All Forum Posts by: David Monroe

Please Click Here for the update from the IRS on the first round of guidance that was released on the QOF's. One thing I want to clarify is that you qualify a fund by self certifying on IRS form 8996.

You can invest in a QOF if you're not using capital gain funds, you don't the tax benefit the other investors get. You get a 10% step up in basis if you hold the property for 5 years and you get an additional 5% step up after 7 years. 

In 10 years the original deferred capital gain must be paid. When the property sells after 10 years, the remaining capital gains on the money invested is stepped up 100%, giving you no capital gains on sale.

The Urban Land Institute published a great book called Multifamily Housing Development Handbook. You can search for it on Amazon and it's available in Kindle.

You have to do what you feel is right and what your partner agrees to. If I'm doing the deal and put in 20% equity then I only expect a 20% return. You can put in fees such as an acquisition fee, and even roll into the deal for a larger percentage. Acquisition fees can run from 1 to 5%. As you mentioned you can have a management fee. I would be careful with this if your going to have a property management company running the property, you can expense yourself into a negative cash flow situation. There's also rehab management fees and asset management fees.

I would ask an attorney before charging or trying to take any fees because blue sky laws in your state may preclude some or all of them.

I assume PI is Principal/Interest. As mentioned above the property can operate without financing so this is not included in your operating expenses. At the end of the year when you do your taxes your interest will come back into play but is calculated outside of the OE.

A couple of more items to take into account are:

Landscaping

Trash Removal

Termite and Pest Control

Fire and Safety Inspections (Fire Extinguishers and Smoke Detectors)

Supplies (Office and Maintenance)

Never assume a vacancy rate. You can find out what the market rate is from many sources; Broker, Appraiser, Property Managers, REIS Reports and Costar.

I would not assume the debt service coverage ratio, DSCR. If you're purchasing 5 or more units contact some local lenders and ask what they require. You will more than likely hear something like, "1.2 DSCR or 75%LTV, whichever is lower." If you don't know how to calculate any of this contact me and I can help you.

@Henri Meli

It does not matter how long the LLC has been setup. Seasoned investors will go under contract with their own name and when they get close to getting funding and closing will setup the LLC and assign the contract to the new LLC. It's not wise to create a single member LLC. You're much better off having an LLC with at least 2 members, even if one is your wife, for tax purposes. A single member LLC is no differently than if your an individual and provides very little protection - Consult an attorney and CPA regarding LLC formation.

When working with lenders it will matter if you do not have any multifamily experience. If you're going it alone and can't use a partners experience then start small, we all start somewhere, and gain their trust. Managing single family is nothing like apartments, and the banks know it. The more you're prepared, see my message above, the better your chances of getting approved.

Bad areas have their challenges but there are ways to invest properly and and you can even improve the property and the tenants in the property if operated properly.

Management is the number one factor. Typically, especially in my market, managers that work low income properties or properties in challenged areas will not give much attention to your asset. They're in it strictly for the fees. It's imperative that you manage the property management company and make sure your using a firm that's experienced with the type of tenants in the property.

Most properties in these areas have Section 8 tenants. This can be good and bad. There's a rumor that you can't evict a Section 8, that's not true. And when you fill the unit with a new lease you scrutinize the tenant with a credit and background check just as you would with a market rent property. AGAIN this is dependent on the property management company you hire.

You have to be very careful to look at the financials closely. If you have a HUD contract attached to the debt on the property and it's rent restricted, then you have no control over rent increases and in the long term as expenses increase you will be stuck with a negative cash flow situation. Allot of investors combat this situation by getting low income tax credits, but they are very difficult to get.

My experience is that when a lease expires they typically renew because the government is paying for most of their rent. If you have a vacancy it's because you had to evict someone and they do not leave quietly. Your make ready expenses will be through the roof repairing the units when you have to turn one. The solution is screen your tenants properly.

I like properties that have low income tenants in them now and have no HUD contract or previous tax credits attached to the debt. This allows me to acquire the property at a lower price point and either do a complete reposition, if the area will support it, or just improve the units sightly to get a better quality tenant and increase the cash flow with rent increases and lower the expenses with lower maintenance costs.

