“You gotta walk through the Courtyard to get to the Hammond”
In the winter of 2013, Jake and I purchased our first multifamily property, a twenty-five unit with tons of “potential”. It had taken us two solid years of rejection and negativity to get to this point. We felt as if a weight had been lifted off our shoulders when we assumed ownership, but little did we know that the real work was about to begin.
In this article, I want to show you how to purchase your first multifamily property by exhibiting the “Patience, persistence but willing to walk away” mentality and how to locate value-adds in a deal. I want to highlight our progression from a rundown twenty-five unit to an attractive 156 unit apartment complex using the identical investing framework.
On our first deal, we were unfamiliar with Cap Rates and Cash on cash returns, two benchmarks that we utilize when analyzing a deal. Our experience with commercial loans was minimal, and managing a “big” property was foreign to us. To sum it up, we were the classic newbies that lacked experience but more than made up with enthusiasm and the will to work. We thought we were buying the Taj Mahal, yet in reality the property was a mixture of cottages, duplexes and a six-unit motel.
Jake affectionately termed the property “The crack den,” and not because of all of the deferred maintenance.
The property did contain multiple value-add opportunities. What’s a value-add? A value-add is an improvement that adds value to a property by increasing its cash flow. A few examples include: renovation, repairs, debt restructuring, vacancy lease-ups, cost savings and instituting revenue generators. These value-add opportunities should all be directed to increasing revenue or decreasing expenses, thereby elevating the Net Operating Income of the property.
Where were the value-add opportunities in the Courtyard property?
Let’s begin with the perception of the property, which was originally called The Shamrock Motel. Its reputation to the community was an undesirable property that catered to weekly renters, and would rent to any potential tenant that had a pulse. We set out to reposition (fancy word for fixing a property and creating value) the tenant base and institute a system to screen tenants. This would allow us to dramatically reduce our “turn” costs when a tenant vacated and would secure a more stable revenue stream.
These better tenants would stay longer and actually pay the rent every single month. Evictions and tenant damage dropped almost immediately once we began to screen the tenants. The perception of the property changed within the first year, thus allowing us to attract much better tenants.
We knew we were on the right path when the mail lady told Jake she felt safe once again delivering the mail to this quaint community.
The next area we targeted was the expense side of the equation. We realized the expenses of the property were running on the high end. Our mistake was our ignorance in what it would cost to run a multifamily property. We just knew that certain bills appeared rather large. We immediately contacted the garbage company and the phone provider. The cost of both of those services was slashed overnight. Next, we decided to remove the cost of cable and required the tenants to pay for their own cable. This single cost saving step saved us over $6,000 per year.
We also placed a cap on the use of the tenant’s utility usage. We would pay for the first $100, and the tenant would be responsible for the remaining portion. It’s amazing what happens to utility bills when tenants share in the responsibility.
Our value-adds did not end there. We were just getting started. It was time to address the income side of the balance sheet. First, we cleared out the sheds on the property and began to rent them out as storage sheds. This added value two ways. One, we were offering an amenity to the tenant by providing additional storage. Secondly, we were able to generate an additional $200 per month. Once a tenant begins to store all of their possessions on your property, those yearly rent increases of 3% will be met with less resistance. It becomes more difficult just to pack up and move out to another apartment.
Next, we began to institute fees. We began to charge late fees, application fees, pet fees and move-in fees. These fees added to the revenue of the property and allowed us to set rules for the community. If you were late for rent, you were going to be charged a late fee. The tenants were witnessing a total revitalization of the property, and some were not very content. The disgruntled ones decided it was time to leave, and we were able to fill their units with happier, more appreciative tenants.
As we were transforming the property into a profitable business, we began addressing the various deferred maintenance located throughout the property. We tackled the exterior of the property by repairing rusty mailboxes, power washing the buildings, painting the exteriors, planting shrubs and bringing the former landscaping back to its former glory. We also began to repair the units as they came vacant by replacing old floors, painting the interiors, replacing appliances and addressing any other minor issues.
By the end of twelve months this “mom and pop” was evolving into a business where expenses were being monitored and revenue collection was the focus each and every month. Most newbie investors do not approach investing as a business, but our vision was to build a huge portfolio that would support our lifestyles and create wealth. Real estate is all about the numbers, and the Net Operating Income (NOI) is king in multifamily real estate. Your focus should be on raising the NOI by employing the strategy that has been laid out.
Let’s fast-forward to the present. We were able to secure an appraisal on the property for $825,000, allowing us to extract $160,000 in excess cash. We left approximately $30,000 in the property to finish all of the deferred maintenance, which included replacing all of the roofs and painting the remaining exteriors. The little crack den is currently cash flowing around $3,000 per month, and we have no more of our initial capital invested in the deal.
Here is a brief summary of the steps you need to take to jump in and get to work:
The Courtyard deal gave us the experience and the momentum to continue in real estate. I often wonder if I did not jump into this deal, would I have been able to purchase our most recent deal? Do not underestimate the power of positive action and momentum.
The Hammond was a much larger property than the Courtyard, but exhibited many of the same characteristics. It was bloated with high expenses, the revenue was not being maximized, the property needed some TLC, (tender loving care) and there was an abundant amount of value-adds. The strategy was identical to the Courtyard: buy on actual numbers, implement our repositioning strategy and increase the NOI.
It took us around six months before we actually went into contract with the Hammond. There were a couple of groups ahead of us, and we had given up on the deal, only to have it come back to us because of our tenacity and persistence.
There were several differences between both deals, such as age of the property, condition, tenant base, property class, desirability, but one feature stood out to us. It was the size of the Hammond that excited us. We were able to provide housing to a larger pool of tenants, thereby increasing our ability to generate wealth. Our profits would be magnified once the property was repositioned.
We are about six months into our plan, and the property is chugging along. The property was purchased with $100,000 in monthly revenue collections.
We have expanded the revenue to $110,000 in six months, and estimate that revenue will grow to around $120,000 per month within twelve months. There are three laundry units that are being converted to apartments, as well as increases in rental rates.
Our goal is to achieve a value of $9,000,000 within twelve months, allowing us to refinance the property and extract the capital we placed as the down payment.
To recap, whether you are purchasing a four-unit deal or one thousand units, the focus should be on:
The financing terms on our first were less than stellar. The interest rate was 6%, it was a twenty-year amortization and the term was five years. Compare that to the Hammond: 4.25%, twenty-five year amortization and one year interest only payments. What is the moral of the story? Expect to make mistakes, learn from those mistakes, course correct and continue to pursue your dream.
If you have any questions, please contact me at firstname.lastname@example.org. I hope this article serves you well and gives you a framework to attack multifamily investing.