You can’t plan opportunities but you need to jump at them when they present themselves.

I got a postcard in the mail from an agent out of the area selling a 50+ unit apartment building for what appeared to be a very attractive price.

As mentioned previously in the Blog I really had not been looking for apartment buildings because the returns generated by many of these buildings in San Diego have been disappointing. When Syndicating partnerships there has to be a great enough return to 1) pay the investors an attractive return 2) get compensated yourself based primarily on the performance of the deal.

So in an a typical multi-family deal here is a simple scenario of where the money is made.

  1. Cash flows from operations
  2. Appreciated value
  3. Loan pay down

Typically in San Diego most of the money has been made on the appreciation side with some cash flow during the operations. Right now the cash flows are better than they have been in quite awhile but when are  we really going to see any appreciation? The exception to this are value added deals where you can come in and reposition the property to create a higher value in the near term.

By doing this your yield will go up substantially and in that situation you could accomplish giving your investors a superior return and if certain performance metrics are accomplished you would get rewarded. These deals are rare at this time.

This is what has led me to flipping the houses which so far have generated on average a return in the triple digits because of the leverage I was able to achieve (Disclaimer – not every deal will make money which will take thereturn down. I have lost money on deals or had to keep properties I planned on selling in the past and am sure Ithese things may happen in the future if I buy enough properties. My goal is to try to achieve an average 15-20% IRR for my investor partners.

The opportunities in San Diego seem to be in the 1-4 unit (this is just my opinion and a lot of people who are a lot smarter than me are making money in other ways). With that being said I don’t seem to be the only person to know this and there is a lot of competition and the prices have substantially went up over the last 6 months. I feel very confident I can keep turning up these deals. The difficulty is doing at a large enough scale.

So back to my original point.. Apartment buildings….

The reason I am buying these houses is so I can keep active in this tumultuous market and generating money waiting for some bigger opportunities to come along in the form of Apartment buildings. These are what I want long term, thousands of units each generating hundreds of net dollars each.

Well for whatever reason someone hasn’t told the apartment market in San Diego there is the Great Recession happening. There is still be a big disconnect between what most buyers are willing to pay and what sellers are willing to sell for. There has yet to be a clearing or a sell off at a price buyers are willing to pay to generate any reasonable sales volume.

The best deals I have seen were in the upper 7 CAP range (in the hood, needed work). Even at an 7 CAP with 6.2% financing running about 40% expenses and a 5% vacancy the actual cash on cash returns is 6.25%. How can I feel right about Syndicating a deal with a 10% return to go around? That’s why I haven’t even attempted to chase San Diego apartment deals.

Well this deal I referred to at the beginning got me thinking very hard about where the future opportunities may lie. Apartments in markets that have been decimated like Phoenix, Las Vegas, the Inland Empire and select other areas. There are many other markets I am sure you could go to I just like that I can get to any of these places within hours (this is really important when doing research and due dilligence since I will have to travel there frequently when buying and researching these markets). I also like the fact that these markets typically have gone through BIG ups and downs. I explain a little more about what we are looking for here.

So with all that being said I found a deal (in neither of these markets but close) that so far has seemed extremely attractive. You may ask what makes it attractive Curtis and how do you know if it is worth pursuing.

The first thing I do is to try to figure out what is wrong with a deal. Why hasn’t someone smarter and better looking than myself snatched it up? Don’t tell anyone but I’m not that smart so if I see a good deal why doesn’t anyone else? I play the green light red light game or as CCIM teaches go/no go analysis. What I am doing is doing strategic research to decide whether I move on to the next step. If something comes up that kills the deal or makes me research that item more it is a RED light, if I am satisfied with my findings it is a GREEN light. I do this until I either hit a RED light that doesn’t let me go further or we buy it.

I run some stress tests on the numbers to see at what point would we lose money and then try to gather and verify data which will lead me to a conclusion on whether to buy or not.

