How do these large apartment projects make financial sense?

Question

Can someone help me understand how these large apartment developments make financial sense?  It seems like the rents do not justify the upfront cost to develop these projects.  What am I missing?

Below is a link to a 50 unit apartment project created from a warehouse in Milwaukee.  Rents are $895-$1850.  The project is $7mln, so $140,000 per unit.  Assuming an average of $1,400/unit, the numbers don't seem to make sense.  I am into my properties for about $70,000 and they rent for $1,300/mo.  What am I missing?  There is another project in Milwaukee where the per-unit cost is $220k, with similar rents.  What's the strategy here?

http://www.jsonline.com/business/former-walkers-point-clothing-warehouse-becomes-apartments-b9955490z1-216697881.html

-Jaden

Joel Owens · Answer

Look at the end of the article. The developer is getting tax credits to offset the costs.

Things like this make the number viable.

Small investors look for a higher cap on older existing buildings whereas re-development projects and  new builds are sold at much lower cap ratios.

Joel Owens · Answer

Yes it all comes down to it when you are  a large developer or an institution how you make money and reduce taxes is more about timing and structure.

A group of small investors or an individual investor is chasing yield. They typically do not have the same strategies as the big guys for obvious reasons.

So only from a cash flow perspective it's not that great.

Jaden Ghylin · Answer

Given the previous replies, here's my speculation on a possible strategy/business model for this.

Finance the project with a non-recourse HUD-backed loan and tax credits for down payment with a small amount of cash down.  This limits the risk to the developer.  If the project fails, they are only out a "small" down payment and they can walk from the loans.  I suspect the down payment is a loan as well.

Pay yourself as the contractor/developer and property manager of the project.  Get the project fully rented and manage it as lean as possible for 2 years to make the books look good.  (no maintenance/repairs, etc, low property taxes for new buildings), manage your property management fees to help the cap rate.  This shouldn't be too difficult with a new property.  Get the cap rate as high as possible, still maybe only 4-6%, but maybe attractive enough at that level.

Pension funds looking for an alternative to low-risk bonds, CDs, and US Treasury's want a high quality, asset-backed, "safe" investment.  It seems like a newer apartment  complex in a quality area with 2 years of solid rent history would be attractive to them even at a low cap rate.

Sell the project off to a pension fund at a 4-6% apparent cap rate.  They take all the risk and the developer walks away with a hefty chunk of cash.

This seems to make more sense.  Holding the project with financing doesn't seem to make sense since it doesn't cash flow well and there is a lot of risk of vacancy, interest rates increasing, or large repairs just a few years down the road.

-Jaden

Dave Martel · Answer

They're not supposed to make sense yet.  Most of the big developments are owned by pension funds, insurance companies, etc.  They have a ton of money they have to put to work and are willing to take the loss for a number of years to offset their gains.  They will either sell them for a profit down the road or hold on to them long enough for them to turn into cash cows when inflation catches up.

Ramon Jenkins · Answer

" This is not the first apartment complex in the area to be built with these rates. who is renting these apartments is beyond me? "

- possible relocation employees
- a person who works downtown
- a few pro athletes might consider
- small group of UWM / Marquette/ MSOE students

totally agree - numbers does not work -

Dawn Anastasi · Answer

People who want to appear hip and trendy to their friends ... never mind the exorbitant amount of money it costs them.  Yes, those people are out there.

Emilio Ramirez · Answer

On a schematic level, the numbers don't make sense to me either... but they make sense to someone. The federal and state programs provide a 25% tax credit combined. Per the OP's numbers, that still does not look attractive.  In researching LIHTCs a couple years back, I found I was able to get to a 4-6% cap rate at the schematic stage. The advice I got at the time was that to some people 4% cap rate was acceptable or the items that would make the deal more attractive would be found in the details.

A 2 bedroom for $1850 in Walkers Point also blows my mind. This is not the first apartment complex in the area to be built with these rates.  who is renting these apartments is beyond me? How it will be sustainable is an even a bigger question in my mind?

Dawn Anastasi · Answer

Well the one thing that makes sense is not keeping a warehouse vacant and instead turning it into something useful.  As manufacturing jobs leave the USA and go overseas, something has to fill up those warehouses.  If there isn't a demand for a warehouse, there is demand for living space.

Walker's Point is a "trendy" area of Milwaukee as it's largely industrial and I can see people who are "trendy" living in a converted warehouse.  Me, personally, I prefer living in a regular house with 8' ceilings and hardwood floors instead of really high ceilings and concrete floors.

How do these large apartment projects make financial sense?

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