All Forum Posts by: Richard McRae

The best investment advice I can give to newer investors can be boiled down to one item: PREPARE. One can hardly pull the trigger with any confidence if you don’t know your market well. Without this knowledge, you will persistently close your eyes and flinch as you shoot. As a result, you will only hit your target by chance! This is not the way to stay in the investment game for an extended time. I want to outline one area that is important for you to understand if you want to consistently hit the bulls-eye: the interaction between supply and demand.

Understanding the balance of supply and demand is critical to making informed decisions. Vacancy rates, rent changes, and values, hinge on this interaction. A number of factors must be considered – most fall under two broad categories: supply changes and demographic shifts. 

I won’t try to illustrate all of the forces at work between supply and demand, but I want to provide an introduction to the evaluation of the interaction between population growth (demand) and multifamily starts (supply). Note, I used free data sources in the following example, but there are a number of very good apartment market data sources. A very good demographic source is ESRI. ESRI provides data for virtually any search parameter. An individual report is $50 and could be one of the best investments you make in your underwriting. A couple of apartment data resources are REIS and Pierce Eislen. REIS is the most comprehensive and provides supply analytics, market research, rent comparable information, etc. Pierce Eislen has good rent and sale data, contact information for comparables, and other market level data.

QuickFacts is a great free data source for population changes, household size, median income, renter percentage, et al. As an example, I performed a quick search for Alexandria, VA. QuickFacts indicated a population increase of 10,569 persons from 2010 to 2014. This represents an annual increase of 2,643 persons. QuickFacts also notes that there are 2.17 persons per household, which indicates an annual household increase of 1,218. Finally, applying the renter percentage (QF notes an ownership rate of 43.3%) of 56.7% indicates an average annual demand increase from 2010 to 2014 of 691 households.

Now, let’s compare to increases in supply. Home Facts notes that 1,630 multifamily permits were pulled in 2013. The trailing 10 year average is 579 multifamily permits/year. Based on a comparison of 2013 permits to the average annual increase in households, what do you think happened with rent levels last year? Yes, they went down. From January 2013 to January 2014 (Alexandria Office of Housing: January 2015 Annual Apartment Survey) rent levels decreased 3.3%. Although this rebounded by 4.3% by January 2015, the total increase was only 1.2% annually over two years. If I were looking to invest in this area, I would dig into 2014 permitting data, as well as planned properties in the development pipeline (pre-permit stage). It is also worth noting that apartment rents DO NOT necessarily increase 2% or 3%, which is what most cash flow models are based on. Good underwriting makes informed estimates – not guesses!

It may seem excessive to plow into this analysis, but I assure you: if you understand supply/demand issues at work in your intended market, you will have greater confidence to pull the trigger or put the gun down.

You can be successful as an investor, but it won’t happen if you can’t identify the target and pull the trigger with consistency and accuracy. There is no easy way to make money. It will require research, data analysis, and nerves of steel – but you can do it!

Good hunting!

Something doesn't seem right about the $3M purchase.  That equates to about $6,666/unit.  I would continue to dig in public records for another loan.  

Hi Todd;

Great question!  The only way to value non-performing assets is to perform a discounted cash flow analysis.  You model income and expenses year by year and then discount the cash flows back to the present.  If you aren't comfortable making those projections/calculations, I would move on to find a property that can confidently value.

Thanks for the reply Evan.  You are certainly correct in that it takes two to tango! And it is quite interesting to see how two giants invest - both of whom have a large investor base to satisfy. Personally, I am not sure I want to lock in long-term bond-like returns with real estate purchases that are not liquid.  Starwood has locked in their investor returns for quite some time. As you say, we each have our own investment needs/parameters!  

I see many properties advertised these days with unrealistically low expense ratios. Inexperienced investors that are excited to make that first acquisition need to be aware of and understand how to accurately evaluate expenses. As a commercial real estate appraiser for over 18 years, I have analyzed hundreds of income statements for multifamily properties. Institutional and investment quality properties seldom have supportable expense ratios below 40% (typically in 45% -50% range), but most 1-4 unit properties have advertised expense levels at well below these levels. Bear in mind that if a large project cannot be operated below this range, you should be skeptical of a one or two unit property that is advertised as such.

One of your best guides is recent expense comparable data. Most small-scale investors skip this step, but acquisition analysts and appraisers are religious with the collection of expense comparable information. If you will email me, I will be glad to forward an excel template.

It is imperative for investors to adequately understand current expense levels and estimate pro-forma levels with some level of confidence. I have included a brief discussion of some of these problem line items: vacancy/collection/loss to lease (VCL), management, administrative expenses, maintenance, and reserves.

