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Is This Deal Worth My Time? The 6 Crucial Steps to Vet a Multifamily Deal

Is This Deal Worth My Time? The 6 Crucial Steps to Vet a Multifamily Deal

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Real estate underwriting isn’t a commonly used term within the residential world. If you’re used to dealing with single-family homes, duplexes, triplexes, or quadplexes, you’ve probably done real estate underwriting to some degree, but you’ve called it “real estate analysis”. In both scenarios, investors are looking at what they’ll make on a deal, how much they need to invest, and what exit strategies they have.

But, in a hot housing market, like we’re in today, by the time you analyze a deal, a deal may already be gone. You need a way to quickly sort deals into the “pursue” or “dump” piles, and Andrew Cushman, expert multifamily investor, may have just the solution for you. Andrew has been on the BiggerPockets podcast before and manages over 2,600 units, so he definitely knows what he’s talking about!

Today, Andrew showcases the phase one underwriting he uses to decide quickly on deals, as well as the four levers to look at before even getting into underwriting. His system can save you hours, or even days, if you’re a full-time investor, and it helps rookie investors quickly analyze deals so they can get into the game. Now, residential owners can transition into commercial real estate with better scale and bigger profits.

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Listen to the Podcast Here

Read the Transcript Here

David:
This is the BiggerPockets Podcast Show 571.

Andrew:
But what that does is that takes the 10 deals sitting in your inbox on Monday morning and whittles it down to the two, then want to go to phase one underwriting on it, right? That’s helping you narrow your funnel and focus on this stuff that has the highest probability of working for you.

David:
What’s up, everybody? It is your co-host David Greene, and welcome to the best real estate podcast on earth. We have an awesome show today. If you are interested in practical, tactical, detailed advice on how to invest in multi-family property. All right, welcome to the BiggerPodcasts Podcast, where it is our job to help you achieve financial freedom through real estate. We do that by bringing in experts in the field who have a lot of value to add in this space to teach you for free, how you can also use real estate to build your wealth, as long as you take action and completely to the purpose that you have decided, which is financial freedom. You want it badly, so do I. Let’s do it together.
Now, today, is a special guest, and he’s special for several reasons. For one, he’s one of my best friends. We have BiggerPockets repeat guest, Andrew Cushman. He was on two episodes before this one, and we’re sort of continuing in that theme. Now, he’s kind of a special guest because we came into the podcast at almost the same time. I was interviewed for the very first time on BiggerPockets Show 169, Andrew was on 170, so that was pretty cool. Then he got into commercial investing and I got into single family investing.
And Andrew became the partner that I invest in when I do multi-family deals. If you ever hear me talk about a multi-family apartment that I’m buying in or partnering in, it’s all through Andrew. Now, also, Andrew was a huge inspiration in the long distance real estate investing book. He’s someone that I would go to, to learn the screening criteria that he’s using for multi-family, and then I adopted it into my long distance investing for single family.
A lot of that information I get about where people are moving to, where jobs are, what I want the median income to be, the stuff that I teach in long distance real estate investing, it was inspired, and a lot of it came from Andrew Cushman. He’s a very, very smart guy. It’s why I partner with him on multi-family deals. And we get into the details today about what he looks for when he’s screening a property. Now, basically Andrew has a three step system that we’ve helped developed and then helped leverage out. We’re going to talk about that too.
But in the episode 270, we basically describe what the first phase was. In today’s podcast, we’re describing the second phase. And in a future podcast, we’re going to describe the third. If you’ve ever wanted to start a syndication or invest in multi-family real estate yourself, or you’re trying to figure out who’s the right partner to put my money with, maybe you want to be in a syndication, but you want to be a limited partner, you don’t want to be the one that has to build the whole system. This is probably the best episode that you will ever listen to.
We get into what to look for, the specific, the six steps that Andrew uses to decide, is this property worth my time, or should I move on to something else? We get into why these are important factors and then how to verify the information that you’re collecting. So, not only you’re learning, what do I need to collect? But you’re also going to learn why that’s important and how to verify it. Then as a bonus, we get into the four levers that make a property profitable.
If you’ve ever been exposed to multi-family real estate, you know that the internal rate of return is the metric that most indicators use to describe, if you invest with them, how much of a return on your money you can expect to get over, say a five year period or a six year period. Well, Andrew describes the four things that move the needle on that IRR more than anything else, as well as ways that you may be deceived by the investor, as well as ways that you may be deceived by the syndicator who’s put putting the property together, so that you can see right through that and you don’t invest in the wrong deal.
This is a fantastic episode. It’s probably one you might want to listen to more than once because there’s so much information and it’s so many good practical, tactical steps that you don’t want to miss anything. Now, before we get into that, let’s get into today’s quick tip. That’s going to be get on the BiggerPockets forums. BiggerPockets has so much value to be offering you outside of just this podcast. They have a rent estimator tool. They have an agent finder. So, you can find agents in different areas that are used to working with investors than invest themselves.
They have calculators that will help you analyze deals. They have forums where you can ask specific questions. Andrew actually talks, in today’s show, about how he goes on the forums himself to look up answers to verify if he’s been told something by a property manager, or by a broker, or by somebody bringing him a deal. You can do the same thing. Check out all that BiggerPockets has to offer by going to the website and cruising around. Now, if you have any questions that you think I should have asked Andrew, or just something you want more clarity on and you didn’t get it answered, go to biggerpockets.com/david, where you can submit your video question or your written question for me to answer on a future episode of the Seeing Greene podcast.
Today is Tuesday. Tuesday is when we do the tactical information podcast, where you get pure raw information to help you on your journey. That’s why we’re interviewing Andrew. But if you need more clarity in any of that, please go to biggerpockets.com/david. It is my pleasure to bring in my good friend and business partner, Andrew Cushman, the best multi-family investor that I know. Andrew Cushman, welcome back to the BiggerPockets Podcast.

Andrew:
It is good to be here, man. Thank you for letting me join the rare group of, I guess threepeaters, right?

David:
Yes. You are in a rare and elite class of people. Although, you’ve been around BiggerPockets for like, feels like forever. So, three episodes really isn’t that much considering your first one was on what? 170, is that right?

Andrew:
Way back in 2016, 170. One episode after you got on for the first time, and now you’re the host of the whole thing.

David:
So, there’s actually a clever backstory here. Andrew and I had a conversation together about being on the BiggerPockets Podcast before either of us were affiliated with the company. And it was Hal Elrod that we spoke to that made the connection to Brandon and Josh because he had just been on the show, and that’s how I ended up getting interviewed and Andrew ended up getting interviewed, and now it’s sort of morphed into this point where Andrew and I are partners now. And he is the guy that I partner with when I buy multi-family real estate, or when we buy it, I should say. And then I’m hosting the show and Andrew has gone on to build a team, very similar to how I built the David Greene team.
I built a real estate sales team and Andrew built a multi-family investing team. Why don’t you tell us a little bit about sort of your biography, what you buy, how long you’ve been doing it, and why you are the expert?

Andrew:
Well, I took the traditional path into real estate and got a chemical engineering degree, but that was just a placeholder. I knew I wanted to do my own thing. I just figured I might as well have a good job until I figured it out. So, I started working for a food company as an engineer and married my wife. She had the same mentality that I did of, “Hey, let’s try to create our own thing.” We discovered, after working as an engineer for seven and a half years, we discovered flipping, and went and learned how to do that.
This was back in 2006. As an engineer, I was not the best on the phone. I found this out later. My wife, when she was calling me, when we were dating, she would make a list, a written list of topics to keep the conversation going because I was so bad on the phone. Then what did I do? Is I went into flipping houses by cold calling people who were in pre-foreclosure. So, not something that I was very good at, but I knew it worked. It took me 4,576 phone calls to get my first deal. But when I did, we made as much as I made all year, my engineering job.
So, I walked in, quit my engineering job. We became full-time house flippers here in Southern California for four years. Had great years, this is particularly in 2009 and in 2010. But then we said, “Okay, number one, this feels like another job. It’s super transactional. You’re only good as your last flip. You put the check in the bank, you got nothing after that.” And then we said, “This is starting to play out. Everyone else is coming in and becoming competition. What’s the next big thing?” So, we reasoned well. We just had a huge recession.
That means we’re probably going to have a big expansion. That means job creation, household formation, all that. And then we also reasoned, okay, well, half the planet just got foreclosed on, which means they can’t buy a house, which means they’re going to be renters. Put an expanding economy to get other with a growing renter pool, well, apartments should do well. We went and found a guy who had done 800 units, hired him to be our mentor. He held our hand through our scary first deal. And 10 years later, we’re at 2,600 units, and it’s been great business. Multi-family to me is the Keanu Reeves of the investment world. It’s on a long winning streak, treats everyone well, and it’s tough to find any legitimate reason to be a hater.

