All Forum Posts by: Michael Ealy

We Always buy based on proforma. Everyone from the lender to the buyer is using the proforma, sales comps, rental comps, and true value ad strategy to form their valuation in this market.

Our number one goal is to find true value add with a clear upside. That often means the current cash flow is poor due to various reasons:

Loss to Lease
Vacancy
Poor management
Over-spending on renovation
Not charging fees to residents
etc...

As long as the upside is there and the story is good - we are interested.

I'm with you -there are several "though leaders" saying you buy based on actuals - but it really depends on the market and each case by case situation.

But be careful as to whose pro-forma you're using.

You can't use the broker's pro-forma and definitely not the seller's.

You have to come up with your own analysis and your own pro-forma based on your analysis.

As always "Buyer's beware" and be careful who you listen to.

1 Vote

Originally posted by @Nik Corbaxhi:

@Michael Ealy,Totally agree with your point of running the numbers and anticipating what comes with the investment, rather than what someone else trying to convince you whether a property is worth it or not.

There is also a human side to being a landlord and not everyone is cut for it. Unfortunately, most see it as strictly a business with no feelings involved. As a landlord, one rule that I don't break is being ethical. I always do what is the right thing to do and not cheap out on stuff that needs to be fixed, regardless of the cost. I am not writing this up so other people can read it, but because I truly believe in it, every day. How do I know if it is right or wrong? I quickly put myself on my tenant's shoes and ask myself the question. If a property is not good enough for me and my family to live in, it is definitely not good enough for any of my tenants. So far, in my 6-7 years of dealing with tenants in multiple properties, I am still to have 1 tenant that is not satisfied. My consciousness does not allow me to cut corners for a couple of thousand dollars more in my pocket, knowing that I wronged someone to get it.

That's exactly right Nik.

What you mentioned about being ethical and putting yourself in the tenants' shoes is basically following the GOLDEN RULE: do unto others what you want others to do unto you.

And the golden rule has made me "gold".

I rehab my properties to be at a level higher than the market where it is at. For example, when I buy a building in a "C" area, I renovate it to "B" or even "A" level quality. The tenants were so surprised that three things happen:

1. They are willing to pay a higher rent;

2. They will not leave because all the other buildings look "crap" compared to my building - so my turnover is very low; and

3. The word spread around in the community and I get the best tenants attracted to my properties - increasing my occupancy

All 3 combined made me MILLIONS - hence, the golden rule will make you gold.

2 Votes

Originally posted by @Jay Hinrichs:

Originally posted by @Whitney Hutten:

I can't wait to see this research @Scott Trench! And thank you for finally calling attention to a few other factors that an investor has to consider before investing in a market. Cashflow is just 1 piece of a very large puzzle to determine which market to invest in. In the publication, will you also be drawing attention to how to use the data to evaluate a market? Like examining trends for the past 5 years on factors like asset class (A-D), unemployment, job growth, economic diversity, income growth, housing prices, vacancy rates, rent to price ratios, etc?

Grant Cardone made a post yesterday or his staff did.. but one of the up takes was that some of his all time best buys were not the best cash flow day one.. actually the opposite is what he said.. He said quality matters in the rental business and buying simply for price or cash flow without taking into considerations many other factors that price these properties which is usually for risk..

I agree with you Jay.

As you know, I started with cheap properties in the war zones of Cincinnati.

Although, I made a lot of cashflow on cheap apartment buildings in bad areas, it was a lot of headaches and the cashflow is NOT passive at all. In fact, I was limited to about 100 units under management and it was a full time job. So my biggest cost is OPPORTUNITY COST. I couldn't do anything else.

When I started buying in "B/C" areas and more so in "A" areas, I was able to hire out the Property Management and I can buy more properties producing more cashflow because now it's more PASSIVE.

So cheap is not necessarily good.

