How do people make large real estate profitable?

36 Replies

I just can't seem to make the numbers work to make any sort of ROI that compares to the 100+% you can get with residential rehabs. I realize you can get infinite ROI with BRRRR, but I don't think that's what the big players do. I'm asking about people that construct or purchase large apartment complexes, condominiums, commercial buildings, hotels, etc.

How do they make them cash flow in an amount that is worth all the trouble it takes to build and manage them?

For example, I was looking at a condo complex nearby, and they're selling for about $108/sq. ft. That is less than a quote I got on residential construction.

I have no problem sticking with residential rehabs if that's the best ROI, but if I could do a condo conversion, etc. that would be cool, too.

Just as an example, I've attached a picture of a building I watched being constructed from ground up over the last couple years. Now, it is being rented out. How do these investors make the numbers work?

https://www.dropbox.com/s/21pv5k60gtuwa17/0416180617a.jpg?dl=0

Here's an example of how the math usually works when I look at it...

http://www.loopnet.com/Listing/3121-3205-Orange-Ce...

Purchase price = $2,480,000

NOI before debt service (derived from 7.6% cap rate) = $188,480

If 80% of purchase is financed over 30 years at 5%, that is $127,807.68 in annual mortgage payments.

This leaves $60,672.32 in profit every year, until Year 31 when the mortgage is paid off.

This is a down payment of $496,000 that you wouldn't see back until over 8 years. In other words, over 8 years will go by before you break even on your investment.

This is ignoring any rise in property value, which you wouldn't benefit from unless you sold it, anyway.

Even after 30 years, it is still less than a 9% ROI.

You are looking at this from a wrong perspective.

Initial NOI is important but almost irrelevant in the long run. When you buy an apartment complex you look for ways to increase that NOI which in turn increases the value of the property (AKA forced appreciation).

Once the property value increases sufficiently you either refinance or sell. In case of refinance, it is not unusual to get all of the initial capital out. This is essentially the same BRRRR strategy.

Virtually nobody holds these properties for 30 years with an intent to pay it off. 5 to 10 years is the usual hold time.

Originally posted by @Patrick Philip :

I just can't seem to make the numbers work to make any sort of ROI that compares to the 100+% you can get with residential rehabs. I realize you can get infinite ROI with BRRRR, but I don't think that's what the big players do. I'm asking about people that construct or purchase large apartment complexes, condominiums, commercial buildings, hotels, etc.

How do they make them cash flow in an amount that is worth all the trouble it takes to build and manage them?

For example, I was looking at a condo complex nearby, and they're selling for about $108/sq. ft. That is less than a quote I got on residential construction.

I have no problem sticking with residential rehabs if that's the best ROI, but if I could do a condo conversion, etc. that would be cool, too.

Just as an example, I've attached a picture of a building I watched being constructed from ground up over the last couple years. Now, it is being rented out. How do these investors make the numbers work?

https://www.dropbox.com/s/21pv5k60gtuwa17/04161806...

 Nobody is building new construction to sell at $108/ft. New construction probably sells for 3x construction hard costs, soft costs, interest, etc will probably eat up total of 50% of exit value. Plenty of money to be made by the big players, they just make different analysis decisions.

Most of the value add B and C class apartment deals I see generate a 25+% total deal IRR...and that is split between the sponsor and the investors. The big players definitely BRRRR...they just do it on a 250 unit community and have professional management handle it rather than doing it on 250 individual homes. It's significantly less trouble and easier to manage.

Originally posted by @Mike Dymski :

Most of the value add B and C class apartment deals I see generate a 25+% total deal IRR...and that is split between the sponsor and the investors. The big players definitely BRRRR...they just do it on a 250 unit community and have professional management handle it rather than doing it on 250 individual homes. It's significantly less trouble and easier to manage.

 Are the best deals new construction or rehabbing existing complexes? And are they flipping them, or renting them?

Most apartment deals are existing B and C class rehabs. They are essentially flips but not in a single family sense. The full cycle takes at least 2 years and requires not just physical rehab but also improvements of the tenant base.

Originally posted by @Patrick Philip :

Here's an example of how the math usually works when I look at it...

http://www.loopnet.com/Listing/3121-3205-Orange-Ce...

Purchase price = $2,480,000

NOI before debt service (derived from 7.6% cap rate) = $188,480

If 80% of purchase is financed over 30 years at 5%, that is $127,807.68 in annual mortgage payments.

This leaves $60,672.32 in profit every year, until Year 31 when the mortgage is paid off.

This is a down payment of $496,000 that you wouldn't see back until over 8 years. In other words, over 8 years will go by before you break even on your investment.

This is ignoring any rise in property value, which you wouldn't benefit from unless you sold it, anyway.

Even after 30 years, it is still less than a 9% ROI.

$60k would be a 12% return. That seems pretty good to me. Stock market returns 8%, so that is 50% better than the stock market returns, and that is just a cash on cash return. IRR is going to be higher than the cash on cash return when equity buildup is factored in.

