@Chan Le it is really dependent on all the factors mentioned above! But like @Arn Cenedella stated with the first question do you want to be active or passive? And as far as your results being out of date on your desire for a 7CAP @Spencer Gray is right about the market as a whole, but there are still a lot of ways around that problem. Like @Chris Levarek is quick to point out and most people overlook is the value of your own time. What did you give up to get this asset performance?
Also @Paul Moore is really on point with his follow up to all of this in his post. Paul and I have had a couple of great conversations surrounding these topics in the past.
But lets look at the desire for a 7CAP again with a new twist and look at New development syndication as one of the ways for you to get your cake and eat it too.
Lets take your typical value add purchase:
Seller has a cash flow producing beauty and she is a rare gem. Built in 1973 as a hotel, this baby has been converted to apartments that are now now boasting 6 coats of paint and a pylon sign no one uses any more. And he wants full retail for this cash cow. So buyers line up to pay retail because they all dream of making this place shine. Taking her from a class C to a B+, and in doing so create the forced appreciation that leads to additional value. So buyers not only are forced to pay retail, but they also bring in the cap X needed to create these transformations and in the process have now paid more than retail for the product, but now they are the proud owner of a JOB!!! And in markets of the past 5 years its been pretty easy to do just that and convert these into a sweet bit of upside. ANd in 10 years she will have been worth it all!
Right down the street a developer has decide to take the vacant land and build some brand new apartments. So he sets about designing and planning, and soon he has a solid set of plans and specs that he can bid out and start talking to banks about. Another huge bonus to this process is the developer is able to build a project that has all of the modern amenities and comforts tenants are currently looking for, but are not often available in older product. Just think, in apartment laundry and energy efficient windows with 9' ceilings and modern layouts. In the developers case he will need to get an experienced GC involved and secure financing as well as a property manager familiar with a new lease up, but the math looks quite a bit different for him.
While he will take some time to build his project, the appraisal will have given him a great snapshot of the market on provable rents and will show him where his true appreciation lies. There is no drinking the Kool Aid on this one because appraisers tends to do a very in depth job on a commercial appraisal to understand, not only the produce but the surrounding market as well. But when he is done he will have pretty significant upside from the cost of the project to the value at stabilization and it will all be his. He will not be paying retail or buying someone else's appreciation and in most cases will see 18-25% appreciation in this time period. All of this with NO forced appreciation! That's right, in fact these numbers will be built on rents from before the project started.
Once stabilized he will continue to tune up the rents until this new development is running at peak cash flow. It will be easy to predict expenses as well, because everything will be brand new so break downs will be rare. Sidewalks will not be being pushed up by over grown roots and air conditioners will still have plenty of life left in them to get several decades down the road. Carpets and appliances will all fall into the same category and at the end of the day expenses will be significantly less than older properties.
But there has to be a catch right? Yes of course there is always a catch. The catch is banks have a bit higher lending standard for developers as far as track record, so team member selection is going to be important. And there is typically a bit more cash needed in the game on the construction loan side too, but that is easily refinanced out on completion. Lastly since there is not any existing cash flow the banks will want interest reserves set aside to pay the loan during construction, but now even value add's are going to require that. All done the rewards are oh so sweet when you have a new asset with that new tenant smell still permeating the club house and your maintenance man is soundly asleep in the corner with the Maytag man!
But take a look at this from the perspective of risk for a moment. Someone that bought a value add project in the last half of 2019 and was in the process of renovating and forcing appreciation is might be struggling to keep rents on an upward trend. In fact he may have abandoned the remodel all together. So here he sits with most of the cap X spent and the rents stagnant. He is in a painful spot with his cash flow and likely his bank. That's hoping he didn't find any undisclosed deferred maintenance that cost an arm and a leg.
And all the while one would argue that this is Covid related, and this would have been a home run if it wasn't for that. But I think we can look back over the last 40 years and see quite a few times when situations just like this have happened in the rental markets and overnight things changed.
Now honestly you tell me where the real risk lies and how much of that you want to assume
We are doing ground up development and syndication of multi family and industrial in Idaho. With the factors you mention on blast here in the fastest growing state in the west (I think the whole country) your google search will blow up with all the great news that has been coming out of Idaho for the last 10 years. But I digress...
We have found that not only is large scale multi family more predictable both short and long term but it is also quite a bit more recession resistant, easier to rent and manage, and is typically producing better and more consistent cash flow.
@Chris Levarek
@Paul Moore