4 Votes

Originally posted by @Grant Cardone:

1) Not investing - Not investing in this asset class is the ultimate, biggest mistake you will make with your finances. While it may seem difficult right now, due to limited funds, credit, experience and confidence, you owe it to yourself to figure this out.

Whether you buy deals on your own, or with others, get involved. When done right, apartments can produce passive income for generations and mind boggling returns, without the risks of other investments.

2) Buying Too Small - Anything under 16 units will not produce enough free cash flow to warrant doing the deal. 2 units, 4 units, 6 units, and 8 units are not enough scale to make sense of the deal, unless you are buying to merely flip the property, but now you are speculating not investing.

3) Single-Family Home Rentals - This is an issue because you are dependent upon one tenant. Never invest in one door. Live where there is one door and own where there are many.

NEVER INVEST IN ONE DOOR.

Single-family homes are bad investments for the most part and have proven to be for the last 30 years, earning about 1% per year when adjusted for inflation. Millions of people found this out in 2008 when they lost their homes.

Single-family homes are terrible investments for rental income but they are easy to purchase. Remember, easy to purchase means hard to keep.

4) Using Too Much Debt - Using too much debt will resort in the property being unable to service the debt at some point in the economic cycle. If you can buy it with 95% financing, that means other people can too, and the more people, the fewer barriers to purchase, the less valuable the property will be in the future.

I watched so many real estate guys love everything in 2008 because they over-leveraged and speculated. I only use 50% to 75% debt on my deals. So, if a deal is $50 million, I expect to put down up to $25 million to buy the deal.

This kind of commitment to capital investment excludes a lot of buyers and becomes a built-in barrier to entry. This is what the big guys know that little investors don't and why the bug guys get the great deals and the little guys get the left overs.

This is the simple economics of supply and demand. I now own something most people can't buy which will make this asset more valuable in 5 to 10 years, or more, when I go to sell. Now, that being said, too much money down may mean the product is overpriced.

5) Buying on Price and Cap Rate - If you only buy deals based on the lowest prices or the highest cap rates, you will never get great deals. The great deals always come at a premium price and a lower cap rate. As crazy as it seems, my best deals have been the ones I paid the most for.

The old adage, "Buy low and sell high" is true, until it's not. I have made my best deals, and best returns, on buying high and selling higher.

The lowest price in apartments is not an indication of a great deal. It is an indication that something is wrong. I can buy property at cheaper prices and higher cap rates in suburban Detroit than I can in the Galleria of Houston.

CHEAPER IS NOT BETTER. I HAVE MADE MY BEST DEALS, AND BEST RETURNS, ON BUYING HIGH AND SELLING HIGHER.

I once bought a deal in Austin, paid the asking price, didn't negotiate a penny, and closed quickly. I knew when I bought it someone else would pay me more. I sold the deal for a 115% return in 6 months.

6) Not Using a Broker - Trying to buy the deal without a commercial broker is a pure rookie mistake. The broker is your friend in this game. I use a broker on every deal and prefer to only use the listing broker moving forward/I hope he or she makes a bunch of money.

I recently bought a deal that was not on the market (off - market) and I had a broker in another city represent my offer only because he knew the seller. I paid him $250,000 to do this for me when I could have probably done it for myself. Why?

Because, I need a buffer between me and the seller. We did the deal and I assumed an unbelievable loan of $63 million on 500+ units in the heart of one of America's great cities. 60 yards away is Amazon's office, Whole Foods, Starbucks is walking distance, there are $800,000 townhomes across the street and you have to drive past $2 million homes to get to the property where the average tenant is a professional making five times what they pay in rent. (Income to rent ratio is a very important metric.)

7) Not Looking at Enough Deals - I look at 100 deals to buy one, so unless you are smarter than me or luckier than me, be prepared to look at that many deals.

I have friends who are financially very successful and could buy deals on their own but quickly realize they don't have time to look at enough deals to know the right deal. Because they are successful they have their hands full operating their successful businesses and their families.

