Our business model normally focuses around the good ole BRRRR strategy, where we will buy houses and small apartments one at a time, rehab them, rent them out, and then package a handful into a portfolio and refinance it with a local bank before, of course, repeating the whole process.
About one year ago, we were able to buy a massive portfolio of 97 houses with a partner. We thought it would be a while before we came across another such deal, but only a few months later, we came across another such portfolio of properties — this time of 41 (40 houses and a duplex) that we were able to purchase.
While this story is certainly not the kind a new investor is going to come across, I think there’s a lot of things that any investor can learn from the way we approached this deal, as well as some tips on buying portfolios in general. Indeed, it took a creative approach to get this deal done, so hopefully this example will help get your mind’s gears turning for whatever type of deal you are looking at.
Evaluating the Deal
Unlike the portfolio of 97 I discussed in a previous article, this deal was not particularly interesting when it first came across my desk. A colleague of mine forwarded it to me from a real estate agent he met at a networking event. The price looked good — $1.95 million — but many of the properties were in areas we weren’t particularly thrilled with, to say the least.
The operating statement and rent roll showed the portfolio that was kind of performing, but had a decent amount of vacancy and delinquency. At the time we saw it, there were seven vacancies, and three properties needed full rehabs. The owners didn’t have a mortgage, so it cash flowed pretty well.
We did a walkthrough of about six houses, and it wasn’t particularly impressive. We saw two of the properties that needed to be gutted and also saw a few that were rented, but we immediately noticed they would need a good amount of work upon turnover.
Since I wasn’t able to look through each property before making an offer, this was a particularly hard deal to analyze. I knew there was a lot of deferred maintenance, but unlike an apartment complex, where a few units might give me a good idea of what the rest were like, these were a bunch of houses spread out all over the place that were likely each in very different conditions.
So I came up with repair estimates on each house I saw and used that to come up with an approximate repair estimate on the total, first for the normal houses and then for the three that needed a full rehab. Then I added a contingency on top of that of about 20 percent and came to a total estimate of about $400,000 in total repairs and deferred maintenance.
Luckily, I knew all of these areas pretty well, so I was also able to put an approximate value to each house as well as review the financials and put together a pro forma.
After that analysis, it was clear that there was obviously some built in equity, but I didn’t want to deal with a bunch of properties in areas we didn’t want very much. We broke the portfolio into two groups — the first was of the 18 properties we wanted, and the other was of 23 that we really didn’t. And if we bought them all and just sold off the 23, we would have a bunch of transaction costs that would eat into our profit. We really wanted to hold the whole thing if we went after it. Thus, we had a dilemma.
Negotiating the Deal
One of the most important things to do when negotiating a deal is to get in front of the actual seller if at all possible. There was an agent in this deal, but he was very helpful, and we were able to get the seller on a conference call. In this case, they were from a small hedge fund out of Texas who had bought these properties over time and were now simply looking to liquidate the portfolio. Getting them on the phone allowed us to 1) build rapport, 2) learn what the seller really wanted, and 3) discuss creative ways of doing the deal.
We quickly learned that the seller had no interest in only selling us the properties that we wanted. It was all or nothing. While this was disappointing, it was important to know.
But we were able to find a very creative way to close this deal.
Financing these properties with a bank would have been quite difficult given the portfolio was only sort of performing. And the sellers had no interest in financing them. We could partner with someone, like we did on the 97 properties, but given that we didn’t want the deal that much, did we really want it at all if we were going to have to split the equity into pieces?
Luckily, as I noted earlier, our typical business model is to buy houses one at a time and then refinance them as a portfolio. We were rapidly approaching the refinance of 25 houses we already owned (each of which was, on average, more expensive than the portfolio of 41) with a local bank. Each of these properties had a loan on it from a private lender who didn’t really want to be paid off. This happy coincidence gave us the opportunity to effectively transfer the loans from the properties being refinanced to the properties being purchased.
However, putting together 25 (or 41) deeds of trust is a huge mess and a lot of work. In addition, we had just gone through the enormous hassle of transferring management on 97 performing units and now we were going to get 41 semi-performing units. It would make it so much easier if we could space this transaction out.
So we asked if we could buy the properties in four groups over the course of two months, each closing 15 days apart. This is an unusual way of closing such a deal, but the seller agreed without hesitation.
Still, we had a problem. If you remember, we didn’t much like the properties. While going over it again and again, my brother finally said, “Just offer whatever price that you know you want it at.”
Sure, we probably won’t get it, but whatever, we didn’t really want it to begin with.
So I put together two offers. One was for only the 18 I wanted, which we made for $1 million. I knew they didn’t want that, but it allowed me to better justify the main offer. Indeed, my offer on the 18 was effectively what they were asking for. But then I said I didn’t really want the other ones and could only offer $20,000 a piece. That brought the total to $1.46 million.
I thought that that would be it, but I didn’t realize we had one critical advantage; there just aren’t many buyers for this type of deal. Small investors couldn’t handle it — it’s not what apartment buyers are looking for, and institutional investors want bigger portfolios in nicer areas. I had to fight to conceal my shock when they immediately came back at $1.5 million, but in hindsight, I shouldn’t have been surprised.
We ended up settling at $1.48 million.
The Due Diligence and Close
With the portfolio of 97, part of the agreement was that we wouldn’t view all 97 to avoid the tedious logistical nightmare. So we viewed a random sampling. On this one, I demanded to see the inside of each one. And normally speaking, with any portfolio or apartment, I highly recommend that you walk every single unit for due diligence. You just never know what you might find.
From there, I wrote up a detailed estimate and compared it to the original estimate I had made (which I submitted to them as one of our assumptions along with the offer, letting them know that if I was quite a ways off, we would have to re-trade).
The repairs did total substantially more than I anticipated. So we sent them our documentation and asked for an additional $70,000 off. We got $30,000. Indeed, the deal would have still worked without the concession, but every bit counts. (Although I should note, be careful not to frivolously re-trade. Whenever you do, you should have a very good, documented reason to do so.)
We also demanded all the updated financials for each month to make sure nothing changed. Sometimes, there can be fairly radical changes right before you close, so don’t just assume the rent roll and operating statement you have from two months ago when you signed the contract is just like the current condition. Sometimes unscrupulous managers stick in tenants who can’t really pay just to increase the occupancy. You want to be on the lookout for this kind of thing.
Finally, I did a comparable analysis on each house (yes, this was quite boring) to make sure we were getting a good deal. And we were. Indeed, the price per house came out to a paltry $35,366, so how could it not be a good deal?
Other than the additional repairs, everything looked fine, and we ended up closing the properties in four groups over two months as we had previously agreed. It was a lot to absorb (especially coming on the back of the 97 properties and a 32-unit apartment to boot), so it has kept our property management team extremely busy.
But we believe the deal was another great one. As someone once told me, “The deal of the year comes along once a week, and the deal of a lifetime comes along once a month.” You’ve just got keep out there pounding the pavement to find it, and then, once you’ve found it, be creative about ways to get it closed.
What’s the latest deal you’ve landed? Any questions about this transaction?
Let me know your thoughts with a comment!