Why is Multi-family Inventory Low

There are a number of reasons it is very difficult to find good quality properties on the market now. There are a number of reasons for it.
1. Price uncertainty. There is a disconnect between what sellers want and what buyers are willing to pay in a Covid world. Buyers are concerned about the stability of collections now that there isn’t a government subsidy to support rent payments, along with the inability to evict those that are unable to pay.
2. Sellers that want to sell are unable to find a suitable replacement property to execute a 1031 Exchange.
3. Lenders have tightened lending criteria and are concerned about rent collections going forward.
4. There are properties on the market now with assumable mortgages substantially higher than current rates. Sellers aren’t willing/able to reduce their price to accommodate the difference in the lower rates.
5. General market uncertainty. Employers are starting to determine how many employees are actually needed in the current recessionary market and are starting to permanently layoff staff now that the PPP programs have ended. The current projections are for the unemployment numbers to crest around Q1-2 of 2021.

The Most Important Step to Investing in Real Estate!

It takes hard work and effort to be successful but most importantly it takes an exit plan before you even purchase a property! Yes, I said that right! You must plan your exit before you buy! That is done by analyzing the area in which you want to purchase in to determine the job and population growth potential. If jobs are leaving, the people will eventually follow, and you end up with declining demand for real estate which means no appreciation. Go to the municipality or county website and you’ll typically find info regarding the major employers there as well as demographic info from the most recent census. It’ll tell you if the population is growing, static, or declining. Look up those employers and see how their business is going. Are they expanding and hiring or contracting and laying off.
While you’re on the municipality’s website, it should also tell you how fiscally responsible they are. Are they operating at a deficit or surplus? If they’re operating at a deficit, the real estate taxes may be increased soon! If you’re not sure, call the County Assessor and ask them about the real estate taxes and the prospects of them increasing anytime soon. There’s lots of valuable information you can get from the municipal government, you just have to ask for it!
Next, if you find a potential property to acquire, get the actual income and expenses from the seller or broker. Ask for a T-12 (trailing 12 months) preferably get the last 24 months along with a current rent roll. Don’t waste your time with proforma projections! In my 25+ years of experience, I’ve never seen a proforma that projected losses! If you can’t get it, move on to another property. Either the seller isn’t serious about selling or the listing broker is trying to attract offers to create a bidding war to not only escalate prices but remove contingencies!
Now evaluate the information and be sure to see exclusions that may artificially inflate the Net Operating Income (NOI, calculated by subtracting the expenses from the income). These may be items the seller claims they perform themselves like landscaping or leasing, but those items must be assigned an actual expense for 2 reasons, an appraiser will build in the expense of a third party performing those function as well as the lender because if they ever have to foreclose and take over the price, they’re going to hire a third party to do the job. Other items that should also be included on the expense side are management fees as well as reserves.
Now set up an excel spreadsheet and list every line item income and expense. Total that column to determine your NOI. Now calculate your annual debt service if you’re financing the property. Subtract that from the NOI to determine your cash flow. Divide the cash flow amount by the down payment to determine your cash on cash return.
Now go back through each line item for the next 5 year period and project each increase and/or decrease for each item, column by column. How much can you raise your rents? How much will raising your rents increase your vacancies? Are you projecting your utilities to increase correctly? What about your real estate taxes? Insurance? Are you increasing your cash flow every year?
Now go back to your year one column to determine your Cap Rate (Capitilization Rate). This is calculated by dividing the NOI by the Purchase Price. For example, NOI of $100,000/ Purchase Price of $1,000,000 equals .10 or 10% which is the return you’d have if you paid all cash for the property. It’s one of a number of methods to determine value. Now go to the last column and take the NOI number and divide it by the original Cap Rate. This number is a rough approximation of the potential future value. If this is an acceptable valuation, you should make an offer on the property. If not, lower the original purchase price and recalculate to determine your potential exit value.
Keep in mind the discipline to maintain the expenses at the annual projected amounts as well as accurately projecting the increases to the rents.
This is a basic valuation exercise and more methods such as Internal Rates of Return should also be calculated with this model. This will at least provide a starting point and annual map for you to be successful.

How Do You Choose An Area To Invest In?

