All Forum Posts by: Jonathan Twombly

@Joseph Todd I personally would focus on deep underlying trends like population growth.  Overall, Ohio has poor to negative population growth - except for Columbus, which is still drawing people in.

Columbus also is anchored by state government, large universities, and the businesses that both of those things attract.  In the aftermath of the Great Recession, I tracked the unemployment numbers for many markets around the country, and I noticed that cities that were dominated by government and universities were not hit nearly as bad as those with other core bases for their economies.

I've also noticed a trend on BP for people to be attracted to many markets solely because the high cap rates.  Cap rates are a function of demand, and the demand is affected by the underlying fundamentals.  High cap rates can *sometimes* result from markets with good fundamentals being overlooked.  (South Carolina was like that when I got into the market, which is why I focused there while everyone else was salivating over Texas.) But that is not usually the case.  Usually high cap rates reflect the market's insistence that investors be compensated more for the risk they are taking.

Another error is new investors going to high cap rate markets because they compare those markets to other markets - but they neglect to look at historical cap rates in the markets they are investing in.

If one market is trading at 6% and another is trading at 9% right now, when Market A returns to the historical level of 8%, Market B is not going to stay at 9%.  It's going to return to its historical level of 12% or whatever it was.  Investors need to take this into account in their investment decisions. 

And, even more importantly, in those high cap rate markets, they need to understand what will happen to the jobs when a recession hits.  Movements in cap rates are irrelevant unless you are trying to refinance or sell.  But a spike in unemployment will definitely hit you hard.  You should focus some analytical attention on this factor.

@Jay Hinrichs  Thanks for the thoughts, Jay.  I see the same thing here in New York.  I watched all the brownstones in Brooklyn that were owned by cops and firemen and teachers run up in price so much that ownership skipped right over the lawyers (like me in those days), doctors, and accountants - right to the investment bankers and fund managers.  That is, if you insisted, like I did on living in a nice neighborhood with decent schools.  If you wanted to bank on gentrification in ten years then you could still afford to buy a house.

@MARK F.  It's often said that occupancy rose during the Great Recession, but this is not technically true.  It rose as a result of the Great Recession, after the economy started growing again but when when it still felt to everyone who was not a professional economist that we were in a recession.

The Great Recession involved a massive loss of jobs, and that caused vacancies to spike, as always happens during a recession.  The hit was worse for B/C properties that have more working class tenants, as these were the people who were hit hardest during the recession.  (In contrast, unemployment for workers with college degrees never rose much above 3 percent.)  Wherever there was a high concentration of working-class jobs, occupancies took a big hit.

But this fact is mis-remembered because the recession was also accompanied by a foreclosure crisis.  Millions of people lost their homes during this crisis, but they were not necessarily the same people who lost their jobs, though there was definitely some overlap to be sure.  Many people who had jobs saw their mortgages re-set to levels they could not afford, so they walked away from their homes or stopped paying mortgages and got foreclosed on.

At the same time, many new households were prevented from buying homes by skittish banks, and then by formally higher lending standards.

These two groups of people - employed people who could no longer afford their mortgages and would-be homeowners who were turned down for loans - had no choice but to rent.  So, they flooded into rental housing, causing the historically high occupancies and rent growth that we saw after the Great Recession.

So, when people say that high rental occupancies were *caused* by the Great Recession, they are right.  But when they say rental occupancies rose *during* the Great Recession, they are wrong in most cases.

The example of the Great Recession has been used by a lot of people (myself included at one point) to argue for the fundamental safety and recession-proof nature of apartment buildings, especially B/C properties.  But I am beginning to re-think this point.

I don't think that we are headed for a Great Recession style meltdown again.  But we will have   a normal recession again, which will involve the usual loss of jobs.  However, it won't be accompanied by another foreclosure crisis, which eventually sends people flooding to apartments, because there has not been a home ownership bubble.  Lending standards are significantly tighter and there are many fewer marginal homeowners in possession of homes now.

The Great Recession was more likely an unusual confluence of events that worked to the benefit of rental properties.  And, even then, as I said, there was a spike of vacancy caused by job loss, but this was then filled unusually fast by those who were foreclosed or no longer qualified for mortgages.  Next time, we will see the spike in vacancy, but it won't start to drop until jobs return to the market.  In other words, I think that the economy may not suffer as badly in the next recession, but the MFRE owners could suffer more - because vacancy could take longer to recover.

A look at past recessions, other than the Great Recession, would probably be helpful.  I have not had a chance to look at this data.  If anyone has it, I would love to see it.