To find great deals, you have to be in the market everyday looking at deals, sometimes it takes years before the market is even ready to invest in.

My formula requires we use tremendous discipline and research, looking at some 100+ deals for each one we close.

8) Unable to Move to Other Markets - I have bought in eight different markets. I knew when I started I would only be able to do so much in the one market where I lived.

In the beginning, as a real estate investor you should stay local. But, what if where you live the market sucks or is already overbuilt or even dying? People in Canada for instance, don't have a lot of apartments to buy. There is very little of this stock, so not a lot of trading going on.

People in European countries don't have this asset class to invest in the way we do in America.

Remember, not everyone makes money in real estate because not all markets are good. If you had invested anywhere around Detroit in the last 20 years, you had dead money unless you were in downtown where money recently started being invested; and that play is still up in the air as to whether it will work out or not.

9) Financing - Buying apartments without using debt makes no sense. If it wasn't for the debt, I wouldn't be able to do the big deals max out returns.

On my first deal, I had to go to 3 lenders and the first two told me no. I took "No's" personally, only to find out later these banks didn't lend on apartments and that is why they told me no. But, the banks almost never say, "We aren't lending on apartments at this time." They will give you some other lame reason why they won't do the deal.

You need to know who is lending on deals, and who is not, and you also need to know their underwriting criteria for approving the loan. Understanding debt component is vital to deal-making as it will provide you with the confidence in your financing to give the seller assurance you can close the deal.

I have been borrowing money and creating relationships with the biggest apartment lenders in the world for 30 years. Fannie Mae, Freddie Mac, life insurance companies and banks, all know me now, and assist me understanding and underwriting my deals. They are partners with me in helping me make my deals work. The lender is not an adversary, it's your partner. I did not understand this early on.

IN SUMMARY

Buy apartments. Don't go small. Don't buy the junk, buy the best product in the market place, make sure you have cash flow, and take care of the property and the tenants. When you find that deal, MOVE FAST.

-GC

Well written GC and my experience agrees with you.

I own 1,000 apartment units and 45 single family homes.

My cashflow is great but every year...1-2 of my houses LOSE money. On the other hand, my bigger apartment deals consistently make money and ironically, they have LESS headaches than single family homes.

But on your point about small apartment buildings not making money - well, it's not true all the time though. It depends on the deal. Some of my 4-plex and small apartments are good cashflow machines (although, admittedly, they take up more of my time). It just depends on how well you bought it and if you bought it in the right location.

Lastly, I agree 100% on brokers. In the apartment investing game, having good brokers in your team is a REQUIREMENT to succeed. I am a licensed real estate agent myself but when a broker sends me a deal, I don't take on any commission. I gave my commission away as my way of saying "Thank you" for finding me a deal. I give away $20,000 even $50,000 because I know, the broker will send me an off-market apartment deal that will make me millions.

1 Vote

Originally posted by @Spencer Gray:

I'm not a developer but have assisted in helping individuals get projects developed who don't know where to start.

What does the area need and what is in demand? It might be apartments, it may be retail or office. I would work to put together a study of the highest and best use of the property. Also see how the land is zoned and if it can easily be rezoned if necessary.

Once you have a general conceptual idea I would reach out to the city/town/zoning board to see what are the steps to get the project fully entitled aka legally allowed to build your development.

At anytime, but especially if the land is entitled, I would reach out to several local developers who have experience in the niche you are pursuing. Find one that you like to work with and is qualified. Pursue a joint venture with a developer where your group provides the land and maybe some capital and the developer provides the expertise and possibly capital as well.

Hire a real estate attorney early in the process who can assist in navigation and help provide contacts.

This is just one way to approach it but it's how I would.

Best of luck!

In addition to what Spencer said, one thing you can do is network at your local REIA, local chamber of commerce and network online here on BP and seek out several local developers.