David:
As long as you don’t make it communicate, right? Like, just keep it to the numbers.

Andrew:
Yep. Keep … Yep. Exactly.

David:
It’s funny you mentioned Keanu Reeves because I just saw the matrix resurrections yesterday, and I realized, every time they make him talk, you start to lose it. As long as Keanu Reeve’s not talking, the movie stays really good. I feel like most multi-family investors, as long as you let them focus on numbers and projections and math, they do great. The second, like you said, they have to make a phone call. It takes 4,576 attempts to make it work.

Andrew:
Exactly. And that’s why you’re hosting a podcast and I’m focused on deals.

David:
That’s funny. All right. So, how many properties have you bought and how long has your career been going on?

Andrew:
I think we’re on like 16 or 17 syndications. It’s about 2,600 units. The last 12 months have been phenomenal. By February, we’ll be at acquiring 670 units for about 108 million. But that puts us at a total of about 2,600 since 2011, which is our first one.

David:
Okay. So, you’re right around 10 years now, maybe a little bit longer you’ve been doing this.

Andrew:
Yep.

David:
That’s perfect. All right. And you were on episodes 170 and 279, if anybody wants to go, kind of follow Andrew’s trajectory to see why I picked him as my multi-family guy. I always like to say, “I got a guy.” Makes you sound cool when you can …

Andrew:
Yeah, I got a guy for that.

David:
… talk that way. And kind of just monitor what your career has done. We’ll put those in the show notes for you. Now, what we’re going to talk about today is the three-step process that we have that we use to decide, should we write an offer on a property? Can you briefly explain what those, how you’ve classified these phases of underwriting?

Andrew:
Yeah. The pre-phase is, like Brandon talked about the funnel a whole lot, right? That’s just getting all your leads and coming into your market. We’re not going to really talk about that, because we’re assuming you figured that piece out or you’re going to do that. The first main phase is actually the one we talked about in detail back on 279, and that’s screening properties because there’s so much opportunity out there. There’s no way to look at it, everything. So, you want to whittle it down to the stuff that fits your perfect criteria. Or again, as Brandon would say, crystal clear criteria, right?

David:
Right.

Andrew:
Just a quick recap of those screening criteria. Again, the details are in episode 279, but number one is you want to just do a quick Google search, right? Pretend you’re a person walking the neighborhood, and look at the neighbors. What do the satellite photos look like? Does it look like a good neighborhood? All of that. Number two, you want to check the median income, and you’re looking for here is, does the median income for that area support the rent that you want to get? It needs to be affordable. If the average family makes $20,000 in that neighborhood and you’re looking to have $1,500 rents, you’re going to have an issue, right? That’s what you’re looking for there.
Third one is population growth. You want to have, at bare minimum, you want to have positive population growth, ideally double the national average, right? That’s what we’re looking for. You stay away from areas that are losing population. Next one is flood zones. That one’s a bit more of just a business and risk decision for us. We do not buy in flood zones. Again, we went through all there’s a handful of reasons for that, but we will not buy a property in a flood zone. If it pops up in a flood zone, we just say, “Sorry, we are out.”
Another one is crime. We will not buy in an area with high crime. And if you do it a couple of times, you eventually will not do that either. Especially low income. Low income and high crime go together about as well as microwaves and aluminum foil. It’s not going to end well and you just won’t do it anymore. Then the final is looping back to good old Google. You look for reviews, property reviews, but you’re also looking for stuff that’s in the news. If you’re looking at Whispering Pines Apartment, you Google, Whispering Pines Shooting, Whispering Pines Fire, Whispering Pines Flood.
It’s amazing, the stuff that Google will tell you that the seller didn’t, and that might affect your decision on whether or not you want to buy that property. Also, if you had a shooting or a fire, something like that, that’s going to affect your insurance numbers, which is something we’ll talk about when we dive into underwriting. That’s really quick review of the screening process. But what that does is that takes the 10 deals sitting in your inbox on Monday morning and whittles it down to the two, then want to go to phase one underwriting on, right? It’s helping you narrow your funnel and focus on this stuff that has the highest probability of working for you.

David:
Wonderful. All right. Let’s recap. This number one is a Google search. Just if you were a person who was looking to rent this apartment, what would you find if you Googled it? What does it look like? What’s the conditions? Number two is what’s the median income in the area? Number three is population growth. Ideally, if you can find double the national average, you’ve got an ideal population growth. Number four is flood zones. Number five is, what’s the crime? And number six is online property reviews. And was the property the subject of any news articles? Now, this is all the first step which you call screening, I believe, that’s what …

Andrew:
Yep. Yeah, we call it screening.

David:
And that’s what was covered in episode 279. So, if you want a more in depth detailed understanding of that very first phase, go check out episode 279. Now, today we’re going to get into the second phase, which we call underwriting one, or underwriting stage one phase one. How do you describe it, Andrew?

Andrew:
We break the underwriting into phase one underwriting and phase two.

David:
There it is.

Andrew:
Yep. And it’s the same overall idea of not only trying to whit it down to the properties that have the highest potential of being great deals, but also saving you time. Phase one underwriting is like just a quick and dirty, right? You’re making assumptions that you’re not necessarily going to go verify. Because the idea is, if you do a quick underwriting on a property and you make favorable assumptions and it still doesn’t look good, there’s no point in spending any more time on it. If you make favorable assumptions and you do a quick underwriting based on that and it looks good, now you go Abraham Lincoln on it and trust but …
No, sorry. Ronald Reagan, trust but verify, right? I don’t know why. Honest day … Well, he wrote everything on the internet, so maybe that’s why. That’s when you say, “Okay, I assumed $100 rent increase. Can I actually get that?” That’s phase two. Right?

David:
All right. In phase one, we’re going to talk about that today. We’re going to actually walk you, everyone here through the detailed steps that Andrew and I go through when we’re going to be buying multi-family apartment miss. But before we get to that, we’re going to talk about four levers to look at that are not necessarily specific to the asset itself, but you found that they’re very, very important. Can you walk us through what those are?

Andrew:
Yeah. Those who are, especially those engineering types like myself, it’s really easy to get focused on the property, and okay, if I spend this much money on a new countertop, I’ll get this much rent increase, and all that stuff is important. However, these four things, if you get these wrong, you can be the world’s best underwriter on all that property related stuff, but you get this wrong, and the rest won’t matter. Those four things are number one, your market rent growth assumptions. Number two, your cap rate assumptions. Three, your time of sale.
Meaning, am I going to sell this in three years or am I going to sell it in five? And then four, your leverage. I’ll step through kind of really quickly what I mean by each of those four. What I did is, and I’ve been wanting to do this myself just to see how it comes out. We closed the deal in this October where our pro forma internal rate of return was 14.4%. I went in and slightly changed each one of these four levers. We’ll walk through just how much it changed the projections for that deal.
And mind you again, the actual deal did not change one iota. Rent growth assumptions. That is, well, how much is the market rent going to increase over time? Market rent, that’s not your properties rent. That’s just saying, okay, the overall market in the last 12 months, let’s say you’re in Savannah and rents were $1,000 at the beginning of the year. And at the end of the year, they’re a 1,030. Well, that market rents increased across the whole market, 3%, right? $30 is 3% of 1,000. When you’re underwriting a deal, you have to assume, make some kind of assumption of how the market’s going to move.
If you overdo that, if you say, “Okay, well I rent growth is going to be at 3% every year.” All right? Well, okay, what if I just say 4%. It’s only 1% doesn’t make that big of a difference. That’s what it would seem like. So, I’ll give an example on that property that we closed, we assumed 2.5% rent growth for five years, and that led to a 14.4% IRR. When you go in and move that to just 3%, so only a half a percent difference, it bumped the IRR all the way up to 16.4%. 2% increase just by making a slightly different assumption on rent growth.
And when we get to phase two, that’s where we’ll really dive into like, well, how do you figure out what that right number is? But again, your rent growth assumptions are a huge lever, and whether you’re underwriting your own deals or investing in other people’s, these four levers are the four most important things to look into, right?

