What You Need to Know About Purchasing Portfolios

Buying portfolios of properties has become one of the most effective ways to grow our business. Recently, we added 26 doors spread throughout the Kansas City metro. This deal included 22 houses, three duplexes, and a fourplex. And when I say “spread throughout,” I mean it.

The package included a house in Pleasant Hill, Missouri (a small “exurb” outside the city limits), as well as another in Kansas City, Kansas—which are almost an hour apart. It also included houses in Kansas City, Missouri, north of the Missouri River, and in Peculiar, Missouri (a southern exurb), which are about 35 miles away from each other.

(Indeed, about half of our units have come from the acquisition of portfolios of properties—mostly single-family houses—which led me to write a short how-to guide on the topic. You can also check out breakdowns on the other portfolio deals we’ve purchased, including nine houses, 17 condos, 41 houses, and the 97-door deal that kept me awake a few nights.)

One nice part about Kansas City is that there is very little traffic. One not-so-nice thing is that it is sprawled like crazy. This is, of course, a disadvantage of portfolios in general. Buying many houses or small multis means you have to do offsite management and drive more. Generally speaking, this is more of a challenge than onsite management like you would have at an apartment, where everything is consolidated and a maintenance tech can walk to his next job instead of driving 30-45 minutes.

At the same time, being spread out also reduces risk by diversifying the areas you’re in. If, for example, a factory closes near one of your properties, it’s not that big of a deal if you have a bunch of properties spread out all over town. On the other hand, if a factory closes next to your one-and-only 100-unit apartment complex, that could be a serious problem.

Finding Deals: The Power of Networking on BiggerPockets

One of the best ways to find properties (or banks, contractors, private lenders, etc.) is by networking. And BiggerPockets is one of the best places to network.

I met the seller on BiggerPockets before he was even looking to sell. I told him about our business, and I believe I had mentioned some of the previous portfolios we had bought. Naturally, when he and his wife decided to sell, we were one of the first groups they contacted.

You may not be looking to buy a large portfolio—or any sort of portfolio—right now. But regardless, I hope this still illustrates the importance of networking. As they say, “It’s not what you know, it’s who you know.”

So, get out there and get to know some people. Get active on BiggerPockets, attend your local REIA, and perhaps a few other groups like CCIM, IREM, your local Chamber of Commerce, other real estate or entrepreneurial meetup groups, etc.

Analyzing Deals: The Right Way to Evaluate a Portfolio

As I noted in my article on buying portfolios, when evaluating such deals, there are two things you need to look at carefully:

Analyze portfolios based both on their cash flow and actual value. I evaluate the cash flow based on the previous 12 months of operating history and creating a pro forma. I want to make sure the portfolio will cash flow at a 1.2 debt service coverage ratio and bring in at least $100 (and preferably $200) a month per house.
Analyze the values of each property. I do this by either going through a data tape (a list of each property in Excel and their key specifications like bathrooms, bedrooms, and square footage) and put down my estimated price based on my knowledge of the area and/or the Zestimate from Zillow.

It can be particularly helpful to use Zillow Zestimates to see if the properties in areas you are unfamiliar with are priced reasonably. (For example, I knew very little about Peculiar.) But don’t’ rely on the Zestimates, they are only a ballpark estimate.

If the portfolio does look interesting, make sure to comp each and every property. Although up front, you can do a “quick and dirty” comparative analysis. You don’t need to be particularly detailed until you get closer to signing on the dotted line. It’s just not worth your time to do an in-depth CMA on 26 properties when you have no idea if the deal has any potential yet. In the same vein, it makes no sense to walk all 26 (and the seller would never agree to this) until after you have the properties under contract.

For that reason, buying portfolios is a bit tricky—you are not going to be able to see every property before making an offer. I make sure to view a couple and look over all the pictures. I also ask the seller to show me the worst ones. Then I list out my assumptions in my offer and tell them to “correct me if I’m wrong.” This way, I can point back to these assumptions if we find something amiss during due diligence and need to ask for a retrade. I believe doing this enhances the possibility of such a request being accepted. (Although not in this case for reasons discussed below.)

On this deal, we included the following in the contract:

Physical occupancy is currently X of Y units. Occupancy will be maintained at close to the current level (no more than Z vacancies).
The large majority of tenants are current with their rent and will remain so (no more than X behind on their rent).
All tenant deposits are on hand and none have been applied to a tenant’s rent.
With the exception of 123 Main Streat, the remainder of the properties are in either good or mostly good condition. (Very few if any major issues, such as foundation repairs, roof replacements, non-functional HVAC, etc. Mostly just standard turnover items, such as paint, flooring, countertops, a few appliances, etc.)
The average turnover of these units should be approximately $5,000 or less to get into functional and rent-ready shape.

To be sure, $5,000 is generally high for a turnover. But this made it clear I was referring to actual significant damage and not just a difference in the level of quality between our perception and the seller’s of being “rent-ready.”

Learning Lessons: The Flaw in This Deal

Two properties were near finished when we got the portfolio under contract. We decided to make it a condition of the contract that those properties would be completed before moving out of the inspection period. This, and a few other issues regarding financing, slowed the deal down. It ended up taking almost three months to close instead of the normal two months for such deals.

We found a few things that we thought were worth requesting concessions on, but since we waited until everything was done before asking, it had been so long it came off as a “last-minute” request and was denied. Had we asked sooner, it may have been at least partially accepted.

We also set ourselves up for a possible disagreement as to what “finished” meant. There was a minor disagreement on one of the two properties, but we were fortunate it was nothing noteworthy. Regardless, while you want the seller to continue leasing and turning units over, be very careful when it comes to making finishing rehabs a part of the contract. Such things could very well lead to delays and disagreements.

Luckily, the deal still worked for us. We went ahead and closed it, and it has worked out well thus far.

The Bottom Line

Portfolios are a great way to scale your business. Indeed, they fall in a sort-of-Goldilocks zone, where new and small investors won’t buy because it is too big, and institutional investors won’t buy because it is too small, spread out, or not in the A and B+ areas they prefer. Thereby, there is much less competition to worry about.

Financing can be difficult. But there are ways to go about it. For instance, consider syndication, tenancy in common, private loans, or a bank loan. Due diligence is also challenging—but certainly doable.

Overcoming these challenges can lead to great opportunities. Indeed, buying portfolios is definitely a great way to grow quickly and effectively (if done right). This 26-property deal, I believe, was done right.

Questions? Comments?

Join the discussion with a comment below.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.