JDT

@Ray Hernandez to follow upon what @Chris Grenzig (hey, fellow BK syndicator - we should chat sometime) says, the 50 unit and under deals can also get a bit tricky in terms of staffing.  Our smallest deal is 54 units and we are able to manage it cost-effectively by sharing staff with a larger property nearby.  But, as a standalone, the issue becomes getting good staff for the property.  It's too small for full-time employees, and it is very hard to find high-quality employees who are looking for a part-time job.  Maybe you get some female property managers who have had kids and don't want a full-time position, but it's much harder with maintenance, because high-quality maintenance staff are always in high demand and hardly ever want part-time work.  And you definitely don't want to hire full-time staff for a property that size, because labor costs will eat all your profit.

You need to ask property managers if they manage nearby properties that have some excess capacity and can share labor and get some of the cost off those books.  Sometimes properties around 100 units have the same problem.  It's hard to staff exactly the right number of people, but if you have 100 units near 50 units, you might be able to get into a good sharing arrangement on a maintenance tech with another property managed by the same company.

Hey Jay, how are you?  I don't have a dog in this fight, because I am nowhere near NoCal, and don't ever plan to invest there.  But what do you think of the affordability issue in California?  What I am reading is that people are leaving the state because it's so unaffordable.  (We're having the same problem here in New York.)  Won't this eventually become a problem?  It may be the case that the demand keeps things from tanking. But, at some point, don't you simply run up against people's ability to pay?  Or is there a limitless supply of rich people willing to pay seven figures for a nondescript two-bedroom bungalow that was built as a starter home for blue-collar workers in the 1940s?

I'm not fishing for a particular answer here.  I just find this aspect of markets like SF and NYC mystifying, and I wonder what your thoughts are.

JDT

 Aside from the issues others have identified, the very first thing to do is get your agreement settled with your partner.  What exactly are you agreeing to do and in return for what? What are his duties and expectations.  When partnerships start, most people assume it’s going to be great and don’t plan for disagreements.  But they inevitably come up.  The question is not if your partnership will end but when.  Even if it’s amazingly successful and smooth, one of you will retire or die.  What  then?  You need to get that settled now, before you do any actual business together.  

One of the big problems that BP reveals is that most amateur investors seem to believe that real estate is not a business.  But it is business, the successful people treat it as a business, and if you want to be successful you must too.  

I agree.  Once-in-a -generation corrections usually only happen once in a generation. I think we will get the run-of-the-mill correction this time around.  But the people who rushed in at the end, as always happens, will wish they had not.

The very first thing you want to find out is how extensive the management company's experience is with exactly the kind of property you want them to manage.  And, when I say "exactly," I really mean it.  I have personally been burned by property management companies with insufficient experience managing the kind of asset I owned.  And please note that I said "insufficient experience."  That company had experience with this kind of asset, but it was not focused on that asset type.  I will never make that mistake again.

Second, you want to make sure that any property manager and the person the PM reports to also have *extensive* experience with your asset class.  It's not good enough that the company has experience.  Don't let them train a new manager on your dime.  It will kill you.

Make sure that you have the ability to require the company to replace the manger if he/she is not performing.

Find out what the chain of command is, and what the company does when a property is not performing up to standards.  Who is reviewing the financials before they get to you to make sure that the property is performing the way it should?  And what will happen when it is not?  Who is responsible, and whose feet will be held to the fire?

It's extremely important to understand how the company qualifies tenants.  What are the tenant qualification requirements?  How do they QC applications?  Find out what the bad debt rate is across their portfolio.  If they cannot get you an answer to the question, move on.  If it is higher than 3%, move on.  Find out how they manage bad debt and keep it to a minimum?  Are late paying tenants sent an eviction notice the day their rent is late, or does the company "work with" tenants (in other words, use your money to give people who don't pay a free place to stay for a while)?

Those of us predicting a downturn WILL be right.  No bull market has ever lasted forever.

But, as for timing . . .

?

Here's the problem you may run into.  What is the collateral for the loan?  If it's the property or the shares, you may get blocked by the original lender on the deal, who does not want any other debt on the property.  Or, the first lender may insist that your lender take a "second position," which means that your lender's claim on the property is subject to the first lender's claim.  Most lenders don't want to take a second position, or if they do, they will require a very high interest rate for the loan.  

If you cannot use the property or the shares as collateral, then you will need some other collateral worth $400K so that the lender is secure.