Lesssons to be learned from Large multifamily foreclosure

[Jaideep Balekar]

By now, many of us in the multifamily world, and in real estate in general know that a Dallas based syndicator recently lost $230,000,000 multifamily portfolio in Houston TX. 3,200 units foreclosed.

It’s very easy to talk about others when it’s not happening to you. Situations like these give real estate a bad name and for me, that’s not acceptable.

Real estate is a rock solid asset class and will continue to be. Don’t blame the horse. The jockey (operator) is equally important

In some cases, situations like these happen due to malice. But malicious intentions aren’t very uncommon on the Wall Street either. Where there’s money, there’s greed.

I didn’t personally know this individual, but in this case, I don’t know if it was malicious intent.

Was it perhaps recklessness, yes. Not underwriting conservatively is definitely reckless.

IMHO here are some lessons learned:

👉🏻 Pick the right mentors.

What kind of message are your mentors conveying? Go big or go home? Going too big too fast comes with a lot of risks!! Real estate is not all about Ferraris and Jets. Its a slow grind….choose who you take your advice from wisely. Listen to people who have survived market cycles

✍🏼Underwrite extremely conservatively

Don't factor in that cashout refi, stress test the deal with higher rates and lower leverage, focus on your exit CAP rate projections, rent growth projections, tax and insurance increase projections. History is not a good predictor of future. Just because you have double digit rent growth in past decade doesn't mean it will continue for eternity. Just because interest rates were at their rock bottom doesn't mean they will always be low.

Conservative underwriting will make you lose 99% of the deals. But that’s the whole point.

🛍️ Buy Right

Going hand in hand with ‘underwriting conservatively’, overpaying for bad properties is a mistake that you can hardly ever recover from. Some people got lucky as the market for helping them but the tables have now turned

💰Finance right

This situation is primarily the result of Floating interest rate debt with no rate cap and very high leverage.

Do NOT over leverage

Try to stick to agency debt that’s fixed for a long term

If going with bridge, try to get fixed interest rate bridge debt with extension options

💪🏼 Manage Right

- Ask how much experience do they have as an operator?

- Does the operator have skin in the deals?

- Is the operator well capitalized and does the operator group have good liquidity?

- Have they grown too big too fast?

- Have they survived and thrived in previous market cycles?

- Do they have solid boots on the ground who have skin in the game?

- Are they vertically integrated? How much control do they have on their deals?

- Do they have experience in the type of asset, in the class of asset and in that market?

There’s going to be a lot of pain on the horizon. This was just the first one, there will be more.

Remember….Pigs get fat, hogs get slaughtered.

#realestate #multifamily #capitalpreservation

#compoundingcapitalgroup

#takeitslow #cashflow #CashIsKing

[Bruce Lynn]

It will be interesting to see what actually comes out of this.

I like your list, but in a way it is a dream list of due diligence.

While all the things you point out, many are near impossible to research and can change.   Like does the operator group have good liquidity.   I don't think you can determine that....and even if you could, you don't always know what other deals they own or have in the works.  Good liquidity today, could be horrible tomorrow.   And who is to say, even if they have great liquidity, that they are willing to spend it on your LP property.

I don't know the %, but I think very very few of the GPs were around and investing during the last downturn. Most I see probably started 2015 or later. Most probably have not had to chase a lot of rent, like during and after COVID. Most have never really had to asset manage or PM thru tough times....and their PMs have not had to manage thru tough times. Seems rare you find someone in the leasing office who has been doing it for 15 years or more. Lots of turnover there. You almost will never know if the GP or Asset Manager or both has done training and education with the property staff about how things work. Sometimes they're quick to outsource a repair, where it could have been done in house for 1/2 the amount. How does that $500 extra expense affect NOI and value of the property? Do the PMs understand who the investors are and where that money came from to invest. Most of us are not giant corporations where that $500 does not make any diffeence.....most of us are mom and pop investors and this is our retirement money....that we worked very hard to save.

I think this group probably had several issues that overwhelmed them.  One was the high leverage. One was floating rate debt.   One is that they were in a different market than their home market.  I live in DFW area, but know little about Houston.   It's only 5 hours away, but when I visit I always feel like I'm in a totally different world.   Sometimes I see operators pitching they're going to turn a class D/C into a B or B+, but I think often they don't understand the demographics and demand drivers for the area.  Potentially it can be done, but these are super heavy lift to accomplish and I think doubly difficult to do if you are not there every day, you don't know the area well, and you have really big properties like these were.  So many people have been pitching you can take a classic unit to a platinum level for $20,000 add washer/dryer connections and a dog park, change the monument sign, and get $300/month more per unit on 1000 unit Class C complex.   Very tough to turn a workforce housing huge complex into one that is attracting highly paid young professionals that value Nest thermostats and swipe locks.   That's rare....but that is what I often see pitched.

It wouldn't surprise me on some of these assets if they hadn't really done great due diligence that ended up adding to their headaches.   I would guess they had a lot of bad debt, more evicitions needed than met the eye, and leftover issues from the big freeze.  Where they have been optomsitic they could have economies of scale on all their expenses, my guess it went the other way.

Very few operators also seem to have a good handle on renewals vs new tenants and have incentive systems set up with PM to make that happen.  PM would much rather renew in many cases at a slight rent bump, vs telling current tenant they need to move to rennovated unit at $300/month higher rent.  I'm guessing most are incentivized on new tenants leases vs renewals.   Renewals are often better for the owners though.  Vacancy is horrible on the numbers.

I don't know, but I get the impression many operators think their work is often done once they close.  On some properties like these, I think it has probably just begun.   It's not sit back and count the cash flow, it is get dirty, get busy, grind it out work.   I'd almost say on a 1000 unit class C in Houston, you'd better be prepared to office in a vacant unit or the amenity center and keep an eye on things, vs going on big vacations and 10 conferences.   I don't think you get success with a one hour conference call with the PM once a month or 2x/month.

A lot of that is very tough to check up front unless you know the GP team very very well.