 
The most important factor in determining an area to invest in is to assess the job market for the area. Is there a major employer that will provide the majority of the jobs for the area, also known as Core Jobs? What is the average wage for this employer? How many people will be employed by them? Are they hiring or laying off? Is it a cyclical industry?
With Core Jobs, you also have Non-Core Jobs, in other words, jobs that support the community formed from the Core Jobs. Examples are restaurants, car dealers, hair care, etc.
Where will you get the majority of your tenants from, Core or Non-Core Jobs?

Part 2: The most important ratios to acquire/run your property

The 2nd important ratio to use when acquiring a property is the DSC or Debt Service Coverage Ratio. What is it and why is it important? It’s important because this is the ratio lenders look at when considering to finance a property. Today, lenders are extremely cautious because of the uncertainty caused by the pandemic and have tightened up lending criteria.
To determine the DSC of a potential property, take the annual NOI (Net Operating Income) and divide it by the annual mortgage debt, i.e., NOI/Mortgage Debt to determine the DSC. In other words, if your NOI is $120,000 and the Mortgage is $100,000, your DSC is 1.20. Lenders are typically looking at a 1.20 as an absolute minimum, but would more likely prefer a 1.25 or even higher, in case the income is reduced and/or the expenses go up, which will impact the NOI.

What Ratios Are You Using to Acquire/Run Your Property

There are 2 that you need to know, expense ratio and Debt Service Coverage or DSC. The expense ratio is your expense to income ratio. This is crucial in determining whether you should acquire a potential property. You need to know what other, similar properties expense ratio is that are competing with the subject property. In other words, if the subject property is supposedly operating at 43% expenses to income but every competing property is operating at 52%, you need to ask why is there such a huge disparity? Are there a number of expenses not getting included that should be? Has the property been underassessed and the real estate taxes are substantially lower than the competition? Better plan on a huge increase after you acquire it! Or is the listing broker manipulating the expenses to show a better NOI than is realistic?
DSC will be discussed in the next post.

Are You Making Offers from Pro forma Info?

Never, ever make any offers based on pro-forma info! At a minimum I require a T-12 (trailing 12 months) before I consider making any offers, and would prefer the last 2 years income and expenses. The broker (if one is involved) will probably tell you many offers are coming in and you better make an offer soon, you’ll get the actual income and expenses after the offer is accepted! Don’t fall for this BS! Either the broker isn’t able to get the actual income and expenses from the seller because the seller isn’t really trying to sell, or the broker is attempting to bid up the property and get the buyers to make contingent free offers so when the actual income and expenses are made known, the buyer can’t back out!

Best Time to Inspect a Property

When do you inspect a property you’re considering buying? I always like to go when the weather is at it’s absolute worst! Every property looks great when it’s 75 and sunny! It’s when it’s raining sideways with 30 mph winds I like to go see how the property is holding up! Are there ponds in parking lot? Tenants complaining about the roof leaking, again? Is the maintenance staff anywhere to be found?

Another good time to visit a property is Friday or Saturday night around midnight. Is there any drug or gang activity taking place? There may be a bigger problem at the property that needs attention! I always recommend getting a police report for the property to see how often and what activity is taking place there.

NOBODY GETS RICH QUICK!

I have known thousands of real estate investors in my 25+ year career and I’ll let you in on a secret! NOBODY GETS RICH QUICK! There’s a lot of hard work and education that goes into being a successful real estate investor and it doesn’t happen overnight! You need to invest in your knowledge of the market, the property, the real estate cycle, financing, and on and on! If someone says that you can get other people’s money to invest and you don’t know a thing about investing in real estate, wake up! Would you invest in somebody who doesn’t know anything about what they’re doing? You have to pay your dues and you do that by being smarter and working harder than everyone else!

Has your broker and/or their firm been disciplined?

What do you know about your commercial real estate broker? What about their company? Would you be surprised to find out they may have been disciplined by their state regulatory board? Or their firm may have been convicted of multiple disciplinary actions by the state regulatory agency? Find out by going to the state regulatory agency and look them up before you find out the hard way!

Your Unique Selling Proposition

You’re considering buying a “C” grade multi-family property and you think you can raise the rents to improve the cash flow. Can you? Did you compare this subject property to the competition? What can you do to differentiate this property from the rest? If this is a “C” grade property, have you checked out the “A” grade properties? What do they offer that you can’t? How much more do they charge compared to this property? What is their vacancy compared to this property?