It is kind of like a red light green light game. You keep on playing into you hit a red light. That red light could be information you find out that makes the deal no longer attractive. For example if I run the numbers at a certain rent level and after surveying local owners and property manager I realize those are not achievable one of two things need to happen.

  1. Drop out of the deal
  2. Reduce the price to a level that makes those new rents throw off an acceptable return

Let’s play red light green light with the out of area deal.

I received a postcard from an out of the area agent with a national company that doesn’t have the best reputation (that doesn’t mean the individual agents are bad BTW) who has this listing which is an REO in receivership. I normally would throw this into my circular filing cabinet except a few things caught my attention that caused me to proceed to the next step (gave me the green light to move forward).

  • Price per unit is $15,000
  • Price per square foot is $20 (it would cost about 4 times that to build it)
  • In a city that I go to anyways and have friends who own property there

The first red light was that the property was only at a 8.5% CAP rate which to me is not that attractive in a secondary out of the area market. After doing some research the property is a 8.5% CAP because it has been in receivership and the occupancy has sunk to around 65% (I verified this by calling area owners and the current onsite manager).

So a couple questions I need answered.

  1. What is a reasonable occupancy level I can achieve on this property
  2. When
  3. How much will it cost me to get there? i.e. repairs, making units rent ready, has the previous owner totally neglected it and will it cost me a lot of money to make the units marketable, etc.

First – I talk to the broker and he explains why it’s 65% occupied and that he has underwritten the deal at 85% occupied and $150,000 per year in expenses. Now it’s time for me to research because at these numbers it is a stabilized CAP rate of 12.4% which is now getting much better.

Second – I call local property owners and property management companies to talk to them about the market (Google is great for this kind of research)

Here are some questions I ask.

  • How is the market. “Hard hit but things that are priced right rent”
  • What is your vacancy rate? The vacancy rate was less than 10%
  • Is $3,000 per unit reasonable for expenses? “very reasonable”
  • What is the lease up time? “4-6 weeks”
  • Do you think this deal (don’t tell them the address) is a good one? “YES!”

OK, well it’s a green light time to move forward with more research.

Now I start looking at the historical books and records and drilling down deeper into my due diligence. Here is what I found

Bank owned.

  •  Purchase Price $800,000 (purchased and appraised for $3,150,000 and a loan of $2,250,000 in 2006)
  • 2.6 x GRM
  • $20.17 per square foot
  • $15,300 per unit (next closest deal on the market is a bank owned at $35,000 per unit)
  • 2 Properties total.
  • 22 & 30 units next to each other. This give more options on the exit.
  • A 12.5 Cap at stabilized income.
  • Assumptions
  • 15% vacancy.
  • This building has had a historic vacancy rate greater than 95%.

o 15% would equate to triple the historic average

o 50% higher than the local property managers and owners I have already surveyed.

  • This property has historically enjoyed high occupancy rates. It is located next to a college, a grocery store and residential homes.
  • The building currently is at 65% occupancy
  • NOI of $100,825
  • This is ½ of the historic NOI
  • NOI in 2008 was $195,000
  • Expenses at 50% higher than 2006 numbers.

IRR is in the high 20’s low 30% range over a 5 year hold based on the assumptions above for NOI . (if the NOI was back to the levels 10 years prior the IRR could be 10% higher than this)

o assumptions

  • financing in the 6.5% – 7% range the IRR is in the high 20% – low 30% range
  • Sale price $1,100,000 which would be about 1/3 of the price paid 10 years earlier.

