"Take action." Over and over, no matter the industry, everyone's best advice on getting started is to do exactly that, START. For 18 months I worked as a Transaction Services Associate at a large international advisory firm thinking daily about how I'd get started. I always knew entrepreneurship was my path, but I had yet to find my entry point.
Six months ago, I had never so much as purchased a house. Today, we are moments away from breaking ground on a 48 unit mixed-use apartment development. So how did this transition from these two opposite ends of the universe manifest itself? Many have asked, so here is our story.
My partner, Alec Harris, and I first started learning about multi-family real estate about 6 months ahead closing this first deal. Like others, we started with podcasts (Bigger Pockets, Apartment Investing Journey, etc.) and just soaked up everything we could about the space - what's a Cap Rate? what does "good" occupancy look like? what's a value-add? what's an agency loan?
We quickly recognized why multi-family was so highly sought after - it allowed you to spread the vacancy risk of a property across more tenants than any other asset class, and historically was the highest performing asset class during recession periods. We were sold. Now we needed to buy.
The value-add commercial real estate strategy is rather straight forward: you purchase an existing asset with a solid rent roll. Then you find various ways, whether it be through renovations, increasing occupancy and rent, or reducing expenses, to add value to the property. Then you sell or refinance and realize the profits. The nice thing about commercial real estate assets is that they are valued based on their income, or through what is known as a capitalization rate. Defined and explained below:
So the beauty of the value-add strategy is that it allows you to increase the market value of the property proportionally to the increase you generate in the property's net operating income. Simply put, increasing the income of the property increases the value of that property. Makes perfect sense right?
Finding the Deal
Like almost all new real estate hopefuls, we took to Loopnet.com in search of that glorified first deal. Many will tell you that Loopnet.com is the trash can of real estate deals, or where deals go to die. That statement has varying levels of truth, but at least we were not (and still haven't been) successful in finding a deal through the site. The best deals are found through the best brokers. All the major real estate firms have divisions designed to sell multi-family assets - CBRE, Colliers, Berkedia, Marcus & Millichap; the list goes on. The problem is that if you want a particular broker to bring you their premiere, crème de la crème deals, with sky high going-in cap rates, huge rent push potential, and a laundry list of ways to optimize expenses - you had better get in line, because so does everyone else. This makes the brokerage world, and first-in-line relationships with those brokers, extremely important.
Fortunately, through a high school relationship, Alec connected with a broker who had just been engaged to market a 48 unit mixed-use property in an exploding multi-family market. The only catch: it hadn't been built yet.
From Value-Add to Ground-Up Development
We were now entering the world of ground-up multi-family development, which is like a second cousin of the value-add strategy - loosely related, but disparate in a number of ways.
This forced us to consider a multitude of details that don't really come into play in the value-add world: PUD agreements, zoning ordinances, land conditions, short-term cash flow short falls, construction timelines, a full-scale lease up process; and so on. The attractiveness of ascending to this level is that the ground-up game unlocks a playing field that is largely less crowded, with (generally) higher return potentials, and the "newest product" advantage when it comes to leasing. The titans of the value-add model can likely argue against all of the advantages in favor of that model, so I suppose you could say these advantages are debatable.
Nonetheless, we proceeded to place the land under contract and begin what would prove to be a grueling 6 month process of vetting all details of the business plan that the sellers had outlined for the development. Essentially they gave us a pro-forma detailing expected rental rates, financing terms, and sources and uses of project funds. We had to analyze and dissect every piece to determine "fact" or "fiction" and corroborate each number on behalf of our soon-to-be-formed investor group. Budgets for items like pre-C of O taxes, marketing, engineering inspections, utility connections, amenity furnishings, and consultant construction administration fees were underwhelmingly represented or in some cases, not at all present in their plan. This drove up the total cost of the development and ultimately threatened its viability. Fortunately, the rental rates and additional income projections were sufficient to justify the costs, so we marched forward.
Throughout the diligence process, we were also assembling our development team. The only way we were going to be successful is if we found an architect and construction manager with decades of experience who could help us navigate the complex waters of real estate development. So we did exactly that. Tower Construction has completed hundreds of projects and built millions of dollars worth of multi-family assets. Designhaus Architecture has a similar story, with over one thousand projects completed. We also had to assemble a team of attorneys, a property manager, insurance brokers, and a number of other ancillary vendors to contribute to various pieces of the development.