To be honest, you don't have the expertise nor the experience to make this work. So, you need to partner up with experienced developers in your area. As you said, you don't even know the questions to ask.

The experienced developer has the contacts to do the feasibility study to see if this deal makes sense.

He/she can envision how to make it work better than you can.

And backed by his/her credibility, raising capital from banks and private investors become a whole lot easier vs. you doing it by yourself.

For example, last Friday, a "newbie" (he is an experienced apartment investor but he has not done a development project before) showed me 3 buildings in downtown Cincinnati owned by a billionaire. The three buildings were just abandoned because the owner does not really need the money and not taking care of them.

The location is topnotch. And at a bargain price of $4 MILLION, I can come up with a plan to make the 3 buildings worth far more than $4M and that's because an experienced developer has the KNOW-HOW and the KNOW-WHO to make a development deal happen.

4 Votes

Originally posted by @JD Martin:

I can't speak to MFH as I don't own any but on my SFHs I always exceed what the previous owner was getting, sometimes by double. This is typically because the previous owner was unwilling/unable to make any improvements to the property.

I hear you JD.

Too low in repairs and maintenance is a red flag in my book too.

The owner is trying to be cheap and in the long run it's really more expensive. Just yesterday, I inspected a 31-unit building that is 50% occupied. The seller tried to be cheap by doing patch up work on the roof but in the end, the problem only became worse so he lost half the tenants. Also, to keep the other half of the tenants from leaving, his rents are $300/month below market.

Why not solve the problem right, increase the occupancy and increase the rents at the same time?

Now he is selling the building cheap because he tried to be cheap.

1 Vote

Originally posted by @Aaron K.:

@Michael Ealy totally agree especially with the first point in California with prop 13, there a lot of agents who don't understand the implication of the sale when they are listing (or they don't care).

Also there are many times that rents are under market and can be raised, or utilities can be submetered easily.

However to caution the newbies while you might not want to base your decision on actual expenses you certainly don't want to use the seller's pro forma numbers, as those will paint the rosiest of pictures, use your own numbers to evaluate always.

I agree.

The seller's proforma is almost always "junk" and if they can achieve the "rosy" picture they painted, you begin to wonder why they're selling the building in the first place.

The actuals can change and will likely be different.

So the bottomline is that I buy not based on actuals or proforma but what I think I can operate the property for. Let's call that my "actual proforma" (which sounds like an oxymoron but it's basically a projection of what my actual building's financial performance will be).

Thanks for chiming in.

0 Votes

Real estate gurus teach: Only buy rental properties based on actuals (actual net operating income) not based on pro-forma (or projected net operating income).

Although it sounds good and reasonable, after doing this since 1999 and having bought more than 1,000 apartment units, I have NOT bought a property based on the actual income the seller is getting (or has gotten while he/she owns the property) ever!

Here are 2 reasons why:

1. The income and expenses of the property will be different after you buy it vs. what they are today

2. How you operate the building will be different than how the current owner operates it

Here's an example of the first one: the property taxes after you buy it will most likely be different that what it is currently.

For example, I just saw an 88-unit building for sale for $4M with a cap rate of just under 7%. The property taxes is only $17K/yr and when I check the assessed value, it was assessed for $580K. Once you pay $4M for it, the property taxes WILL INCREASE (once it's assessed) to more than $100K!

If you followed the gurus' advice, you just lost over $83K/yr in income - which, at a 7% cap, you overpaid for the property by more than $1.185M. Ouch!

Here's an example of the second one: repairs and maintenance.

I see newbie investors shy away from properties that have high repairs and maintenance. But if the repairs and maintenance is more than $60/month per unit, I can smell a potential opportunity. When I buy the building, I put in the necessary replacement and renovation upfront so that the on-going maintenance goes down to $60/month per unit or even less. In other words, I can operate an apartment building so that my repairs and maintenance is $60/month per unit while the current owner might not be able to do that.