 In the last 6 years there has been over $400,000 in improvements

o These renovations included air conditioners, new appliances, new roofs, resurface asphalt, carpet, fencing, painted six buildings, landscaping, laundry room, swimming pool, and renovation of 28 units.

o I have been told the property is still in good condition and not to neglected


2004 2006 2010 Assumptions
Price $3,150,000 $800,000
Price Per Unit $60,576 $15,384
Price Per Sq. Foot $79.91 $20.17
Occupancy 100% 65% 85%
NOI $204,647 $66,990 $100,825
Expenses $98,290 / 29% $137,541 $152,624 (54%)
Effective Gross Income $336,612 $204,531 $253,449
Improvements $414,582
CAP Rate 6.5% 8.37% 12.4% Stabilized
GRM 9.36 2.84

[1] Information gathered from April 2006 Appraisal. Crown Appraisal Group collected historical property data.

[2] Interviewed 2 property managers and 1 owner totaling over 400 units. Effective vacancy is less than 10%

[3] Owners and managers say NOI is down 25% from 2006 levels.

[4] Information given to the appraisers from the sellers in 2006. Sellers renovated property in 2004

Deal Points

  • Needs to be an all cash purchase
  • Short due diligence 14 days
  • Quick close 21 -30
  • Stabilize 6-12 months and refinance out 65% or as much as possible at market rate interest
  • Sell and exchange in 3-5 years
  • Preferred return to you and equity split TBD

Here is why I like this.

$15,000 per unit & $20 per square foot. This is trading at a third of replacement cost and about 1/3 of the previous sale in 2006. In addition it is about 1/2 the cost of any other property on the market in Havasue.

Plan

  • 15,000 Per unit 2006 sold for $60,125
  • $20.12 per sq. ft and in good condition
    • insurance underwriting it at $115 a foot.
  • 35% vacancy because of being in foreclosure.
    • Underwriting at 15% once stabilized
    • As I have been doing due diligence talking to other property owners and property managers so far the 8-10% has been recommended.
    • Rents are in line with market
  • 4-6 week lease up period
  • 2 Separate buildings which will allow us to sell them individually. Having 2 smaller buildings will open up the possible pool of buyers which could increase the overall aggregate value.
  • Using about $3,000 per unit for expenses which equates to about 50% of the Gross Scheduled Income. Considering the property tax only consist of about $160 of those expenses the rest will go to all the other expenses. This has been agreed on by property owners/mangers a very conservative number.

Will need to probably be an all cash purchase or bridge loan until the place is stabilized.

Exit strategy is to stabilize and get debt on it and pull out 65-75% of the cash invested while getting long term financing in the 7% range and sell it when we hit a our target IRR which I am still contemplating what that will be.

Sell it as

The IRR will be based on some reasonable sales price assumptions. Once the target is achieved we will sell (or whatever investors want to cash out they can) and exchange into other opportunities taking advantage of the tax deferral of a 1031 in addition to capital gains tax and depreciation along the way.

The lowest price active comparable is at least double the price per unit than this property
After purchase buy some more bank owned properties at the same price per unit. We will now be the new comp and can justify the lower price. This will drive down some other prices allowing us the opportunity to buy more.

So this was written about a month ago, and I have to be careful about putting up to much information when I’m working on a deal. We put in an all cash offer at $810,000 hoping that everyone would try to low ball the deal with a 2 week due diligence and a close of escrow 2 weeks later. Well after a week of waiting the bank took another lower offer that only had a 5 day due diligence. In this situation we couldn’t of matched that and that is the way the cookie crumbles.
I probably spent about 60 hours doing research running scenarios hiring property mangers to walk the property and tell me what they can rent it for. The reason I tell you this is this business is about 95% of the time chasing deals and being prepared for that 5% of opportunity. I knew our shot was small and we got in the game late, but I decided that the potential was worth spending the time on this and that we had a shot.
So in summary it’s important to be able to quickly understand a market and know how to research a property and an area. There are many ways to do this and you need to be very good with your time management and prioritize your activities. Playing the red light green light allows you to focus on one activity that is important without moving on to another activity that really won’t matter if the previous activity isn’t satisfied.
If you are reading this and are in the Phoenix, Vegas, Inland Empire, Or San Diego market and you have any deals please let us know.

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