By Yosef Hyunseong Lee
To my busy W2 professional friends out there. What is your investment goal? (I know you are busy but just spare a few min for this. You will end up with something valuable)
It’s not too long ago that I seriously decided to aspire to achieve financial freedom and control. I mean in a very practically achievable way through my research. What is it for you to be financially free? To me it’s owning a system where I can be physically free from one specific location (I didn’t say from work. I still want to work), control my own time, and yet still generating income enough to live a quality life with my family. Yes. you got it. I’m talking about Passive Income.
Basically, it’s letting our money work for us, not the other way around. (This includes hiring someone else with your money and let him/her work for you, but I consider it the same as letting your money work for you as money was the source power.) There are two ways then to achieve this. Being a business owner (Entrepreneur) or an investor. Among the two, I would like to talk about being an investor.
A few weeks ago, I told you why I personally believe investing in multifamily apartments is the best bet over many other vehicles. And I am not talking about owning one to four-family property. I’m talking about more than 5 unit property where residential apartment gets considered commercial property for the purpose of valuation and lending. Multifamily Investing is not a get rich quick plan, but building your wealth slowly but surely.
Now next question is – What is your goal in Investing through Multifamily Apartments?
What do you want? Decide why you are investing in real estate. Is your goal to eventually quit your professional job, and become a full-time active investor? Is your goal to maintain your full-time professional job and invest passively for extra passive income? Or a nice mixture of both?
If your goal is to be a full-time active investor one day or at least to be involved actively maintaining some portion of your professional job, then you should consider the following among many other things, and start your journey slowly one step at a time while working full-time. You need to educate yourself first and take necessary actions towards your goal while continuing to educate yourself. This is the path I chose. I still work full time during the day as a W2 professional and grind at night and weekend to become a Multifamily apartment investor. Here is my simplified step-by-step guide of what it takes to be an active investor in multifamily apartments.
You are not a landlord. You are not managing the day-to-day operation of a property. This is a single-family landlord mindset (I have nothing against it). This is a job for a property manager. You hire a property manager who will report back to you. You are actually acting as an asset manager. You manage the whole process from acquisition through management to exit.
Learn the essential terms to understand the deals. You need to know terms like Net Operating Income (NOI), Capitalization (CAP) Rate, Cash on Cash Return (CoC), Return on Investment (ROI), Gross Potential Income and Operating Expenses, etc., to properly analyze the deal.
What is your investment criteria? What class of property? How many units? Do you want to create wealth by buying properties with a value-add component, reposition, and sell? (I’m not talking about a house flipping) Or refinance and hold further for cashflow? Do you want to preserve wealth by buying stabilized properties and hold for cashflow?
Do you want to Invest in your back yard? Or Out of State? In my situation, I’m targeting out of state as investing in my back yard (NYC) didn’t make sense to me. If out of state, then where? I’m settled down for a few areas like Kansas City, MO-KS, Knoxville, TN, Atlanta, GA, Tampa, FL, and there are more! Why these States? There are some factors I considered. You do your homework to find out things like Population Growth, Job Growth, Median Household Income Growth, Crime Rate, Condo/House value growth. There are a handful of free websites where you can find these data. If you are already in the good markets like above? Good for you! You can actually add value to someone like me acting as boots on the ground and do a deal together.
You must have partners. Once you select a market, then you have to network. Be active in investors groups like mentorship groups, mastermind groups, FB groups, and Local Meetups, etc. You can do it alone if you have all the resources and a great amount of luck. However, it is not a good idea. You need to find partners who have different strengths than yours, who share the same vision and strategies with you. For example, you might be a number person. You can be the one underwriting deals with Excel sheets. You might be boots on the ground to be a contact person to speak to local brokers and check out the properties. You might be the one who is good at capital raising. The question is not only what value the potential partners bring to you, but also what value you can add to them. You can have as many partners as you want, but I recommend to partner with at least one experienced investor. I built up a team with 2 other core partners and 3-5 more potential partners.
Along with the partners, you or your team also need to contact the local RE brokers, property managers, Lenders, etc. You can further get referrals from them secondary team members such as title company and home inspectors, etc.