Project Funding
The next task was to fund the project. The total project costs were about $9M. This was the amount required to acquire the land, construct the 50,379 square foot building, and get it blessed with the highly coveted certificate of occupancy. The sellers had already engaged a debt financier interested in providing about 80% of the proceeds ($7.2M), but this was far from a green light. It took weeks for us to work through pages of approval requirements and get this lender comfortable with the team we had put together to carry the development forward.
The other critical piece to the funding equation was to assemble a team of investors capable of supplying the 20% in equity financing ($1.8M). This required that we build an offering memorandum (OM), which outlined the opportunity; complete with a market analysis, project timeline, and of course, financial projections. We met with a series of "friends and family" investors who were intrigued by our endeavor and one by one, began to secure verbal subscriptions, or agreements to provide capital. The final capital stack was complete with 12 investors providing the $1.8M and an approval from the bank for the $7.2M note. We were now (almost) ready to close.
The clock was ticking. The seller had to close by a certain date in order to avoid exorbitant interest exposure that matured shortly after the intended closing date. If we missed this deadline, our purchase agreement would be void and the price of the development would have to be renegotiated. This meant we had to move very quickly to finalize investor and loan agreements, receive wire transfers of equity contributions, and provide the bank with necessary documents from vendors and consultants who would assist in the build. This was by far the most stressful part of the entire process. Three days before closing, I was on a client site in Memphis, working 15 hour days to build an integration blue print for our client, while spending every spear moment replying to investor emails, taking calls from the lender, confirming wire transfers, and so on. It was an all out sprint to the finish line, but Friday, November 22nd came, and we were able to close the deal without delay.
Time to quit our day jobs
Up until this point, Alec and I had been doing all of this work while still balancing our full time jobs. This added to the complexity of the due diligence phase, but was completely necessary because prior to closing, it all could have fallen apart. Once we closed, formally funded the project, and had the plan in place to execute the development, we were comfortable that leaving our jobs in pursuit of a career in development was a justified move.
Ok so back to the action. We were now the deed owners of the land, development rights, and had the equity and debt necessary to fund the project, but our job was far from over. In fact, it was really just beginning. The pressure was on because we had now spent nonrefundable investor capital and the only way of generating a return was to complete the building, on budget and schedule, lease to tenants, and begin generating cash flow.
We spent the next two months re-designing the building in an effort to squeeze out every drop of revenue potential, while holding construction costs at an affordable level. This was a team effort among our architect, construction manager, and ownership group working diligently to complete the plans with ample time to process them with the city, garnering the necessary approvals and preparing us to begin construction on schedule.
And that leads me to today. We are now just over a month away from putting shovels in the ground and finally bringing this project to life. We just received site plan re-approval last week and subsequently submitted our 95%, or permit set, of construction drawings to the city for their final review. From here, we will work with our development team to value-engineer the plans in a way that optimizes construction spend and allows us to solidify our Guaranteed Max Price agreement (GMP) with the construction manager and begin building. This GMP is a critical component to the financial viability of the project, as is effectively guarantees the amount of construction costs by the construction manager. This allows us to operate with a much more lean budget than would otherwise be required for a project of this magnitude. With continued hard work, collaboration among our teams, and a little bit of luck, we will begin construction this May and complete the project 12 months thereafter.
Reflecting With A Look Ahead
This experience over the past 9 months, taking the leap from corporate employment to an entrepreneurial pursuit, has been enormously valuable. Certainly, it has tested my patience and taken my stress levels to new heights, but it has also unlocked a 6th gear I didn't know I had. The funny thing about being an entrepreneur is that it forces you to thrive in the chaos. You have to love the uncertainty and be capable of coping with it 24/7. At my old job, I signed off for the night and (most of the time) could forget about it until the next day. This world doesn't work that way. Now there isn't a minute that passes where I don't think about "what if" and quickly race to outline a plan A, B, and C. The craziest part of it all is that I've never been happier.
From here, Alec and I will continue to build Detroit Riverside Capital into a full-scale investment and development firm, with this first project remaining the top priority until its completion. We are already into the due diligence phase on a number of new projects and are on pace to close our next two deals by the end of the year. Our goal is to be among the largest and most well respected real estate investment and development firms in the state. The goal will remain at the forefront of what we do, but it will never replace the "why". The "why" is in the day-to-day. The "why" is being in the trenches and obsessing over the smallest details of success. The "why" is because there is no where else we'd rather be.
I hope reading this article has been a valuable use of your time, and perhaps has inspired you to take similar action.
All the best,
Michael
