Who’s investing in new build apartments?

Question

I see a lot of talk on every RE investment site about buying underperforming apartment complexes and adding value. Laundry, rent raises, storage, parking, etc.

Obviously everyone enjoys an undervalued asset.  Isn’t there plenty of value in building an already value-added complex from scratch on good urban land. Why is there less talk about pooling for new builds? How’s your experience with it? Who’s investing in new builds besides REITs?

Sue Hough · Answer

@Colton Tapp I am a huge proponent of new build and believe it can be very profitable assuming the following criteria are met;

1.  Land development is complicated and you absolutely need a qualified developer on your side.  Working through the ins and outs of everything from assessments to  soil compatibility require some solid knowledge and experience.

2.  New construction comes with very few, if any, “surprises”.  Everything is out there to build and cost containment is reliable and dependable.  As opposed to buying a building which requires renovations, which we all know, always lead to the unexpected surprises located in the walls or foundation.  Those pitfalls do not happen in new construction.

3.  It is crucial you know your market inside and out.  You absolutely need to know who is going to rent from you, how much can they afford, do they need schools, medical care and so forth.  You need to determine, through exhaustive MLS analysis; where your property falls into the housing market through rents, how close are you to the areas which are getting higher rents, why are they getting higher rents, are you in a market which is declining and so forth.

4.  Don’t quit your day job just yet :). New development takes quite some time without reaping the rewards.  Plan on at least one year and up to two years depending on the size of your project and the difficulties you many encounter within the municipality obtaining permits.

The one large hurdle which prevents many investors is you, most likely, will not be able to fund the land itself. Banks do not issue loans on raw land unless it is “Prime” real estate (in the heart of Downtown Chicago, Manhattan, etc) so you need to prepare a financial structure to obtain the land.

Good luck!

John Warren · Answer

@Colton Tapp said is totally true in that new development is inherently more predictable than rehabbing because when you rehab you are trying to save existing structures while you are working backwards at different points (demo) before you can move forward.

Jordan Burnett · Answer

There are certainly developers developing new complexes. However, their investors sometimes do not receive cashflow until the project is complete and/or stabilized unless it's some kind of simple interest not from actual cashflow (as there is no cash flow from end consumers until the building is either sold or filled with tenants). For example, your IRR may be much higher, but you may not receive any cash flow for 2+ years while the project is completed (assuming you are on the equity side).

A common investment philosophy for REITs and individuals is investing in construction loans or loans to developers to sit on the debt side and collect interest while the project is completed.

As far as existing investors, a new development can be a bit riskier than investing in stabilized or value-add assets. A lot of it has to do with absorption rate and whether or not the area can sustain another complex, the cost of building/materials/labor vs a rehab of an existing building, etc. Developers "tend" to know the market very well, although I have certainly seen several new complexes sit vacant and have to offer significant concessions to fill the units.

A few brand new complexes that were finished this year near me have had to offer significant concessions to fill the units with tenants and they're still only 20-30% occupied. Long term they'll be fine, but short term it's ugly. However, when they started building there was really no way to know that the COVID-19 pandemic was going to occur.

Andrew Hogan · Answer

@Colton Tapp as you may have seen, the time it takes from the first shovel in the ground until the first rent check in your hand can be 1, 2, 3 or more years. That's a lot of time for the economy to take a spin in the wrong direction and the gameplan to not go accordingly. Many experienced operators for value-add deals offer monthly distributions to investors shortly after investing.99% of New product is luxury A+ and HAS TO rent for much higher than existing product in order to make a profit.

We like to position ourselves to perform better during a recession and have higher occupancy instead of more moveouts or concessions when the 'you know what' hits the fan.

The spread between A+ and A- apartments can be as much as 1,000/mo in some cases.

Jordan Burnett · Answer

I'm not super familiar with new development deal structures. It's always possible that they could still offer a preferred return. However, the preferred return would be "caught up" after the development completes in year 1-3 or whatever.

Another option is they can simply over-raise and return your own capital back to you as "cash flow" even though it's really just returning your capital (not preferable).

Some others like @Brian Burke may have a better idea of how new development deals are structured.

Colton T. · Answer

Thanks @Jordan Burnett. Are you aware of any particular methods a deal provider might structure a new construction development to alleviate the early year cash flow concerns to investors (perhaps at some expense to returns in the stabilized years)?  Building MF in a desirable area where absorption would allow for an average stabilization time seems like it would be a no-brainer investment for many investors, but I understand the first few years offering no "Cash In" may look less appetizing than an option where the flows can start almost immediately (i.e.- value adds in older, underperforming Class B apartments).

Who’s investing in new build apartments?

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