Originally posted by @Patrick Philip :
Originally posted by @Mike Dymski:

 Are the best deals new construction or rehabbing existing complexes? And are they flipping them, or renting them?

Many B and C class value add apartment deals are a combination of a hold and a flip. The IRR is maximized when capital is returned to the investors and redeployed into the next value add deal. Many private investors also want their investment back within 3-10 years. The property plans can range from a 2-5 year hold, 3-7 years, 5-10 years, etc...communicated up front with financing that matches that plan. It's a "buy, improve, and sell at the right time" strategy. As Nick mentioned, it can take a couple of years to execute the plan and then show the elevated NOI for a period of time afterwards.

What's "best" for an investor is particular to their individual goals and opportunities.  Many investors are currently focusing on value add and cash flow over development deals due to their perception of where we are in the market cycle.

Originally posted by @Nick B. :

Most apartment deals are existing B and C class rehabs. They are essentially flips but not in a single family sense. The full cycle takes at least 2 years and requires not just physical rehab but also improvements of the tenant base.

 Where are these deals found? Are they found through traditional channels like Loopnet, or are they off-market?

Also, why would anyone buy it from me if there's no room for improvement?

Originally posted by @Russell Brazil :
Originally posted by @Patrick Philip:

Here's an example of how the math usually works when I look at it...

http://www.loopnet.com/Listing/3121-3205-Orange-Ce...

Purchase price = $2,480,000

NOI before debt service (derived from 7.6% cap rate) = $188,480

If 80% of purchase is financed over 30 years at 5%, that is $127,807.68 in annual mortgage payments.

This leaves $60,672.32 in profit every year, until Year 31 when the mortgage is paid off.

This is a down payment of $496,000 that you wouldn't see back until over 8 years. In other words, over 8 years will go by before you break even on your investment.

This is ignoring any rise in property value, which you wouldn't benefit from unless you sold it, anyway.

Even after 30 years, it is still less than a 9% ROI.

$60k would be a 12% return. That seems pretty good to me. Stock market returns 8%, so that is 50% better than the stock market returns, and that is just a cash on cash return. IRR is going to be higher than the cash on cash return when equity buildup is factored in.

 How is it 12% if you don't have that cash until you sell it?

But I can see how my original post was flawed since most people wouldn't be holding for 30 years.

Your math is wrong the 60k profit a year on a 500k investment is 12%

Originally posted by @Michael Lewis :

Your math is wrong the 60k profit a year on a 500k investment is 12%

 But you don't see that equity until you sell the place, so you would also have to include the opportunity cost of tying up $500k in cash.

The only way you could see that down payment back in cash is to take part of it out as a loan secured by the property.

The apartment I live before it was built was commercial offices the office building was bought for 5M then it was demolished and a A class 89 unit luxury apartment complex was built for 20M a year later the property is stabilized and fully occupied with it is worth 35M could be sold for a profit of 10M minus selling costs. 10M profit in 3 years not including the cash flow made for a year which is around 2-3M a year. There is money to be made otherwise you wouldn’t see people doing these kinds of deals

It's basically the BRRR strategy but on a larger basis.

When I worked for a large apartment owner/operator, they would buy an older apartment (around 20-25 years old) that was outdated and rehab it. In their rehabs, they would put new counters, appliances, cabinets, etc and pool and renovate the leasing office and usually add a gym.  

Once they had the units upgraded, they would increase rents to maximum the market would allow. In my specific apartment complex, we used software that would change the rate daily depending on availability & market rent. We were also asked to push other ancillary services (like fans installed at $10/month) or insurance for an extra $10/month. It was mandatory to have valet trash pickup (an extra $25/month) too, so that boosted the NOI.

After 4-5 years, they would sell the complex or portfolio to another institution and made back the money invested. My former employer was also kept on as the management company for day to day operations. 

You see that 60k every year has nothing to do with equity.

Originally posted by @Michael Lewis :

You see that 60k every year has nothing to do with equity.

 I know. But you had to spend $500k in cash to get that $60k/year.

$500k that could have been doing something else.

Originally posted by @Mohit Asthana :

It's basically the BRRR strategy but on a larger basis.

When I worked for a large apartment owner/operator, they would buy an older apartment (around 20-25 years old) that was outdated and rehab it. In their rehabs, they would put new counters, appliances, cabinets, etc and pool and renovate the leasing office and usually add a gym.  

Once they had the units upgraded, they would increase rents to maximum the market would allow. In my specific apartment complex, we used software that would change the rate daily depending on availability & market rent. We were also asked to push other ancillary services (like fans installed at $10/month) or insurance for an extra $10/month. It was mandatory to have valet trash pickup (an extra $25/month) too, so that boosted the NOI.

