All Forum Posts by: Marc C.

We've been blessed with low interest rates, even for commercial properties, for several years now. Right now, http://www.crefcoa.com/apartment-rates-main.html shows apartment rates under 5% for almost all types of loans. Short-term loans are under 4%.

It is NOT a coincidence that cap rates have compressed over the same time. Low interest rates allow for lower monthly payments and therefore higher cash flow (cash-on-cash returns). Brokers and sellers know this, and they have TONS of demand for multifamily, so they therefore charge more for their properties and investors will still be able to earn higher cash returns than they could in most other investments. It's even possible to make a property cash-flow at a 5% cap rate if the LTV isn't too high and the interest rate is low enough.

I read lots of apartment deal sponsor pro-formas. Most of them say "hold time of 5 years." They therefore get financing which has a term of 5 years, meaning they will have to refi or sell at that point. They also typically assume they will be able to sell (or refi) at a lower cap rate than they are buying it at (at least for value-add/turnaround deals). For example, they buy at 8%, turn the property around, and assume it will be worth a 7% cap rate as a result. That calculation almost guarantees appreciation, which results in a high IRR (total property return) over the 5-year hold time.

But what if you have to sell/refi at a HIGHER cap rate in 5 years? Does the deal still make sense on an IRR basis? At the same time, what if interest rates rise to 6.5% in 5 years (not exactly a huge stretch from where they are now)? Will the deal still offer a 10%+ cash-on-cash return? Will there be any appreciation if cap rates rise 1-2 percentage points between now and then?

Higher interest rates and higher cap rates are inevitable, at some poinit...they can't go much lower than they are now. The coastal markets have now topped out on multifamily rents and values. It is likely that condition will spread inland over 2017 and 2018. So the market is softening even BEFORE interest rates rise. What will happen if rates rise 1 percentage point over the next 5 years? 2 points And, God forbid, 3 points? What if 5 years comes and we're in the bottom of the market, due to overbuilding, poor wage growth, etc.?

To be conservative and prepared, I'd like to see investors calculate their selling/refi cap rate 1-1.5 percentage points higher than they bought it at. I'd also like to see folks get 10 year financing rather than 5 year, allowing the investor to wait until times are better if they aren't so great in 5 years. (Yes, the interest rate on the loan will be higher, but if the deal doesn't make sense with 10-year financing rates, it's probably too skinny of a deal to begin with.)

What are YOU projecting for your deals? Are you taking a conservative approach and expecting times to get worse? Or do you think these good times will more or less continue forever?

"I'd be curious to hear more about your thoughts on how using more of your own money makes deals less risky."

Oh, I don't care who's money it is, only that 100% financing is risky. We had a real estate downturn a few years ago: Those who had little equity in their properties suffered the most. Many lost their properties (yes, even in multifamily). 

Nobody asked this obvious question: What is the Debt Coverage Ratio? A bank is going to want to see 1.2-1.25 on the ENTIRE amount borrowed, not just on their own portion of the deal. But even if it's in that range, I don't think there is any bank that is going to finance 75-80% and allow a 2nd mortgage for the rest of the equity. I don't think you'll find a private lender willing to do it either, unless they are newbies unfamiliar with the risks. Why not turn your investors into equity investors instead of debt investors? 

I also worry about refinancing in the future. Does the property still cash flow at say, 6.5% interest at a cap rate 2 points higher than you are projecting now? What if the occupancy rate falls to 85% at that time? If rates rise, the value of properties will decrease so that cash-on-cash returns remain attractive. People seem to forget that cap rates rise with interest rates, driving down property values. Yet most of the projections I see from investors assume selling at a LOWER cap rate than they are buying at (value-add). That's not going to happen. We are not going to see 7 caps in Midwestern markets again after this cycle completes. We have already peaked nationwide. The Trump effect (driving up stock market values, causing declining bond values/rising interest rates), could affect mortgage rates on commercial properties soon...they have already risen nearly 500 bps on residential mortgages. It is time for ALL investors to prepare for a period of rising rates and a peaking market, using more conservative assumptions based on HISTORICAL norms, not the norms of 2011-2015. 

