How to Loose Money on Multifamily!

[Ben Leybovich]

One of my partners called me yesterday.  He said he had a lead from a wholesaler on an 126-unit in good part of the country that we should take a look at...

The marketplace really is quality - a stone's throw away from a major city.  Highly motivated seller with a story that made all kinds of sense - my partner spoke directly top the seller.

I come into the picture today.  My job is to underwrite the deal.  I spent 5 hours in which I researched the market, the little bit if info that I had (this is a very distressed situation), called my management contacts with boots on the ground in the geographical vicinity, and finally built a pro-forma based on available information.

According to my underwriting, the stabilized operation of this particular asset would result in negative gearing NOI to the tune of $120,000/year...

Let me say that again:

Even after everything is functioning as it should, this asset would still be loosing $120,000 of NOI! We are not even talking about Cash Flow here - NOI! No **** they are motivated...lol

Even if I were $100/month/door off on the rents, the NOI would still be negative $20,000.

Guys - I could not imagine that this would be the result of my underwriting.  I can look at a 4-plex and tell you if it works in 3 seconds.  The big stuff has so many moving parts, and so many line items you've never heard of that I literally had to go through the entire process to arrive at the results.  

It's really hard to underwrite mutli-unit.  And most people, whether they know it or not, loose money in this space...

Be safe and be wise!

[Brian Burke]

@Ben Leybovich  I see the problem that you are experiencing to be sourced from the opposite angle from which you are looking.  Yes, deals, as you define them, are difficult to find. Why?  Because other people define a deal differently than you.  

You see, the problem isn't that the property will not support the expenses to operate itself (well, this can and does happen but I don't think it is your predominant obstacle). Most properties will generate a positive NOI even with proper staffing levels and management structure. If they didn't, every 100 unit C deal would be in foreclosure or torn down / abandoned.

So if it's not the property, WHAT IS IT?  It's...cost of capital.  

To syndicate a deal you have to attract investors. You do this by producing a return on their investment. Since you don't have deep relationships with capital investors you likely have to show them an IRR in the mid-teens to attract them to the deal. This means that only the very best deals will make the cut. Mediocre deals don't qualify. You can't squeeze out mid teens from them and still take a cut for yourself.

REITs and private equity firms have deep relationships with their capital partners. They might have to produce a 4 or 5% return to their investors. Even mediocre deals will do that and still leave room for their promote when they borrow 2/3 of the capital stack at 3.85%.  They can turn your great deal into a mediocre deal simply by submitting a higher offer than you. The property didn't change at all...so you can't say the property was a bad deal, only that they got a bad deal (at least as you define it).

Family offices are looking for parking places for boatloads of capital and they can't put it all in treasuries at 1.8%. So they buy some real estate and put in a risk premium that still results in a return much lower than you need in order to make your investors happy.

1031 exchange buyers arguably have a negative cost of capital because if they don't buy something, even at a zero percent return, they lose money to the IRS for capital gains.  

The buyers in these last two categories have no carve outs...there's no general partner or syndicator to share with.  100% of the return goes directly to them.

Those with a lower cost of capital than you can outbid you every time. Your only chance is to buy a deal that they don't see.