David:
Let me jump in real fast. What is an IRR? And then how do these levers affect that?

Andrew:
So, IRR is actually one of my least favorite metrics. However, it’s like the one that just about everybody uses. That’s why … My favorites cash on cash, but everybody uses IRRs. So, it stands for internal rate of return. What that means is it factors in not only the amount of money that you’re making, but the timing of that money, right? Because if you make $100,000 today, that $100,000 is more valuable today than if you make same amount of money five years from now, right? What internal rate of return does is it discounts, or in a way, cheapens that future money by accounting for the fact that money today is more important to you than money in the future.

David:
Also, it deals with more than just the cash on cash return. So, every investor understands their return, their ROI, right? Their return on the investment. If I put in X amount of money, how much will I get back as far as cashflow goes? But real estate makes you money in more ways than just cashflow. You also make money as you pay down your loan, you also make money as the property appreciates. You also can make some money through saving in taxes. The IRR takes all of that into account, correct?

Andrew:
Yes, it does. Exactly.

David:
So, you’re looking at all the ways that this property will make money and then you’re looking at, over how much time, if I hold it for five years or eight years or 10 years, what can I expect at the end when we actually sell property for the return on my money to be? Is that more or less accurate?

Andrew:
Yeah. IRR is like the all encompassing. The intention is it factors in everything, the amounts, the timing, all of those things, and it kind of boils it down to one number. The reason it’s so popular is because someone can look at a self-storage deal, or an apart … And compare the two, right? Otherwise, it’s hard to compare. That’s why IRR is so popular, but it’s also one of the most dangerous, because as you’ll see, as we walk through these, it’s the most easy to manipulate, either intentionally or unintentionally.

David:
And these levers we’re talking about are ways that you can manipulate, either honestly or dishonestly, the internal rate of return to make your investment look either better than it is, or maybe even measure it accurately but improve its performance, more or less, correct?

Andrew:
Yeah. IRR is the easiest way to do financial engineering on a spreadsheet.

David:
Okay, perfect. One way that you could do that is through rent growth assumptions. Now, you do need to make some form of assumption of what rent is going to do because it’s probably not going to be the same in year one as it would be in year eight. So, it’s not honest when you just assume rent will always be the same. A lot of people make that assumption, but really assuming rent will go up is no different than assuming it won’t go down. I mean, maybe statistically it’s more likely to go up than down, but just to say, well, we’re going to assume rents are never going to go up is just not accurate because statistically rents do go up over time. That’s one way that you can affect the IRR of something. What is number two?

Andrew:
Number two is cap rate assumption. We probably don’t have time to dive into what cap rates are and how to calculate them and all that. A lot of this stuff is also … Brian Burke did a really good job in his hands off investor book. He did a great job of explaining why he hit … Cap rate, people get way too focused on that. However, you do need to know what cap rate is and how to estimate it because that’s how you determine what your exit price is.
Let’s say you’re doing a deal for five years. You take your projected net operating income, NOI, in year five, and divide it by the market cap rate, which I love Brian’s definition. The way to look at market cap rate is market sentiment, right? It’s how the investment world is valuing an income stream. In order to calculate your sales price, you have to make an assumption about what cap rates are going to be in the future.
The short version of how to do that is figure out what today’s cap rate would be for that asset and say, “Okay, well, if I think this cap rate’s going to be higher or lower in the future, and then you plug that number in to calculate your sales price.” Generally what we do is we say, “Okay, if today’s cap rate’s a four and a quarter, every year that we hold, we’re going to increase that cap rate by 0.1%.” Five years from now, an exit cap rate would be 4.75%. Now, okay, Andrew, why does that matter? Does it really change everything that much?
On that deal that we did, we had a 0.5% cap rate expansion. If we take that out, the IRR now goes up to 21.1%, right? It increased by 4.7%. All of a sudden, a deal that was at 14.4, if you make a slight increase in your rent growth assumptions, and then you remove the cap rate expansion, boom, your IRR goes from 14.4 to 21.1. And did the deal get any better? No. Nothing’s changed. You changed some very sensitive levers on your underwriting.

David:
All right. Now, 10% of our audience thinks that this is genius, what you’re saying. The other 90% is embarrassed to admit. They don’t actually know what we’re saying. Let’s take a step back and explain what we’re talking about. How would you define what a cap rate is?

Andrew:
Cap rate, it stands for capitalization rate. The short version is, how quickly does that investment return what you put into it? If you bought a property for $1 million and it returns a hundred thousand a year, first of all, send it to me because I’m looking for that stuff. But if you bought that, every year you get 100,000 of that million, or 10%. So, in 10 years, you’ve got all your money back, so that property has a cap rate of 10%, right?

David:
Also, being said, if you bought it for cash, that’s what the ROI would be.

Andrew:
Yes, that’s actually, that’s another really good way to say it.

David:
When you hear people say it’s a five cap, what that means is, if you paid full cash for that property, you did not use any kind of debt at all to leverage it, that is the return that you could expect for your money. The reason that we use the cap rate that way is because, just like what you said, anytime you hear us talking about metrics, the reason metrics like this were created are so you can compare one investment to another. It’s all a way of trying to turn apples to apples for … That’s what ROI is. Well, should I put my money in the bank or should I buy a house with it?
Well, you need to understand what the return on your investment is to compare, to decide which would be better. The cap rate is the way that the metric that we use to decide, what is like a multi-family or commercial property worth? Well, if I get a 5% return on my money, if I pay cash, that’s a five cap. Now, the other time that cap rate becomes very important, like you said, is when you’re exiting. Because the way the departments are basically valued is that you take the net operating income, also known as the profit you make in a year, and you divide that by the cap rate, and whatever number you get is how that property is pretty much valued. Is that more or less accurate?

Andrew:
Right on.

David:
Okay. So, here’s the thing to understand about this. If you want to make an apartment worth more, there’s two leverage that you pull. The first is you increase the NOI. Meaning, if you can get your rent that you collect to go up or your expenses to go down, or some combination of the two, your net operating income will go up. You made the property worth more. The other way, and the bigger lever in this, is the cap rate. If you get the cap rate to go down, meaning there’s a higher demand for that property. So, if everybody says, “Man, I really want that thing. It’s got a five cap. I could get a 5% return if I bought it cash.”
And then one person says, “Well, I’ll actually take it at a 4% return because I want it that bad.” Now it’s trading at a four cap because there’s more, like you said, Brian Burke’s definition. The sentiment in the market is I want that type of income stream. And right now, apartments are a very, very, very popular income stream, for many of the reasons that we’re going to be talking about on the show today. When you get into a market and the cap rate goes down, if you compare that to residential real estate, that’s like if the comps are going up.
If the neighbors are willing to pay more for the house, all the other houses in the neighborhood are worth more, if the cap rates are going down on apartments, all the other apartment complexes are also going to be worth more.

Andrew:
Yep. Exactly.

David:
All right. Cap rate is a huge lever that if the cap rates are going down, where you buy, you can make your property worth more. What you’re saying is when you underwrite, you’re actually assuming cap rates will go up a little bit every year. It’s just another way to be conservative, to protect yourself so that if you raise money and then have to sell the apartment complex, you’re not assuming that cap rates are going to go down, even though they have been going down. Is that more or less accurate?