Couple of other issues: How big is the town? What is the competition like nearby? Have you run student housing before? (I see you're from Lawrence, as am I. Hopefully, you have a lot of experience dealing with annual turnover and student housing, since it sounds like this property will function as student housing.) Where can you advertise your vacancies for greatest impact? Can you work a deal with the college to promote it to their students through their student advising offices? Any opportunity for providing furnished "corporate" housing in that market? 

You need a business plan for this investment; I don't think you are there yet. 

Come up with multifamily in KC or near Lawrence and I'd be an investor. (Lawrence's occupancy rate is going to suffer from all the overbuilding, though.) 

I'm not understanding something. Using the 50% rule, your expenses should be around $2000/mo., right? So let's say the net is $2000/mo. and you have a $1600 payment. That's $400/mo. cash flow, x 12 = $4800/year. Divided into $15,000, you're looking at something like a 30% cash on cash return. EXCELLENT. Why do you say there would be "almost zero cashflow?" Are the expenses far higher than 50%? If so, why? 

That said, amortization over 7 years is an unnecessary drag, nonetheless. I have never run into that short of am before. I agree: counter with a longer amortization period; say, 15 years min. But be ready to increase the interest rate as well in order to make it worth it to him. I would counter with 2-3 different options that all would work for you, but let him choose what works for him. 

First off, you need an experienced real estate attorney. Find one NOW. 

When I was an apt. broker, I took about 2 dozen purchase agreements, pulled the best stuff from them and created my own purchase agreement that is neither pro-seller nor pro-buyer. Many buyer and seller attorneys have looked at it since and I incorporated their suggestions. PM me and I'll share a copy. 

As for financing docs, I typically use Fannie Mae instruments, 

https://www.fanniemae.com/multifamily/security-ins...

I figure they get it right, everyone knows their forms, and they are specific to each state. 

The Freddie Mac Small Balance program looks really attractive to me:
http://www.crefcoa.com/apartment-rates-main.html

Listen to the Old Capital podcast...they recently had a Fannie vs. Freddie comparison podcast. They are also big-time apartment financing brokers and they'd be able to answer all your questions. 

"I am being charged 8% of gross rents as a management fee."

Regardless of the water situation, for that large of a building, that sounds high to me unless it includes an on-site person who the PM is paying to be their eyes and ears on the property. Is that what competitors are charging as well? I get quoted 4-6% from managers in my area, not including on-site. Meanwhile, 10% for managing individual house rentals is pretty standard nationwide, it seems. But, as someone else posted, it's ALWAYS negotiable. 

Office, warehouse, and retail are higher-risk plays than multifamily. If your definition of "commercial" includes those, you probably need to do a lot more education on the subject. 

As others have said, having a 10-year due date on a loan is a lot better than 5 years. I'm ONLY looking for these at this point, so I have more options if the cycle looks to be turning (and it is right now). 

For some idea on rates, I like http://www.crefcoa.com/apartment-rates-main.html

Direct mail is working for me in my market, but doesn't work at all in "hot" markets where the brokers are working it harder than investors. For example, one broker in Denver told me his office calls EVERY multifamily owner in Colorado at least once a month. I can't compete with that. 

Getting brokers to take you seriously as a newbie is difficult. Check out:

http://www.valuehoundacademy.com/

for free videos. He pushes the idea that newbies should 1.) Learn the lingo, which takes reading and watching videos, and 2.) Create a "pitch book" to show to prospective lenders, brokers, sellers and investors to clue them in to how serious you are and how well-thought out your business strategy is. He recommends it include a "sample deal" of the type you are looking to buy, perhaps from an old listing. Make sure you store it on the web with a short URL so you can easily include links to it in emails and on direct mail pieces. 

Good luck. Get reading. 

"Seller is offering to owner finance with as little as $40,000 down (which I will use a private lender for @5%), at 5% on a 20 yr amort schedule, with a 5 year balloon."

You're saying this is an all-debt, no-equity deal? Seems really skinny to me, and risky. Can you cash flow at 75% occupancy on an all-debt deal? 

Thanks, Mark! Sounds like exactly what I was thinking. I PM'ed you and look forward to seeing it.