I don’t watch that much TV. But every once in a while, after an especially exhausting day at the office, I will plop down on the couch. Picking up the remote, I usually scan thru a few shows. I spend most of my time just channel surfing from one boring show to the next. Most of the time, I end up on ESPN, the Weather Channel, (yes I am a weather geek) or the National Geographic channel. I am also an avid outdoorsman, so naturally I am drawn to the incredible cinematography on NatGeo.
It was not all that long ago that I happened upon a documentary about the life cycle of baby turtles and the incredible odds they face to make it to adulthood. It reminded me of the training I took while being mentored in multifamily investing by a multifamily investment company in Virginia called 37th Parallel. During one of the sessions, our instructor made the statement that evaluating multifamily assets is much like the life cycle of baby turtles. Now this was not my first rodeo when it came to real estate investing but I could not for the life of me figure out what he was talking about.
You see, a baby turtle has to overcome incredible danger and insurmountable odds just to make it to adulthood. Its journey just to make it thru the first year of life is fraught with danger. When a baby turtle is first born it has a serious struggle just breaking out of its shell and digging up thru the sand. Then there is the long crawl across the beach to reach the ocean. As they are slowly crossing the sandy beach they are easy prey for all kinds of predators. Birds, dogs, crabs, and raccoons are just a few of the culprits that can swoop in and snag the defenseless little guys.
If they are lucky enough to make it to the open water, the little guys are in for another wild and dangerous adventure. Predatory fish, eels, and even sharks love to pick off the smallest and most vulnerable. If they do survive the first year of life then man made calamities await them such as fishing lines, float nets, and plastic pollution which reduce their numbers even more. With all the obstacles it’s a wonder any make it to adulthood at all! And the reality is that the survival rate of baby turtles is estimated at just 1 percent. So by now you are also probably asking…
“What, if anything, does this have to to with real estate investing?”
Great question! I have seen and heard many sources complaining that in this overheated market they can’t find a good deal. And when they do find a deal, it does not make sense. Everything is overpriced!
When our company comes across a new multifamily or self-storage deal, we put it through a multifactorial screening process. This includes a good number of hurdles the prospective deal must clear. First up is a cursory 10,000-foot review of the deal. What is the age of the asset? Is it a class A, B, C, or D asset? What is the whisper price? How soon is the call for offers? Is it a market rate deal, low income housing, student housing, or rent controlled? Is it located on a back road, high traffic area, growing suburb, or declining area? A full 50–60 percent of the deals we look at are weeded out at this point!
Then comes the location screen that includes evaluating the city, the submarket, and the immediate neighborhood where it is located. Then comes crime scores, school ratings, and economic condition of the area. Next up is a review of area shopping, grocery stores, coffee shops, healthcare, and proximity to job centers. Probably another 35 percent are weeded out at this point.
If the deal makes it this far, we feel like it has a decent chance of survival. We will invest more time and energy to put it thru an in-depth underwrite and evaluate the financials including T12, rent rolls, and history of occupancy rate. No stone is left unturned and at any point a deal could be eliminated.
Slow and Steady Wins the Race!
Because so many deals die at this stage, if a deal does not quite clear our economic hurdles, we take a second look. We go back in and look for operational inefficiencies, management errors, or some sort of value-add proposition that might push the deal over the finish line. The point is that if a deal has made it this far, we will give it a little push, or “helping hand” so to speak to help it clear the last hurdle.
If and only if a deal has cleared all these hurdles will we consider a site visit. Some deals will fall out at the 11th hour due to an overwhelming amount of deferred maintenance or physical damage we find on the site visit. It’s an understatement to say it is a long process from initially finding the deal to eventually making a bid on it. Most deals die along the way.
At this point in the market cycle when you are evaluating deals, you have to think about deals like baby turtles. In fact, because of our conservative approach, our company’s experience has shown that less than three in 100 deals will survive all of our underwriting and screening processes.
Once deals do clear all of our hurdles it’s finally time to bid on them. Unfortunately, many times we lose deals at this point because 1031 or foreign money is willing to overpay by 10 or 20 percent. We won’t ever knowingly overpay so it can be depressing. That is of course until you find that winner, that one baby turtle (deal) that makes it all worthwhile!
My point of this entire article is to suggest that finding deals at this over-heated stage of the market cycle is just a numbers game. There are still investment opportunities out there but you have to be willing to invest the time and energy to find a winner. Patience wins the day! Patience and persistence. Are you willing to invest the time and energy to find the needle-in-the-haystack? The diamond-in-the-rough? The one lucky baby turtle?
What about you?
Leave me a comment about your experience finding deals and any shortcuts you use!