower cap rate than an old property. Cap rates change over time, and you need to expect that.

Since you don’t have a crystal ball, you have to build in an assumption that the market might go down and cap rates might go up. You have to understand cap rates in your market.

Where have they been in prior years? Were they much higher not too long ago? Then they could go higher again. Or steady over the last 6-8 years? That’s important to know.

The reversion cap rate you use should align with a reasonable expectation of a worst case scenario. If it’s a half percent or two percent higher than where they are today, you need to build that into your projections. If it causes your returns to fall below your minimum requirements, pass on the deal.

This is not about stress testing your property against wildly unrealistic worst case scenarios, because then nothing would work. It is about being prudent, using the information that you can find, and being able to defend your conservative underwriting principles.

“Failure is the condiment that gives success its flavor”

                                                            -       Truman Capote

    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.