Andrew:
Yeah. I mean, in one way, if you look, we’ve been wrong for the last 10 years. Every deal we’ve done, we’ve factored in cap rate expansion, and it’s gone the other way. But however, especially if you’re bringing in outside money, you would rather have it work out that direction than assume it’s going to go down and it goes up because now you’re even not going to get your equity back out.

David:
There you go. It’s just a conservative way that you work into your underwriting to make sure that the investors are protected.

Andrew:
Exactly. Yep.

David:
Okay. Lever number three.

Andrew:
Lever number three is hold time. This is one where there is not really a right or wrong. It’s just a matter of transparency and understanding how big of an effect it has. Getting in, we had that discussion on IRR. One of the things that it factors in is the timing of cashflows. Well, most apartment complexes, especially in the last 10 years, there’s been a nice profit when you sell. If you move that profit from sale upward, closer to the time of purchase, that IRR goes up because that cash flow is getting closer and closer to today, right?
If you are driven by IRR, and that’s what you’re trying to hit, then what you’ll see is you’ll see people will move that sale closer maybe two years or three years, because the IR goes up. It can dramatically change that internal rate of return, and it can actually make you miss deals that otherwise fantastic deals, right? Some of the richest people I’ve ever met are people who bought an apartment complex or built it and held it for 20 or 30 years.
Well, if you put that in a spreadsheet, your IRR is going to look like crap, but because of just how that’s calculated, but otherwise, it’s a great property. You have to be really careful of not letting this lever drive the investment. Again, as an example, that property that we bought in Savannah in October, we had a 14.4 IRR that was on a five year hold time. If we move that from five years to three years, that increased the IRR 5%. It adds now five full point to it. Again, and nothing changed on the property.
Especially if you’re looking at passively investing or you’re looking at trying to bring investors on, it’s really important to educate yourself and whoever you’re working with how much of an effect that can have. It can make a bad deal look great, and it can make for fantastic deal look bad, and you can pass on the deal you shouldn’t, or do a deal that you shouldn’t if you get that hold time wrong. That’s one where you need to do a sensitivity analysis. How does it look at your three, four, five, six, seven, eight, nine, 10? And then also realize that, that really shouldn’t necessarily be the driving factor.
Is it going back to the screening for process and some of these other levers? Just be careful that a hold time that you plugged in isn’t covering up something else that maybe is incorrect or missed.

David:
Now, if you get a better internal rate of return selling in year three, instead of year five, why doesn’t everyone just sell in year three?

Andrew:
Because not everyone is focused on the velocity of money. Again, there’s nothing wrong with selling in year three. If you’re looking to get in, make some money, move it to another project, or something like that, then selling in year three is fine. If you’re looking to build longer term wealth, most of the work is really in the first couple of years. So, if you want to do that work and get in, get out, then three years can make more sense. But if you’re looking for a little bit longer term appreciation, especially cashflow, then that’s where years five onward make a little more sense.

David:
I think also, in many cases, a three year turnaround time just isn’t reasonable to do, especially if it’s a big value add project. It just might take longer than three years to be ready to exit. If the syndicator is telling you, “Well, we’re going to sell in three years.” They know that makes their IRR look good and then people chase it because the return’s great, but that doesn’t mean that they can actually accomplish that.

Andrew:
Also, with a three year timeframe, you increase the probability of getting caught by a bad market turn three years is a pretty short period of time. But if you’ve got five years or longer, you have some more flexibility there.

David:
And you always can sell after three years, if you want, and get your investors a better return, right? But it’s not good to assume we’re going to be able to do it in three years, and then when it goes wrong, now the IRR is dropping from the really enticing one they gave you, to the more reasonable one that would be a five year term.

Andrew:
Exactly. Again, I don’t want to give everyone the message that you’re saying three years is wrong. Definitely not. Just be aware of how much of an effect it has when you are doing that in your underwriting. Then the final one is just leverage. This has basically been covered in other podcasts as well, but you’ll see log deals, especially lately coming out at 80% leverage. If you go from even 75% to 80% leverage, meaning you’re getting a loan for 5% of the purchase price, versus getting a loan for 80% of the purchase price.
Doesn’t sound like a whole lot of a difference, right? Well, typically that loan is cheap money because it’s coming from Fannie Mae or maybe a bridge lender or something like that. So, by increasing that leverage, at least on a spreadsheet, it increases the rate of return to whatever your equity is, whether it’s coming out of your own pocket or investors. Again, just to give an example of how that affects everything, that deal that we purchased in Savannah, we went in with 75% leverage.
If we had increased that to 80%, it would’ve added another 3% to the IRR, right? So, you go from 14.4 to 17.4, or 17.3, just by going that extra 5%. Is it a better deal? Again, property didn’t change. The market didn’t change. We just increased our leverage. So, the returns go up, but so does your risk because you’re higher leverage. Again, just something to be aware of and just how sensitive your underwriting is to that. Especially again, as engineer types, it’s really easy to dive into rent comps and loss to lease, and all these things that are easy to tie down a set of data, but these are the big four that actually have the biggest effects.
If you do, on that deal that we did, that was a 14.4, if you slightly change these four levers combined, it takes the deal from a 14.4 to a 29. I can guarantee you that deal will not be a 29. That’s the purpose of going through this is, that 29% IRR deal, that’s a deal based on hopium, right? Everything has to go just right for that to work. These days, sponsors and deal underwriters saying that they underwrite conservatively, that’s about as trendy as meatless hamburgers, right? I mean, just everybody says, but no one says what that means.
Underwriting conservatively, at least to me, is being aware of these four levers and plugging in values, especially for these four, that have a very high probability of happening, right? Conservative underwriting is realistic underwriting, meaning that it’s your base case, and it has a high probability of happening without everything having to fall perfectly into place.

David:
And now I think this is brilliant. I would like everyone just to go back and listen to the four levers. They are rent growth assumptions, cap rate assumptions, holding period, or time of sale, and then leverage. Those four things make a huge impact on the internal rate of return of a deal. And if you’re going to invest in someone else’s deal, you want to know how they’re using those levers to make it look better or accurate for how it could be. Someone like Andrew, When we do, we always just take a worse case scenario.
We look at these four things and we say, “Hey, if they all go poorly, will it still make sense?” And if so, those are the deals that we move forward on. Now, that wraps up the levers point, which I just think is, if you want to understand commercial investing or multi-family investing, that’s a great place to start is just seeing like, hey, as you tinker with this, how do you make the deal work better? The next part is much more practical. We’re going to get into our phase one underwriting. And these are the six things that we look at once we’ve identified a property and we’ve gotten through that initial screening process that we talked about to start the show.

Andrew:
Yep. You want me to just hit what the six are and then we can dive in?

David:
Well, let’s start with what … Basically this is the, does this property deserve by time? That’s what we’re looking at.

Andrew:
Yeah. That’s what you’ve done. So, you did the screening process and you found out that, okay, this property checks every box in terms of those things that we talked about, and you whittled it down from 10 to two, and you’re like, okay, in phase one underwriting, like you said, David, you’re trying to figure out, does this property deserve any more of my time? We’re going to walk through the six things that we do to answer that question.
The high level is you’re making the hopium assumptions, right? Oh, I can get this rent growth, this renovation, all of this, and plugging it in. And if it doesn’t look good in that situation, ditch it. Right. Because in the reality is going to be something less. That’s kind of what you’re doing here.

David:
So, we’re saying, hey, if everything works out hunky-dory, that’s a funny phrase. I haven’t said that in a long time.

Andrew:
I haven’t heard it in a while.

David:
If everything looks good, it is worth digging in deeper to verify that our assumptions in phase one were accurate.

