All Forum Posts by: Nick B.

@Todd Dexheimer,

For starters, 50% is a rule of thumb and is not even relevant for the most part. Look at the latest NAA survey (https://www.naahq.org/news-publications/units/september-2019/article/2019-naa-survey-operating-income-expenses-rental) that shows highest expense ratio being below 45%.

In addition to that, there is virtually no functional dependence between rents and expenses. I.e. increasing rents by $100 does not automatically mean increasing expenses by $50. The only expense line item that really depends on the rent (and rent growth) is management fee that is calculated as percentage of collected rents.

Expense growth varies by market but most markets are close to or below 2% (some are even negative) according to NAA survey.

Here is a bit of anecdotal evidence from one of the properties I invested in: over 4 years hold period expenses grew 5%, 18%, -20%, resulting in a little over 1% total growth (.25%/year). 

Lastly, we are discussing proforma growth rates and 2% is a plug number that is somewhat close to reality. Real number may vary but still come close to that level on average. That said, I use lower rent growth (sometimes flat) as a way to stress test my proforma.

3% is below real inflation. The methodology was changed in 1990 to make inflation look lower but if you use the same method it is closer to 6% (http://www.shadowstats.com/alt...)

Also, let's put 3% in dollars terms. If the current rent is $700, 3% of that is $21. This is a "nuisance increase" that most people wouldn't be very concerned about. It is definitely not worth moving expenses. 

What prevents you to still use 70/30 split on a 40% IRR project? It is a lot fairer to investors than 30/70

@Todd Dexheimer, what rent growth do you refer to as "aggressive": 3% or $200?

These are two different components of the rent growth. $200 is the initial "below the market" bump that should be achieved on lease renewals or new leases after rehab in the first year. A purest example would be two properties across the street from each other: same age, same unit mix and sizes, but one rents for $900 while another one for $700. This means that $700 property is less attractive and/or the owner is asleep at the wheel. In this case $200 rent increase is just waiting to happen: spend $7K/unit, increase the rent to match the neighbors, and increase the value by $27K/unit (8% cap rate, 10% economic vacancy).

3% is the "organic" (or inflationary) growth starting in the second year of ownership. 

I agree on the affordability though. If the area income only supports $700 rents it makes no sense pushing it to $900. There should also be an "income cushion" for even higher rents. E.g. the minimum income to qualify for $900 rent is $32.4K ($900x12/3). However, I want the median income in the area to be at least $45K for $900 rent to be more affordable. This also helps with future rent increases. 

On the market: population growth 20%+ since 2000, income growth 30%+ since 2000, single family home value growth 40%+ since 2000, down trending crime rate (city-data.com index below 500), unemployment at or below national average, jobs growth of 2-3% annually.

On the property: 16%+ IRR with the following assumptions: 75% LTC, economic vacancy of at least 10%, rent growth 3%, expense growth 2%, property taxes are based on 90% of the purchase price (TX-specific), current rents are $200+ below the market, exit cap rate is above historical average. At least half of the returns have to come from the operations.

Networking beats letterheads all day long in my opinion. Especially if you don't have a track record.

If you know a broker personally and can convince him that you are a capable buyer, he would not have a problem to introduce you to a seller even if you use gmail account :-)

Do you have a definition of a "good deal"? 

There are three types of LLCs most people use:

• personal LLC that is used as an investment entity of a person or family. It is optional
• management LLC that is formed to represent sponsor entity and can be reused in multiple deals. It makes sense if there are multiple sponsors but for a single person it is an overkill.
• single purpose holding LLC that owns real estate. This is a must.

It takes a few days to register an LLC in Texas. Usually holding LLC is formed at the time when LOI is accepted by a seller.

As for LLC being used to build one's credibility - I don't buy into this argument. If you have a track record you don't need an LLC to show it. Likewise, no corporate structure or a fancy letterhead or a website is a substitution for your track record.

Like I said,  the model is almost irrelevant. What matters are assumptions used as inputs. Things like economic vacancy, rent growth, exit cap rates, projected expenses, etc.

A model is just a formula that calculates ROI based on given inputs. It doesn't make a decision for you. You need to know how to assess and verify these inputs. That's the important part, not a fancy spreadsheet.

Proforma doesn't mean much. There is not a single deal out there that performs exactly as underwritten.  It is either better or worse.