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October 2019

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We often don’t have the time or take the time to say what we want or ask what’s new to interesting people we’ve met. We want to change that. This newsletter is intended to be brief but informative, a small diversion targeted to those who like to keep current on the market and our activities pursuing real estate investments.

As you know, we pursue investment opportunities for commercial apartment buildings. These are your opportunities as well, because we are painfully aware of how difficult it can be to produce income, let alone tax-favored returns and capital appreciation. We met because you already know how commercial real estate can literally transform our lives. We shared that interest, and hopefully still do.

Here’s what we’ve been up to. We’re definitely not stepping back from a market everyone says will collapse soon. We’re not market predictors but we do understand market phases, we know we’re in a late stage seller’s market, and we have risk management strategies for each phase. We are searching for B or C class properties in the Southeast and Midwest, of around 100 units. We see them but today, holy cow, everyone sees them and is paying through the nose to acquire them.

We wish we could be bringing you your next opportunity but we’re not there yet. We will be there soon, though. We have had offers in but chose not to pay more and flip a good deal into a bad deal.

Let’s take a look at one particular market, the city of Gainesville, GA. In in the middle of Georgia it is over 45 miles from Atlanta and it is not a huge city, only 34,000 people. It is on a major highway artery, though, and has some larger apartment complexes. But job growth has been among the highest in the nation, and consistently for the last several years averaging 3.6%. We like the market and would invest there with the right opportunity. Industry is diversified, not a onecompany town. Sometimes it just takes a committed group of city leaders focused on growing opportunity and reducing business impediments to bring the jobs. That’s what seems to be happening here.

What to spend on improvements
When you spend $4,000 to renovate a unit, are you looking at how much more per month you get, say $50, and deciding it will take you over 6 years to get back that investment? Or – are you looking at market cap rates, where $50 a month, $600/year, in a 6% cap rate market, produces $10,000 of additional value?

You like the property because it’s in a great area and the rents are below market. Fantastic. But what does it take to get rents up. I’m ignoring how to be sure of what “market” rents are, a topic for another discussion, but you have to know what you can spend. That’s what helps you decide whether to buy the property or not.

First, some quick math. (Want to invest in real estate? Learn the math! ☹) Capitalization rates tell you how much the property costs in relation to the income it produces, Net Operating Income (NOI) / Purchase Price. It also gives you an idea of what you can sell the property for, and therefore the value of your property. If it’s your goal to increase value you want to know what kind of value you’ve created.

If I bought my property at $1,000,000 and it produced NOI of $50,000, that’s 50,000 / 1,000,000 = 5% cap rate. Let’s say your broker told you other properties in the same area also sold recently for cap rates of 5%. That means if you increased your income from $50,000 to $60,000 and your market cap rate stays the same at 5%, and if NOI / Price = cap rate, then Price = NOI / cap rate, your new value is 60,000 / .05 = $1,200,000.

You added $200,000 to your value by increasing income by $10,000. But what did you have to do to increase income by $10,000? You raised rents by making the property nicer and the units newer. If you have 20 units you increased rents an average of $42, because $10,000 a year is $833 a month, divided by 20 units is $42.

This helps you decide what to spend. Remember you have $200,000 in greater value, not just $10,000 more in income. If you want your renovation to pay off in, say, two years, you’re allowing yourself to spend just $1,000 per unit, because $20,000 / 20 units = $1,000. $1,000 might pay for a new countertop or a couple of new appliances but will that bring $42 in higher rent?

Focus on what tenants love. Flooring, kitchen, bathroom. Do you need carpet replaced? With what, new carpet or LVT? Does the bathroom have a sink or a vanity? Is the tub area pretty gross? Is the kitchen countertop chipped? Are the light fixtures straight outta the 80s?

What would you pay? Make it nice but keep in mind the location. When you’re sure there are tenants who will pay the premium for a nicer unit then invest with confidence. One spending guideline is 50% of the improvement in value. For example, if you increase rent by $50, that’s a $600 increase in annual income, or $12,000 in value. You might only need to spend $2,000 but if you have to spend $6,000, you should still be in good shape. If your estimate for bringing that unit to the level it needs to be is $10,000, you better have more than a $50 rent increase opportunity.

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.

October 2019

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