Andrew:
Yeah, exactly. The first is purchased parameters, and we’ll get into these, is second revenue. Third, operating expenses. Fourth, renovation budget. Fifth is loan terms and equity extraction. Again, we’ll define that when we get there. Then six is just kind of your pro forma. What does it all come together and look like at the end? So, purchased parameters, that’s different than your property parameters, right? Your property parameters are, I want to buy stuff that’s built in 1990 or newer, stuff like that.
Purchase parameters are simple things like price, right? If the seller is asking for 10 million, and what you want to do is you want to plug 10 or 9 million into your underwriting. With that price that they’re asking for, if it comes out at a negative three IRR, you know that it’s really probably not worth your time. But if they’re asking for 10 million and you plug in nine and the deal basically looks like it works, that checks that box.
Again, it’s just coming down to say saving time in, whittling it down to deals that can work, right? You don’t want to deal with sellers that either have crazy high expectations, or where a property is likely to trade at a price that doesn’t meet your criteria, which happens a lot in today’s market. Maybe the seller’s not crazy. Maybe it is going to trade at 10 million, but it only works for you at seven, you don’t want to spend any more time on that. You want to call the broker back and say, “Hey, this is a great asset. Unfortunately, it doesn’t work for us because of this, this and this. I’m not going to be close on pricing, so thanks for showing it to me, but this one’s a pass.”
That’s what purchased parameters are. This kind of the overall terms, the pricing, they say, you have to close in 30 days. Well, if you know you can’t perform that way, then trash this deal. Those are purchased parameters. Before we head to revenue, anything you want to touch on or expand on that, David, or?

David:
I just want to highlight to everybody that if you’re getting into this space and you’re trying to do what Andrew and I do, or maybe you’re just trying to invest with somebody else, it’s important to recognize no experience investors run all the way through an entire deal once they come across something that they know won’t work. So, conserving your time, but more so your energy. You’ve only got it in you to do this so many times. You only have so many phone calls in you in a day. So many rounds of taking data from one place and sticking it into another and thinking through how it would work.
I think people assume they’ve got all the time in the world, and maybe they do, but they don’t have all the energy in the world. So, what we’re talking about are these are the big disqualifiers that experience has shown from all the deals that Andrew’s done and all the deals that he’s analyzed. If I see this doesn’t work, I’m just going to not even waste my time. I’m going to move on to the next one.

Andrew:
Yeah, and really what you’re doing is you are looking for reasons to say, no.

David:
There you go.

Andrew:
Like, get this thing out of my inbox as quick as possible. Say no, say no, say no. And then every once in a while, you’ll be like, “Oh man, this thing’s perfect. I got to spend time analyzing it now.”

David:
That’s a great way to put it.

Andrew:
You get to that point, right? Here’s the reality is we are, in this past year, we are averaging and looking at, at least going through screening, 200 something deals to make 20 to 30 offers to buy one. You don’t want to spend eight hours analyzing 200 … You’ll be brain dead. That’s part of what this … You’re saying no, and then just running through, and then trying to confirm that so you can get rid of it. And every once in a while, you’re going to be wrong, and be like, “Oh, this could be a good deal. Let’s take a deeper look.”

David:
That’s a great point. You’re looking to say, no. Not looking to say yes. When you really want a deal, you start to get tempted to overlook problems and try to find a way to make it work, and that’s where it becomes dangerous.

Andrew:
Exactly. Yeah. You start tweaking one of those four levers and it’s like, this will be okay. You know?

David:
Yep. There you go.

Andrew:
The second part of phase one underwriting is revenue. All this applies, whether you’re looking at 10 units or 200, right? The principles are all the same. There’s revenue today, but then, where are you going to be able to take the revenue in year one, two, three, four, and five. Again, with phase one, it’s kind of quick and dirty. What we found to be the most effective is we look at the T12, which stands for trailing 12, right? It’s the historic, the last 12 months of operations at the property. We use that as our baseline. We call it year zero. Like here’s where it is, boom, today, at the beginning.
Then what you’re going to do when you plug things like market rent growth assumptions and renovation, and rehab budget, and then how much of a rent increase you’re going to get from that, over time, as you hopefully increase rent, your revenue is going to increase. But one of the key things to keep in mind is to compare it back to where it is today. Now, most properties are strongly trending up today. So, in today’s market, what we found the most effective thing to do is look at the last three months, and then annualize that, right?
Take the last three months and multiply it times four, that gives you what the annual revenue is if the property just stays right where it is. One of the biggest, I’d say probably one of the most common mistakes that I see a super tempting to do is to assume a big revenue increase in year one. It’s really difficult to make that happen, because for whatever reason, whenever you purchase the property, people get, “Ugh, the new owner’s going to screw me. I’m at out of here.” And people move out. People think, oh, it’s just like when the substitute teacher comes in, everyone thinks they can get away with not turning in their homework.
Well, oh, hey, rent’s optional. This is a new owner. I don’t have to pay. Right? The delinquency tends to go up. I’m not saying you can’t increase revenue the first year. In fact, most cases, you will be able to, but when you’re doing a phase one of revenue, you want to say, okay, well, here’s where it is today, and I’m going to improve it at 3%, whatever your number is. Every year, I’m going to improve it by this amount. But you always want to look back to the starting point to make sure that you’re not assuming too big of a jump, especially in those early years.
So, it’s kind of your reference point. Again, in phase two, we really dive into the details of this, but phase one of underwriting, I say, “Hey, if I get a hundred dollars rent increases, my underwriting says my revenue’s going to go up 4%. Is that reasonable?” And you just kind of answer that question, yes or no, based on all the other factors. That’s what you’re doing in phase one. You’re making basically a favorable assumption, plugging it in, and saying, “Okay, is this deal still a no?”

David:
When I look back at the deals we’ve done together, I think almost every one of them, we assume rents were not going to go up much in year one. By the time we hit year three, four, or five, they were way more than what we had projected they were actually going to go up. I think, in general, this is a principle that I really like when investing is I give myself a longer runway.

Andrew:
Yes.

David:
Don’t assume you’re just going to start it off, and boom, the plane’s going to take off right off the bat. Year one, anything I buy, single family, multi-family, anything, I assume will at best break even. So, if I buy a single family house and I’m going to rent it out, I just assume there’s something that was missed in the inspection. The tenants are not going to like what happened. There’s something I could not have foreseen that will pop up in year one. It always does. And then year two is actually like, okay, now we’re actually having some expectations of what I want. Is that a similar … I mean, obviously with multi-family, there’s a little more detail that goes into it, but overall, do you agree that, that’s a better approach?

Andrew:
Yeah, it is. And not only does it give you more runway, it also gives you a higher probability of beating expectations. So, we got a deal under contract last December, which was COVID winter. A few months later, things got a lot better. But at that point, December, 2020, the market was really uncertain. On that deal, we actually underwrote a revenue decrease for the first year, and turns out the market went completely the other way and revenues are way up because the market shifted in a way that none of us foresaw.
And now it’s fantastic because we’re just so far ahead. So, it increases the odds of you beating expectations. There’s nothing worse than getting behind from day one. It’s not fun for you. It’s not fun for your investors. So, resist the siren call of giant increases in revenue for the first year.

David:
All right. Awesome. What is the third thing that we look for in phase one

Andrew:
Third one is your operating expenses, right? Again, just as phase one, it’s quick and dirty. You’re just kind of coming up with an estimate. This is going to vary a lot depending on the market you’re in. We operate in the southeast due west, and operating expenses might be anywhere from $4,000 to $6,000 a unit, depending on the type of property in the sub-market. But basically what you want to do is you want to take a quick look at the historical operating expenses, what has it been costing for utilities and wages and repairs and all that?
Make any adjustments that you think you can make? For example, let’s say their wages are really high and you’re like, you know what? I’ve got two great people I can bring in, and this is how much I’m going to pay them, I can reduce wages, right? Or when I buy it, the tax assessment’s going to double so I need to factor that in. The source of that information is twofold. The seller should provide you with at least a year’s worth of historical data so that you can see, this is how much they paid in utilities for the last 12 months. This is how much they paid for repairs. This is how much the cable contract costs.
All of those things, you’ll get from the seller. You take that is a starting point and then you adjust for your business, right? And you say, “Well, okay, Andrew, that’s great.” Because if I don’t have a business yet, I’m trying to get started, I’m buying my first 10 unit. Well, how you come up with the future data is a number of ways. Number one, find a good management company and ask them, “Okay, the properties that you manage in this more market that are similar to this, what are reasonable ranges for these five expenses?” Whatever the ones that you don’t know are, say, where would you expect a property like this to operate expense wise? And get that information from them?
A lot of times brokers will give you pro forma expenses. Be a little careful of that because pro forma is Latin for pretend, but it least gives you a baseline right of something that seems reasonable.