Mastermind group. I have networked with many like-minded people who are passionate about Multifamily investing. These people can be your accountability peers. When you feel like you are not moving forward and hitting the ground, you have some people who can light the fire again. Also, you better have a mentor. You can find a coach/mentor to expedite your learning curve and get clear guidance.
Either yourself or your team member must contact the local broker to introduce you and your team and ask for a listing of properties. Give them your criteria and meet with them if possible. Having boots on the ground partner can be handy for this. You also need to talk to local community banks or other agency lenders. It’s not easy to be considered seriously by them when you are new in the market. You would have to build credibility using your team member’s credentials.
Nice! You got a deal from a broker! What do you do now? You underwrite. It simply means you analyze the deal to see if it meets your criteria. You ask for financial documents for the property and then analyze it. Basically, you will plug in all the numbers (Rental income, Expenses, future projections, and Debt service) and conclude if this property is a good deal or not. You should strictly abide by your minimum criteria. What is the target CoC and Internal Rate of Return? How long are you planning to hold it?
If it’s being a deal, then how are you going to finance it? How are you going to come up with the down payment? Decide if you are going to joint venture (JV) or Syndicate the deal. JV partners are all general partners whereas Syndication partners are divided by general partners (GP) and Limited Partners (LP). As an active investor, you are a GP. Typically, you will be required by the lender to put down between 15%-25% of the entire purchasing price as a down payment. By using a different creative method such as owner financing, you may be able to purchase with no or less money down. For JV deal, unless you bring nonmonetary, yet significant value to the table for your team such as that you found, negotiated the deal and brought it to the team, you will need to financially contribute to the down payment. Syndication is little different as your team can raise money for a down payment. You may end up underwriting 50 deals to find one good property that meets your criteria. However, no deal is better than a bad deal as you will be stuck with it for the next couple of years.
When you finally find a good deal, then you need to submit a Letter of Intent (LOI) enlisting basic terms with your offer price to the seller. There will be back and forth negotiations with the seller. Once the parties reach agreeable terms and prices, then the Purchase and Sales Agreement (PSA) will be drafted and executed. You will then have to put Earnest Money Deposit (EMD). And the rest will be a typical closing process with heavy Due Diligence (Property inspection and Finance). Finally, you close the deal.
Once your team closes the deal, now your team manages the property according to the business plan and strategy to maximize everyone’s ROI before exiting the deal. You will raise rent over time while reducing the expenses via a more efficient management system so that your NOI goes up. Your NOI goes up, then your return goes up. You will be distributing and receiving monthly or quarterly distribution as profit. Yes! Passive income cashflow right there! The depreciation Tax benefit is a bonus!
Deal can be exited either by selling it and returning the profit to everyone (Capital Gain), or refinancing it to return all or part of the capital investment back to the investors or yourself (Tax-free money) and holding it longer for further cashflow according to the team’s business plan and strategy.
This is one cycle. This is a system that can be duplicated and multiplied.
Whoa. This is a lot of work. Being an active investor takes lots of work and time. And I love to work. I did not say you will be free of work as an active investor. You actually need to do a lot. I chose to be active because not only I would like to collect passive income, but I also like to work and control the system.
If your goal is to be a passive investor, meaning you just want to put your money into work and collect the cash flow passive income, then you can skip many of the above steps. Depends on how much due diligence you want to do as a passive investor, you can screen and pick a syndicator (Deal sponsoring GP – This would be an active investor above) and invest as a passive investor(LP) and grow your wealth over time. No paperwork for you. You don’t have to worry about finding potential partners. You are not liable for anything and you can have peace of mind while the GPs manage the property and execute on business plans.
My conclusion. If your heart pumped while reading what it takes to be an active investor like mine did, you love to control the process and system, and still want to become an active investor then go for it. I love my time spent talking and thinking about multifamily. It’s hard. But educate yourself, and take the step slowly. However, if you like your professional job, it makes good income, and no way you would give up on it, then keep it. Instead, find a good multifamily apartment syndicator and invest with him/her. Either way, you know you must create a passive income stream to achieve financial freedom.
One more comment. You will surely encounter your family members or friends being naysayers and questioning your endeavor and journey. Politely ignore them for now. Do not try to argue with or convince them. As you get on the flow and gain momentum, they will come to you and ask how you did it.