VCL expenses are notoriously under-represented:

• Vacancy is relatively straight forward and should not be difficult to ascertain. As a check, divide total rents collected during the past year by the gross potential income and see if there is a difference. You may be surprised!
• Collection loss is a different story. For example, owner-managers typically do not collect or record late penalties or the cost of the non-payment. Attorney fees may be accounted for, but the income loss may not be recorded, particularly if the tenant remains in place.
• Loss to lease can also be extreme and must be considered in your underwriting. If one unit is rented at $500 and is supported by market rents (assume a GPI of $60,000), and the other nine similar units rent for $450, your loss to lease is $5,400, or 9%! It will be a costly process for you to increase rents as vacancy levels will potentially increase, or you may be need to incrementally increase rents over time for those nine tenants. Budget for this expense in your overall V/C/L estimate.

Owner-managers often do not pay themselves the market rate for managing and leasing their property. Management expenses are often seen as profit. Assume that you will have to hire a manager and pay lease-up commissions.

Administrative fees can also slip through the cracks. Often-overlooked expenses include: tax preparation fees, licenses, bookkeeping, finance related fees (will an appraisal be required every 3 – 5 years for asset monitoring, checking fees, account expenses, etc.).

Maintenance and re-let expenses fall under the same category as management: ownership will often make repairs and not charge the property for their time. Be realistic!

Lastly, the cost of capital expenditures can quickly add up. Depreciate the cost of your appliances, roof, driveways, etc. over their useful life and you will be surprised at the actual cost. Lenders typically require $200-$300 per unit for reserves for replacements.

Take-away: Start an excel file to record operating expenses from every property you underwrite. As the data mounts you will see a more accurate picture of what operating expenses should be for the type of asset you seek to purchase. Be realistic in your assessment of the potential for increases or decreases in the advertised level. Understand as well that the seller may not be trying to hoodwink you, but may have just not understood and recorded all expenses incurred.

Good hunting!

Mixed Signals

Many of you are aware of Starwood Capital Group’s $5.4B purchase of 23,262 multifamily units owned by Equity Residential. This comes on the heals of the additional purchase of some 67,800 units during the past year and the merger with Colony America Homes, which will result in the addition of some 30,000 single family housing units. These purchases come at a time of historically high rent and valuation levels in the housing sector. What drives such purchase decisions?

According to a recent #BloombergBusiness article (Starwood Bets $5.4 Billion that Apartment Rents will keep Rising, Oshrat Carmiel, October 27, 2015), Starwood’s CEO, Barry Sternlicht, indicated that the purchase decision was made not on the presumption of strong rental growth, but on a rent growth that is projected to increase just marginally over inflation. Sternlicht appears to be betting his investor’s money on continued low inflation and the lack of increasing yields for many years to come.

However, #Starwood’s future growth projections appear to lie in direct opposition to those of Sam Zell’s Equity Residential. The #Equity Residential game plan appears to be based on the assumption that rent growth/valuations have topped out in a number of markets (this sale included 10 Washington DC properties along with 33 properties in South Florida, 18 in Denver, 8 in Seattle, and 3 in California). Equity Residential’s CEO, David Neithercut, indicated that there were no plans to replace the assets, but a $9-$11/share special dividend would be distributed to shareholders. His concern over tenant concessions and oversupply is likely to lead to the further sale of all of Equity’s Connecticut assets as well.

So how does one reconcile such differing business plans? Starwood’s Sternlicht indicated that holding period is the only difference between the two strategies. Is locking up your investments at all time highs a reasonable and responsible use of investor capital? Equity Residential’s Neithercut believes not as he indicated that the sale of their assets at historically high levels was the best capital-allocation decision he could make for his shareholders.

What is your take? Would you invest today with Starwood or Equity Residential?

#Richard McRae provides acquisition/disposition consulting and commercial brokerage services across the Mid Atlantic region

https://www.linkedin.com/pub/richard-mcrae/107/170...

It is too bad that you have had such negative experiences with salespeople of all persuasions!  I have appraised commercial real estate for 18 years and have more recently been involved with investment sales of multifamily assets.  There are certainly bad apples out there, but in my experience, and I've worked with hundreds of brokers through the years, the ratio is similar to that of humanity in general.  I've met liars and benders of the truth in all walks of life.  

I would make one suggestion to those of you that think listing agents are shopping your offers.  Remember that they don't work for you.  They have a fiduciary responsibility to their client.  If you want someone to represent you, then hire a buyer rep!  Furthermore, don't just hire a salesperson, hire an expert in the field in which you plan to buy.