David:
That you can then compare to the information you got from someone else that might [crosstalk 00:45:59].

Andrew:
Exactly, right. And thank you, David. Because that’s really what you want to get the data from multiple sources and then compare and contrast. If it lines up across the board, you know you probably have a good assumption. If there’s huge differences, you want to dig into that. So, the broker is another source. Then also, I would go on BiggerPockets, and the forums. You’d be like, “Hey, I’m buying 10 units in Kansas City. I know a ton of you guys already own stuff in Kansas city. What have you guys been paying for utilities? How much are you having to pay management companies? How much are you having to pay staff?”
So, networking, right? Again, I can’t think of a better place than the BiggerPockets forums to do that. Those are the three ways that we get that data. Now, you can also, at a higher level, you can pay for services like CoStar, Esri, and all this other stuff. But if you’re not at that point yet, those three, first three that I mentioned will take you 90% of the way there.

David:
I just want to highlight the temptation is always go to the seller and say, what’s your numbers, and then you get when they end up not being what they provided, which is kind of silly because everyone is going to do what’s in their own best interest, so you can’t expect a seller to give you accurate information if you have no relationship. I mean, it’d be nice if we lived in a world that worked that way, but we don’t. And then many of those people they get mad at when that happens would probably do the same thing if they were in the seller shoes, to be honest, when they go to sell. They put make up on their numbers too.
So, if you go to a property manager and say, “Hey, you manage a lot of properties in this area. What are you finding?” That’s much more reliable, objective information. It isn’t biased by the person who actually has an interest in getting more money for that deal.

Andrew:
Yep. Exactly.

David:
All right. What’s number four?

Andrew:
Number four is renovation budget. Again, keep in mind, we’re not buying deals off of this. This is just phase one. You’re trying to say no. This is where we say, you know what? Based on the pictures that we’ve seen, eh, we think it’s going to cost $6,000 a unit to renovate this, or maybe 10 or 12 or whatever that number is. All right, this is 10 units. It’s going to cost $10,000 a unit. Okay, my renovation budget is a hundred grand, boom, plug it in, and then, okay, well, what kind of rent increase can I get from that?
Well, if I’m looking around there’s these other properties advertising, all right, I should be able to get a hundred dollars rent increase. That’s literally you should do on phase one. Number one, contractors are super busy, right? You’re not going to call them for every deal that you’re looking at, and be like, “Hey, can you run over there?” Or anything like that. Even if you don’t feel like you have a good grasp of how much stuff costs again, this is where BiggerPockets community, brokers, and even management companies can help you with this too.
Say, hey, email your property manager three pictures of inside from inside a unit. Say, “Hey, I’m thinking I can spend eight grand to renovate this and get $100 increase. What do you think?” If they respond back, “Yeah. You know what? That might cost you 10 grand and you’re going to get $80.” Okay, cool. Plug it in. That’s what you do if you feel like you just have no idea and you’re trying to learn the market or the cost. Once you’ve analyzed a few of these, you’ll pretty quickly get a feel for what that is.
Again, at this phase, you just plug it in. Ah, you know what? I can do this for six grand. I’m going to get $80 rent increases. And you’re looking for a reason to say no. If you plug in the best case assumption of, I only got to spend $6,000 to get $80 rent increases and the deal doesn’t work. You’re like, “Cool, I don’t have to spend any more time on this.” If it does, and you are like, well, okay, spending six grand and getting $80 rent increases, this looks like a great deal. You’re going to continue on. It’s that simple. Just a quick guess, yeah, six grand.

David:
I think what I love about how this system is built is that it’s getting 80% of the problem taken care of before you dive in and put a lot of time into it. You don’t know until you actually look an inspection report and walk it with the general contractor what it’s going to be, but you can get a pretty good idea. And if it’s like, oh my God, it’s going to cost $75,000 a unit to get these up to market rent, or to bump rent a little bit, you can quickly plug it in and realize the ROI in that is going to be terrible, it just doesn’t make sense to do it.
Versus if you’re like, you just said, “Wow, only got to spend six grands, [inaudible 00:49:56] up a little bit. We can bump rents by 80 bucks or $100.” Then it’s worth verifying. This is just so simple. If you just follow these steps, it takes all the mystery out of, what am I supposed to do? What should the renovation budget be?

Andrew:
Yeah. Again, this is one where you can take the broker’s number and plug it in. The real reality is probably not much better than what the broker’s perform is. So, if the broker says, “Spend eight grand.” Okay, cool. Does that work? And if it doesn’t, you know it’s not worth your time.

David:
There you go. All right. What’s number five?

Andrew:
Number five, loan terms and equity extraction. What I mean by equity extraction is basically that’s with the bird method, right? Pulling money or equity out of a deal via supplemental or refinance. Those are two main methods. Again, if you’re negotiating an LOI and your best and final, or you’re close to a deal, you’re going to want to be talking with your lenders so that you can narrow down terms. At this point, you don’t want to spend your time doing that or their time. So, again, if it’s your first time at analyzing a deal, okay, maybe you want to make a few phone calls and get a sense of the market, but once you’ve done a few of these, you’re just going to be like, “Well, okay, if I’m buying a 50 unit apartment complex in Dallas, and I’m going to get agency debt, and I want a 10 year term.”
Yeah, interest rate on that it’s probably going to be, I don’t know, 3.5% or whatever it is. And you just plug that in. How you get that data is just call a few loan brokers and lenders and say, “Hey, can you put me on your mailing list?” Most of them will send a weekly or monthly update on what market rents are for all the various loans that you can get on multi-family. What I do is I just save those to a folder. When I’m doing a quick, dirty underwriting, I say, “Okay, I a 20 million loan. I’m probably going to go Fannie Mae.” Okay, so this week, where are those trading?
Oh, that’s going to be a 3.4%. All right, I’ll throw in 3.5 just to be safe. Does this work right? That’s all you’re doing at this point. Again, you’re making a somewhat favorable assumption and hoping the answer is no, and so you can throw this thing away and move on to the next. You put this favorable assumption in and it looks good. Okay, I’m going to move to the next step. But when I get to phase two, I’m going to go verify that these loan terms really do work.

David:
Yes. That comes up a lot, as you know, anyone who’s done a lot of loans realizes that loan officers will frequently tell you, “Oh, I can do it 3.4. Yeah, you got it.” And then dig into it. Andrew’s laughing because he’s seen this happen so many times. And then that 3.4 was actually for the person with perfect everything, right? Everyone knows credit score, but a lot of people don’t realize your debt’s income ratio, how many properties you might already own, the purpose of what you’re going to use a property for all effect interest rate. Sometimes it’s just a high balance loan.
This is more for the single family space, but if the loan balance that you can borrow in an area is 800,000 and you’re trying to borrow 780,000, just the fact that you’re close to the limit will make your interest rate higher. There’s all these tiny little things that will accumulate. And if you’re planning on barely making that thing work with the 3.5, and they come back with a 3.7, you don’t want to just have spent 15 hours of time that gets blown up because of something that the loan officer then tells you later. So, it’s very smart to just make these assumptions and see, am I close? Does it work? Before you go all the way in.