David Monroe

Despite what most "Gurus" will tell you smaller commercial properties will require you to guarantee the loan and not just look a the property performance. If you have a partnership, they will look at all parties for security. For properties more than 20 years old it will be very tough to get a 25 to 30 year amortization. Due to the age of the property they typically will only do 15-20 years and sometimes will expect a a 5, 7, or 10 year balloon. You can expect a 75% loan to value or 1.2 debt service coverage ratio, whichever is less and this depends on your experience and creditworthiness. The Interest rate will also be tied to experience and creditworthiness.

The lender will want to see last 3 years of property performance in the form of profit and loss statements or Schedule C tax returns if the sellers are an entity or Schedule E if they're an individual. They will ask for a current rent roll and will want to see all the leases. They will also want the last 3 years of tax returns from you and your partners. If the property is valued less than $5,000,000 then you can expect the loan to be recourse. Non recourse loans are typically reserved for properties over $5MM in value.

They will want to see an executive summary that explains how you will acquire, operate and eventually sell the property. This should also include a financial cash flow analysis for the period you expect to hold the property. They will want the Articles of Organization if you're going to create an LLC and they will want to know if you're going to use a professional property management company.

The lender is going to ask for a survey, title insurance and a termite report with at least a one year bond. If the property is older than 1978 they will require a lead based paint disclosure. If the property is in a coastal county or in tornado alley, they will require a wind binder on your insurance policy and if your in an earthquake zone they will require an earthquake binder.

You will want to target community banks. Credit unions typically will not lend to commercial properties. Depending on your strength as borrower and the strength of the property and your executive summary try and negotiate a good rate, less than 5% and not pay any points. Lenders will compete for your business.

David Monroe

The questions I would ask to come to a conclusion would be:

• Does the property have all the highest amenities in the market that new properties have, such as, resort style pool, clubhouse or social setting, top of the line gym, dog park, car wash area, walking trails, free common area wifi, coffee shop, garages, etc...?
• Do the units have washers and dryers, granite counters, stainless appliances, open floorplan, and a master bathroom and common bathroom for 2 bedroom units and above, walkin closets in every bedroom and tile baths and showers, not surrounds?
• Are the rents in the top of the market, typically more than a dollar per square foot?
• Are there any properties that have been built in the last 5 years and is this property absolutely comparable?

If the answers to the above questions are yes, then I would classify it as a Class A property, no matter what market it's in or how old it is.

David Monroe

So I'm seeing in this community some kind of 1 to 2% rule. My guess is that it's some kind of SWAG formula that someone in the community has come up with. Can someone help describe what this is?

@Henri Meli You definitely want to know what the economic conditions are for the area before you purchase a multifamily asset. You want to know if there are new jobs coming in and no layoffs scheduled. The jobs need to come from companies that bring money from out of the market so the money flows into the market. You can find the information about jobs at the local chamber of commerce and they will be glad to help you.

You also need to know what the trends in the demographics for the submarket are doing. Is the population growing or shrinking? Will new jobs bring more population? Is the median household income in that submarket strong enough to support rent increases? What is the vacancy and absorption look like over the last 12 months?

Some of the local information you need to know is if the property complies with current zoning and if the all the utilities are separated. In the 70's it was typical to have only one water tap due the fees associated with separating it per unit. What are the property taxes and how does the local government assess the property when it sells? How much is the insurance cost per door?

Your best source for all this all of this data is to build a relationship with the local multifamily expert in that market, preferably a CCIM or CCIM Candidate. If you want to go it alone then you will need to contact the local zoning commission, tax assessors office and chamber of commerce. You can get the local demographics from the Bureau of Labor Statistics and US Census websites.

David Monroe

@Mark Mosch

That was a great reply and very informative. I noticed in your post that your paying a $500 leasing fee for new tenants. Are there any incentives for tenant retention or penalties for not renewing a certain number leases? If not this is an incentive for them not to retain the existing tenant. Always remember management agreements are negotiable, and if they're not willing to agree to certain concessions then maybe they aren't the right management company.