The Real (Often Overlooked) Reason Many Multifamily Investments Fail
Well, I feel as though I haven’t been home in a month.
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Likely, this is because I have not. It all started in January, when my wife said to me nonchalantly as she can, “The kids aren’t getting enough educational opportunities in Lima. We need to move — figure it out!”
It might be difficult for you to receive what I’m about to say, but I don’t like to argue. I mean, I’ll tell you when you’re being stupid all day long, but that’s not arguing — that’s just being real. Disagreeing with Patrisha, on the other hand, is quite detrimental to my health, so I don’t usually.
Thus, we took two weeks off in February, put the kids in the Tesla, and went to scope a few markets out. Which markets, you might ask? Let me put it in a way you can understand — if I am going to pay 6 CAP for apartments, I’d like it to be in a place people are moving into, not out of. I also must tell you that if I never see another snowflake, that’d be just fine and dandy by me!
Three days after coming back home from this trip, Patrisha and I flew out to California to hang out with my buddy Brian Burke. Al Williamson put together a great event in Sacramento.
Here’s the thing about Burke — the whole reason to be friends with him is just so we can hang out with his wife, Suzy. I mean seriously, Brian, talk about marrying up, dude!
As a side note, guys, something is very apparent to me. It seems that every successful man I meet becomes successful in large part due to pursuing the objective of making his wife proud. In other words:
Achieve to make your wife proud = success
This is certainly true in my case, and it is most definitely true in Brian’s case. It is so obvious that those two are tight as tight can be. No personal or business decision of any consequence is made without Suzy being onboard, period. No personal or business decision is made without Patrisha being onboard, period!
Brian, she is proud!
Well, to finish this intro off, I’ll tell you that I am writing this in a hotel room in Jersey City. I drove from Lima — 14 hours! I am here for the BP meet-up this Tuesday and whatever else he has planned. I’ll tell you what — this 14-hour drive was such a breeze compared to the flight to California, which took 12 hours all said and done. Here’s why…
Here’s How Tesla Works
Tesla is a fully electric car, and by that, I mean if you wanted to put gas in it, you couldn’t. What this means is that instead of stopping at gas stations to refuel, you have to stop at Supercharges to re-charge.
Well, all things being equal, depending on the outside temperature and how fast I am going, my car goes about 180 to 220 miles. This means that about every two hours or so, I have to stop for a charge. The car at that point tells me how many kWs I need in order to get to the next charger. But the end result is that I usually need between 30 and 45 minutes’ worth of charge for every two hours of driving.
Tesla Superchargers are most often placed near shopping and restaurants, which makes it convenient to plug in and go grab a bite. But more importantly, being forced to stop for a break every couple of hours is a good thing. Unlike sitting in a plane for five hours, unable to move your extremities, this offers some much needed “change of scenery” before you start going loopy.
And when traveling with kids, they can’t sit any longer than two hours anyhow. So, we pull off and either eat what we’ve packed, or I take them to Chipotle (because it’s non-GMO), and I go plug in for a half of an hour. Then, when I’ve got enough juice to keep going, I head over to the restaurant and finish eating with the family. It works out perfectly in terms of the kids getting the much-needed time to stretch and get some energy out at just the right intervals, so nobody gets crazy from being stuck in one place for too long.
I can’t really imagine a better way to travel with family!
A Call Came In
I was at a Supercharger when a call came in. No names, since you may know him from the Forums, but this is a very experienced investor in a fairly major Midwest market. Most of what he does is flipping; however, he does have a few rentals and wants to grow that part of his operation.
He had emailed before to tell me he was having real difficulty coming up with anything worthwhile in the multifamily space. To this I said, “Why? If you look on BiggerPockets, everyone seems to be finding fantastic deals on multifamily — what the hell is wrong with you?!” 😉
We agreed to talk, and he was calling back. Ladies and gents — pay attention. This is how the pros think!
He told me that as part of his DD, he had studied historical data on the cost of utilities in his marketplace. As it turns out, the cost of gas and water have both outpaced the cost of inflation by a very significant margin.
He told me that he could not anticipate rent growth anywhere near the magnitude to accommodate OPEX growth, and with this being said, he wasn’t sure how to underwrite apartments nor why so many people are buying so much junk.
Why is this a problem?
Well, if the building is heated with a boiler system, the the cost of gas is a problem and so are the incessant leaks, which cost nothing but money. Many building in the subject market are indeed heated this way. Additionally, most buildings are not sub-metered for water, thus making the ever-rising cost of water a big issue.
But there is a deeper issue. Even if the cost of gas and water could be passed onto the tenant, people’s ability to fund their living expenses is not unlimited. If most people in the marketplace bring home $2,000/month, then the most they can reasonably spend on their housing expenses is about $700. Any more than that, and they will default.
What this means is that if tenants have to pay utilities, all it does is compress rents. Understand — these people cannot spend any more than a cumulative $700/month, and it doesn’t matter if that’s $700 including utilities or $500 rent + $200 on utilities.
Unless the economics of the market are such that population growth, fueled by job growth, is responsible for income growth, there is nothing you can do as a landlord to combat OPEX inflation in a sustainable way, period.
Did I mention I am moving? I’m not moving to another depressed Midwest town, I’ll tell you that right now. 🙂
It’s Not About Today!
First, I told him that he was right — and the people buying are either aware that their NOI will be compressed over time but don’t care because it’s still better than being in the stock market, or are simply too stupid to know.
Second, I told him that this is precisely why I am not interested in buying in his market. I looked at it, and while the pro forma looks OK, the future is very cloudy in my estimation due to rents not being able to keep up with OPEX. The only way to compensate for this is to buy at a much lower basis and with plenty of up-front value add. But this doesn’t seem to exist in this marketplace today…
Which is why I am looking elsewhere. 🙂
Underwriting the Right Way
Understand, what’s going on here is that we are considering the future. Is it a guess? Yes! Everything in this business is a guess. But not taking a guess at what the future might look like is akin to sticking your head into the sand.
It has become increasingly popular on BP to say things like, “Don’t buy for appreciation,” and, “This is a cash flow play.” This messaging is especially popular among the TK crowd.
Although it’s not completely void of logic in that we don’t want to bank on incidental appreciation, we must underwrite the future to ensure sustainability. If there are two lines on the graph, of which one stays horizontal while the other keeps going up year after year, then eventually they will meet. And if the way you make money is in the spread between those two lines, then eventually you won’t make money — unless there is appreciation of different kinds.
Be wise about this stuff, guys. REI is not black and white!
Investors: What are your thoughts on OPEX and making solid multifamily investments?
Leave your comments below!