Andrew:
Yeah. Also, it is good to keep in mind that the loan officer who’s trying to get you to fill out an application, his purpose in life is almost the opposite of the loan underwriter that is trying to dig up everything that might cause an issue. Just put everything you can think of out front to save you both time. The other important piece of the phase one loan assumptions is your leverage. Because going back to what we talked about before, this is one of the huge levers. Ideally, you start off with a little bit lower leverage than where you hope to end up. Let’s say you’re going to say, all right, I’d like to buy this at 75% loan to value, and let’s start, let’s plug it in at 70%. Does it work?
I’ll go, well, all right. It’s a little thin. All right. If I go to 75, is that good? We’ll even look at 65, right? Because if you plug in initial numbers at 65% and it works, that means you’ve got some margin to work with and that deal really probably is worth your time. You’re playing around with your assumptions on your interest rate, how many years of interest-only payment you have, the term of the loan, is it amortizing over 10, 20, 30 years? Also, just again, can you refinance it down the road and pull money out? All of those things, you make an assumption that again, you’re not verifying until phase two. Make a middle of the line to slightly positive assumption. And if it doesn’t work, there’s no point in spend any more time on it.

David:
All right. Cool. And what is the sixth step?

Andrew:
All right. The sixth is just pulling all of these pieces together, and that’s what creates your pro forma. Whether it’s four units, or again, 400, your pro forma is your projection for how this investment is going to perform over the next three, 10, 20 years, or whatever that is. What you’ll do is you’ll put in these first five things and then go look at your performance. Let’s say you’re a cash on cash investor, or maybe your investors that work with you are focused on cash on cash, and your minimum target, 7%, right?
You go ahead, you make five quick assumptions on those first five steps. You plug it in and then you go look at what your perform is. If your cash on cash is 2.5%, well, that’s an easy no. We’re out of here, right? But if you’re looking to make a minimum, let’s say 7% cash on cash, you made those first five assumptions, and you look at your pro forma, and it comes out at 8.5, huh, okay. Well, what if we drop that leverage a little bit? What if operating expenses are a little bit higher? Oh, this still looks like it could be a good deal. Those are the ones you kick to phase two, is when you make five assumptions here, then you go to step six, look at your pro forma, which is the projections that all of those assumptions create.
Most cases, it’s not going to work. You’re going to kick it out. But on the ones that do, that’s when you move it to phase two. Keep in mind, a pro forma, it’s not an exact science, right? As much as it drives those engineer types crazy. A pro forma, all right. A pro forma is like the center of a toilet, right? It’s just something to aim for. But except in this case, you want to exceed it. You are never, ever going to exactly hit pro forma. You’re always going to be below or above. And you want to underwrite in a way that gives you a high probability of being above. That’s what, again, we’re predicting the future three or five or 10 years out.
No one can accurately do that. That’s what you’re doing. You’re making five assumptions that you quickly put in and says, “Okay, let’s say five years out, if the these happen, here are my numbers.” If that’s acceptable, you move to phase two. If not, you kick it out.

David:
Wonderful. I love it. Can you just give a brief definition of what a pro forma is, if anyone hasn’t heard of it?

Andrew:
It’s a prediction of how a property is going to perform over a given to. Let’s say you are looking at something for three years, right? And you have a three year pro forma that says, in year one, it’ll produce this much cash flow, and then in year two, in year three, and then when in year three, we sell it. We think it’ll make this much profit. And then when you factor all those things in, the cash on cash returns will be much, the internal return rate of return will be this much. It just breaks down the property performance based on the assumptions that you put in, right? So, a good pro forma will show those assumptions. It’ll say, hey, based on this rent growth, these expenses, these taxes, etc, here’s the projected returns.

David:
All right, awesome. We’ve got a trait for the audience because we are going to move on to the next segment of the show, the deal deep dive. And we are going to dive into a deal that Andrew and I have actually bought together and work through the specifics of that deal. So, you can kind of get an idea for what this looks like when it works out good. Andrew, you got the information handy for the deal you have in mind.

Andrew:
I do.

David:
All right, awesome. Question number one, what kind of property is it?

Andrew:
This was a 252 unit apartment complex in the Florida panhandle. Average year construction is about 2010. So, it was a B plus, and we’re taking it to an A minus.

David:
All right. And how did you find this deal?

Andrew:
This deal was brought to us by a broker who we’ve known for years and who knows exactly what type of properties we like to buy and what we like to do with them, and he saw that this was a really good fit for us.

David:
For the sake of context, how many hours would you estimate you’ve spent building relationships with various brokers to bring you these kinds of deals.

Andrew:
Many, many, many hours. There’s brokers now that I’ve known for 10 years, and that really is the key to the business, is relationship. And relationships are like showering. You have to keep doing it for it to be effective. You can’t do it once and be like, “Okay, cool. Now they’re going to send me a deal.” People always work with people that they know like and trust, and that’s just across the board.

David:
So you didn’t just grab this thing off LoopNet and say, “Ah, let’s just run it through. What do you know? It worked out.”

Andrew:
No, exactly. No, he called us because he knew we had a reputation for being easy to work with. We would close, and it’s what the kind of asset we were looking for.

David:
Beautiful. Okay. And how much was this deal?

Andrew:
We ended up purchasing it for 49.8 million

David:
49.8. Okay. How did you negotiate that price?

Andrew:
That was a four and a half month process. This was purchased from a developer that built these properties for his own family portfolio, and many months of back and forth, several in-person meals together with him and his family, and after four and a half months, I ended up getting final agreement on a three-way conference call as I was boarding a plane back home. We had spent two days on site meeting with him and looking at the family. It was off market. However, these days off market doesn’t mean that no one’s looking at it. There were still a handful of other offers.
He actually had another offer that was 1.2 million higher than ours. However, we had taken the time to build relationships and get to know each other in person, even during COVID time. And not only that, we negotiated some special factors that helped us win the deal. Number one is we saved him about 2 million in taxes by letting him take a large equity position in the property. So, the seller himself put about a third of the price proceeds back into the deal as preferred equity, which gave him again, a couple million in tax savings, and he’s going to get depreciation because he’s a limited partner.
Also, not surprisingly, a handful of family members were working at the property. That was their livelihood. So, we agreed, for a minimum of 60 days, that we would keep them on as staff. Of course, interestingly enough, they have done a phenomenal job. We’ve kept them on permanently. We’ve increased their wages. And let me tell you, have your property manager be the guy who literally built the property from the ground up and knows every single nook and cranny of it. That negotiation piece that was intended to help us win the deal actually ended up being huge win for us.
Because given the right systems and tools that we brought in with professional asset management, they’ve excelled beyond our highest expectations. They’re happy, we’re thrilled, and it worked out amazing.

David:
Okay, great. Next question. How did you fund it?

Andrew:
We got a Fannie Mae agency loan. So, a 12 year loan, which gives us a ton of flexibility on the exit, kind of getting back to underwriting and making sure you have flexible exits. So, we did Fannie Mae. Then the equity was, again, a large, excuse me, large chunk of it was the seller himself. And then the rest of it was just from our investor pool. We syndicated the deal 506(b) and sold out the equity in a matter of hours, and that was it.

David:
That’s awesome. And what did you do with it once you bought it?

Andrew:
We immediately started renovations. We’ve only owned this, that was March 1st is when we closed on it, we’ve owned it nine months. We have rents up on average $408 a month per unit. Revenue is up geez, about $60,000 a month. And if we were to sell it today, it would trade for about 72 or 73 million versus the 49.8 we paid for it in March, so it’s been pretty good.

David:
Mr. Engineer, how much profit is that on this deal?

Andrew:
If you put in a hundred grand in March today, that’s worth 256.

David:
Pretty good return.

Andrew:
Not counting the cashflows. Now, that is … Well, I do want to give the standard disclaimer of when you’re looking at deals, don’t look for just the home runs like that because you won’t end up doing a whole lot of deals. The reason that deal ends up like that is going back to the underwriting parameters that we talked about and making realistic assumptions. But then also going back to the screening that we talked about in episode 279. What that screening does is it puts you in properties and markets where you have a tailwind that increases the odds of this kind of thing happening, right?
Remember, I said, you will never hit a pro forma. We screwed up. Our pro forma was way off. We are so far ahead of that pro forma that, in one sense, we failed. We got it all wrong. But by walking through the steps that we’ve been through in these last two episodes, it increases the odds that, that’s going to be the result.