After 4-5 years, they would sell the complex or portfolio to another institution and made back the money invested. My former employer was also kept on as the management company for day to day operations. 

 Interesting. My follow-up question would be...

Why would anyone buy it from them? Who would want a fully renovated apartment complex with no room for improvement? Are they relying on selling it to a fool?

Originally posted by @Storm Silva :

The apartment I live before it was built was commercial offices the office building was bought for 5M then it was demolished and a A class 89 unit luxury apartment complex was built for 20M a year later the property is stabilized and fully occupied with it is worth 35M could be sold for a profit of 10M minus selling costs. 10M profit in 3 years not including the cash flow made for a year which is around 2-3M a year. There is money to be made otherwise you wouldn’t see people doing these kinds of deals

 Interesting. Do you know the square footage and average rents of this complex?

Originally posted by @Patrick Philip :
Originally posted by @Nick B.:

Most apartment deals are existing B and C class rehabs. They are essentially flips but not in a single family sense. The full cycle takes at least 2 years and requires not just physical rehab but also improvements of the tenant base.

 Where are these deals found? Are they found through traditional channels like Loopnet, or are they off-market?

Loopnet is definitely one channel but it generally has listings that nobody wants to buy (there are exceptions, of course).

Most large MF deals are listed and marketed by commercial brokers such as CBRE or Marcus & Millichap. There is no centralized listing service and many deals are not even sent to a broker's usual email list. Rather brokers shop for likely buyers among those who bought from them before. It's a small world.

Also, why would anyone buy it from me if there's no room for improvement?

Many reasons. First, there is always some room for improvement. Second, a stable asset that cash flows predictably attracts buyers who want relatively hassle-free stream of income and have a long term time horizon. What kind of buyers? Wealthy individuals who live off of cash flow, beginner syndicators, family offices, REITs, foreign entities. Also, let's not forget that cash flow is not the only way to make money on a stable MF. There are three more: loan principal paydown, tax benefit (depreciation & 1031), appreciation (rents increase over time and so does NOI which in turn pushes property value).

Originally posted by @Patrick Philip :
Originally posted by @Mohit Asthana:

It's basically the BRRR strategy but on a larger basis.

When I worked for a large apartment owner/operator, they would buy an older apartment (around 20-25 years old) that was outdated and rehab it. In their rehabs, they would put new counters, appliances, cabinets, etc and pool and renovate the leasing office and usually add a gym.  

Once they had the units upgraded, they would increase rents to maximum the market would allow. In my specific apartment complex, we used software that would change the rate daily depending on availability & market rent. We were also asked to push other ancillary services (like fans installed at $10/month) or insurance for an extra $10/month. It was mandatory to have valet trash pickup (an extra $25/month) too, so that boosted the NOI.

After 4-5 years, they would sell the complex or portfolio to another institution and made back the money invested. My former employer was also kept on as the management company for day to day operations. 

 Interesting. My follow-up question would be...

Why would anyone buy it from them? Who would want a fully renovated apartment complex with no room for improvement? Are they relying on selling it to a fool?

 No, the company I worked for sold it to large institutions like pension funds, insurance groups, and private equity funds. They don't want to do the work and would rather buy a stabilized asset (like the portfolio of apartments I worked for) and just reap a nice stable return for their shareholders. 

As other's have stated, typically a large apartment community deal is going to be value add. It's the BRRRR method on a large scale.

We prefer buying stabilized, cash flowing assets that have a value add opportunity to them. We are looking to renovate the interiors and exteriors and raise rents during a 5-7 year hold period. The asset is already cash flowing, if we spend $5,000 per unit rehabbing the property and that nets us an extra $100 a month in rent per unit, that's an additional $1,200 a year, which is a 24% return on that investment in year one. That doesn't factor in the multiplying effect of the cap rate on the value.

Cash flow is nice. In fact, in my opinion, it's your foundation and your safety net that allows you to wait out any market shifts. If that happens, we just stop the renovations and sit and cash flow.

If you buy a 200 unit apartment community for $20 million with a Net Operating Income of $1.1 million a year, it's cap rate is 5.5% (NOI $1.1 million divided by purchase price of $20 million equals 5.5% cap rate).

If you are able to increase the NOI by $100 a month per unit, that's an additional $240,000 in Net Operation Income. Add that to the existing NOI and you get a total NOI of $1.34 million. Divide that by the cap rate of 5.5% and the new value of the apartment community is a little over $24.6 million. You've created an additional $4.6 million in value by spending $1 million in renovations.

Once you've achieved that added value, you can take that to a bank and do a cash out refi which will return a substantial portion of your investor's capital.

It's the value add leveraged by the power of the cap rate that really makes you your money.

Many properties, especially older ones, sell for less than what it takes to build them. You need to look at what it will cost to maintain them versus how much money they bring in.

Yes Patrick the apartments are around 800-900 square feet and the rents very from 2900-4000

It’s potentially the nicer apartment complex in my county

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