Now keep in mind the $60/month per unit is more for apartment buildings and that's the number I can get my buildings to operate at.

So what about the more experienced landlords - what other examples can you cite where you do NOT buy a rental property based on actuals?

5 Votes

Originally posted by @David Friedman:

Originally posted by @Michael Ealy:

Hi David,

No I have not done that. My question to you is - have you renovated a historic house? If not, I will probably start with a house first or partner up with someone who has done what you want to do.

If I am going to do it, I will find out the specific requirements on how to develop a historic building in your county/town/city. There are things you can't replace. Restoration of historic articles/structures of the building might also costs way more than replacement but it you can't replace, then you will have to eat up the significant cost upcharge.

Utility costs might also be higher than modern, better insulated buildings specially if you get below freezing weather.

Historic buildings might be cheap but renovating them usually cost a LOT higher than the usual buildings. Partner up with someone who is very experienced and has connections with the city & very familiar with historic building renovation/restoration.

Makes sense? Do you have an actual deal lined up?

I do have a deal lined up. $1,050,000 for 26,000 sq. ft. not including the basement space. I’ve never developed or purchased a hotel space before, but I do own several adjacent properties. I own a building on the same block that is 30,000 sq. ft. and we are currently converting the ground floor to retail and upstairs to creative office. The historic building has a parking lot and we could further develop that lot (Zoning allows 100% lot coverage).

I’ve remodeled several historic houses before and I’m confident I can return this property to life. It’s mainly available capital and hotel experience that I am lacking. Maybe we could discuss?

David,

Sounds good and sorry for not responding sooner.

Let's discuss offline if the property is still available. Thanks!

1 Vote

Originally posted by @David James:

So I was having another discussion with a friend of mine yesterday. He is my potential lender and has money to invest but is skiddish about jumping in. I told him that with his backing and my drive, knowledge and willpower we can make a good bit of money. His famous line is "If things go south all you would lose is time and effort, I would lose my total investment!" I told him that its my reputation on the line as an investor and also that we would analyze the properties before jumping in. What else can I say or do to convince him to take the plunge with me???

David,

I understand your lender sentiment. There is a problem then with how you set up your deal.

I set up my deals so that my LENDERS will still make money even if my deals go south.

For example, I set up my deal so that my lender gets a first mortgage lien on the property. Not only that, but I buy my properties with significant discount to value. So worst case scenario, they take the property and sell it at a discount to get their money back.

Here's an example of one of my deals a few years ago:

- Acquisition + renovation + other costs = $423,400

(it's a 48-unit apartment building)

My lender lent me $385,000 at 11% and 2 points. He got a first mortgage lien on the property.

The value of the building once it's financially performing is at least $1.2 MILLION

Worst case scenario, if I screwed it up, he can sell the building in a hurry and get his money back plus more. There is an $800K upside!

But what happened was this:

I turned around and increased the occupancy of the building and reduced its expenses. I sold it 6 years later for $1,695,000 (higher than what I was expecting).

The lender was quite happy and me and my partner got ourselves our first MILLION dollar profit deal.

If you structure your deals so that even in the worst case scenario your lender makes money, you will have no problem borrowing private money!

3 Votes

All Forum Posts by: Michael Ealy

Michael Ealy has started 68 posts and replied 1506 times.

Post: Why You Should NOT Buy Based on Actual Income of the Property

Post: Why You Should NOT Buy Based on Actual Income of the Property

Post: What's the Best Cash Flow Market in the Country?

Post: Mistakes To Avoid When Investing In Apartments

Post: How to evaluate "the deal"

Post: Why You Should NOT Buy Based on Actual Income of the Property

Post: Why You Should NOT Buy Based on Actual Income of the Property

Post: Why You Should NOT Buy Based on Actual Income of the Property

Post: Small Deals Mean Wasting Time & Making Small Money

Post: When a potential lender says "Im taking all the risk!"