David:
Yeah. I liked that you mentioned the momentum aspect of it. That deal would never have been someone’s first deal. That deal was a result of the other deals you did that were base hits. It accumulated into being a very good baseball player that then can hit a home run, because they recognize the pitch that somebody else might not. It’s even opening more doors, right? Because we won’t get into it a ton, but you and I are actually looking at another deal in that same area, very close to it, that we would be able to use the same management to now run that deal. So, we would be able to operate that thing much cheaper than somebody else who bought the same property.

Andrew:
Exactly. Yep.

David:
Okay. Next question. What was the outcome? I guess you just described it went up about 20 million, maybe a little bit more than that.

Andrew:
Yep. That’s something we planned to hold that for our whole time, and that was six years, for a variety of reasons. Yep.

David:
Okay. So, what lessons did you learn from this deal?

Andrew:
Creative financing and deal making scales up really, really well. It’s a lot of times, that’s kind of portrayed as something you just do in the single family world or small properties. That is absolutely not true. We won that deal. We were not the highest priced. We won the deal because of the seller financing aspect, because we were willing to say, “Yeah, you know what? We’ll keep the family members on. That creative structure, and actually, this is, I’d say the second thing that we learned is keep pushing.
When you’re told no, verify that the answer is no. We were told that we could not do that structure with Fannie, that because seller equity, they see it as basically a recapitalization and you can’t do that, whatever. We finally found the right people that said, “No, we can get this through because I know a guy who knows a guy, and he likes this. We’ll get it approved. And they did, they got it done. Don’t take no for an answer, especially if getting to yes has a huge win to it.
When we bought that in March, that was the largest deal that we had ever done. We had not ever tried to raise 18 million in equity. And going into it, told you the results, sold out in hours, but going into it, I wasn’t sure like, oh man, can we really raise 18 million? Today, in today’s market, finding a great deal is everything. A great deal is like a homing pigeon, right? If you have a homing pigeon and you send it out and it doesn’t come back, you did not lose a homing pigeon, you lost a regular pigeon.
So, if you’ve got a great deal and you put it out there, to either your investors or the BiggerPockets community, or your network and you can’t get funding, you don’t have a great deal. You just have a deal. It means you didn’t do the underwriting properly. In today’s market, great deals will get funded. I know for a lot of people, it is super discouraging, how hard it is to find great deals right now, and it is, there’s no question about it.
But the good news is, if you get it, you can get it funded, either by partnering with somebody or networking, or anything like that. So, just persist and go out and find that great deal. Again, and this property that we’re just talking about, that was bought this year, 2021, hottest time of the market. You can still do it.

David:
Okay. One thing we learned from this deal that we’re talking about is that they go quick, right? There’s a lot of investors that were like, “Hey, I want to get into the deal.” And they just weren’t able to get in because it sold out in ours. Now there’s a new system sort of set up where people that want to invest with us, they can raise their hand and say, “Hey, can you keep me in mind so that the email can go out?” Andrew, first off, what do you recommend that people should look into when they’re trying to figure out what the right deal to invest in is? And then where would you recommend people go if they want to get sort of on a list where they can be told, “Hey, there’s a deal coming down the pipeline?”

Andrew:
If you like and trust David, as much as I do, go to investwithdavidgreene.com, right? Yeah, invest yeah, investwithdavidgreene.com, and that’s definitely a good place to start. I believe we’re going to be talking about some additional pieces of this stuff down the line, right?

David:
Yeah. There’s a lot of people that I know are wondering after they hear about this, well, what comes next? You’ve done the stage one underwriting and then there’s stage two underwriting, and then you’re actually going to write an offer. Andrew has graciously agreed to do some more education on the topic. What’s the best place people could follow you on social media? Do you have social media actually? I don’t know that I’ve ever seen you on there.

Andrew:
No, I’m old school. We’re just focused on the real estate. I don’t think I’ve ever made an Instagram post in my life.

David:
That’s funny.

Andrew:
We’ll get to social media eventually. I do plan, one of my goals for this year is to communicate a whole lot more in LinkedIn, to try to put out a lot more original content and commentary on there. So, I’d say go to LinkedIn, but to connect with us …

David:
Let’s do this, follow me.

Andrew:
Yeah, follow David.

David:
@davidgreene24. And then I will post when we’re going to do like a webinar or some topic, where we’ll go into like, hey, this is how you write an offer. This is the more intricacies of what you do here. Because if you’re on BiggerPockets, you want to learn this stuff, and we want to be able to teach you. Of course, that will all be for free, as it should be. So, we’re getting close to wrapping up. Is there anything Andrew that you think we should highlight or you’d like to leave people with before we wrap up here and then we’re going to get into stage two on a different show.

Andrew:
Yeah. I would trust the process, especially at this point in the market cycle, and just go into it knowing that the best way to spot a really great deal is to look at a thousand bad ones first and have that relentless persistence to just keep at it, whether it’s building your relationships, whether it’s, I got to look at a thousand deals. Don’t get me wrong. I mean, there are many times when I look at something in my inbox, it’s like, ugh, I got to look at another property. Fortunately, and then of course, at this point, we have an acquisitions’ team and things have changed.
But when it was just me, I’m like, oh my gosh, I’ve got all these deals to look at. That’s part of where this process came from. How do we effectively whittle it down? So, have that persistence. Yes, it can still be done. Yes, there are great deals out there. I can’t think of a better business than real estate for the average person to jump into and really have the potential to become quite successful and quite wealthy.

David:
All right. Check out BiggerPockets Podcast episodes 170 and 279 to hear more of Andrew. Check out my website, investwithdavidgreene.com, if you’d like to invest with us in one of the next deals that we’re doing. Message Andrew on the BiggerPockets website. A lot of people don’t realize we do check those inboxes, and so when you’re trying to get ahold of a guest, or one of us, that’s a great place to go to. Then make sure you’re following me on social media because I will be sharing when we’re going to do a webinar where we basically break into a detailed analysis, just like this, of explaining what we do once we’ve identified a property, how we write and offer, how we present it to the seller.
As you’ve seen, Andrew is a relationship ninja. He’s very, very good at being authentic and building relationships with these people and sort of getting ahead of all the other investors that really looked it up more from just the financial side.

Andrew:
Yep. Also, I want to throw out there, so for all of you who are still listening to this and your eyes haven’t glazed over as we talked about all these numbers and technical stuff, this is definitely not your motivational podcast, right? If you’re still listening and this stuff got you excited, we are looking to hire an analyst at the beginning of 2022. So, please reach out, if you think that might be you, just go to vpacq.com, short for Vantage Point Acquisitions. There’ll be a tab on that website. Let us know that, “Hey, I’d let to work with you guys and be an analyst,” and we’ll be in touch soon thereafter. And looking forward to hopefully meeting a bunch of awesome BiggerPockets members.

David:
That’s very cool. What’s the ideal person or personality or skillset that you think identifies, if someone is a analyst?

Andrew:
Somebody who, if you go to the DISC file is high C, which is just a very analytical person. Where a lot of people, the idea of running numbers and diving into data, just ugh, can’t stand doing that. We’re looking for the person who would love to do that all day, who gets excited by the prospect of finding that one in a thousand that is true gold, and goes through the rent comps, and look at a T12 and say, “Oh, there’s opportunity here. No one’s going to see this.” And loves Excel, lives and breathes Excel.

David:
Yes. That is a prerequisite. It’s like, if you want to be super into fitness, you got to going to a gym or being outside. You got to like Excel if you’re going to be analyzing properties. That’s a great point. All right. Well, thank you very much, Andrew, for being on here and sharing your wisdom. As always, I really appreciated this and I think you gave a lot of value. I’m going to get you out of here. This is David Greene for Andrew BP threepeat Cushman. Signing off.

 

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In This Episode We Cover:

  • How Andrew scaled from zero to 2,600 units in only ten years
  • The basic screening process that allows you to triage your deals and waste less time
  • Four levers every investor should look at when analyzing a new deal
  • The six factors of phase one multifamily underwriting and using it to unlock “home runs” 
  • Developing and nurturing broker relationships so you can get off-market deals before your competition 
  • And So Much More!

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Books Mentioned in the Show:

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