All Forum Posts by: Serge S.

Mike hit the nail on the head here. Sure there are opportunities out there but when IRR is 100% driven by rents having to rise and a cooperating market ...

What the savvy investor/syndicator understands is that not all markets are at equal points in the cycle. Astute investors that intimately know a submarket and have been through a cycle in that specific submarket can spot this. The last deal I did was a 128 unit in a submarket where average rents, unit prices, job growth etc were still 25-40% off peak. Now there are reasons for this and not all markets recover but I was in that market already and knew the numbers did not tell the whole story. The seller was a group that operated in a different region and struggled with management and had no other assets in the sumbarket. As such average rents were literally recession era which translates to 1985 rents. They simply were not following the comps and were satisfied with the returns based on their low basis. In less than 12 months of ownership I have raised the rents 3 times and am sitting on a T12 cap rate well over 10%+ year 1 with a cash on cash over 20%. Is that sustainable? Maybe, maybe not but I did not have remodel every unit, double NOI or add $300 in rents per unit. I have a traditional portfolio bank loan 80% LTV 1.3 DSCR going in and 1.5 now. I can decrease rents 10% and operate at 85% occupancy and service my debt. Whats my projected IRR at exit? I have a decent idea but honestly don't care much. Deals like this come along a few times a year and I make sure to be ready. I can still renovate every unit and push rents another $100 and I have the funds in reserve with the bank to do so. Multiple levels of safety. I have neutralized many of the risks associated with a plan that requires huge rent and NOI swings. I've been in the market 10+ years and watch the economic signals carefully. I have flexibility to hold through an adverse cycle. I have been through full value add cycles from purchase to sale and know exactly what happens to inputs such as vacancy, bad debt, concessions, etc when I begin to push rents to the top of market. Safety in cash flow. When I purchase $400k NOI for $4.2M with $500k NOI year 2 and $600k year 3 WITHOUT major unit capex I immune myself to many (not all) market risk.

Now compare this to a typical PHX/Vegas/Denver syndicated deal. Syndicator buys the same $400k NOI for $9M at a 4% cap on a 3 yr balloon bridge loan and a 1:1 DSCR. Justification is that the last owner was an idiot without resources to upgrade units (even though the seller purchased the same asset for $2M just 4 years ago and just made $7M without doing any heavy lifting). Promise is for 15% IRR but its not cash flow driving that number its a "projected" future sale based on a projected cap rate off a projected doubling of NOI. Now how is that possible? Simple he will say. Just spend $1.5M renovating every single unit over 12 months (a laughable timeframe) and boom population growth and gentrification takes care of the rest. This is a great strategy in 2010-2015 when rents were well below historical mean. The bet was continued growth and reverting to equilibrium combined with a low and stable interest rate environment. But for this strategy to work today EVERYTHING must go right. What if that $300 rent bump across 100+ units leads to doubling of the velocity of turnover? What if it doubles bad debt? What if class A gets overbuilt (already happening) ? And how long does it take to address loss to lease recapture? A spreadsheet says one thing but how did your sponsor address these questions and issues with the deals he has successfully repositioned across multiple cycles? If your sponsor was jerking it waiting for prices to fall further during the last recession or just getting his drivers license then maybe its not a good idea to invest $100k in a spreadsheet and a podcast. I'm feeling great watching on the sidelines and I'll be ready to swoop up the foreclosed asset in 2022-2025 when that bridge comes due just as I was ready in 2010.

@David Smith I second @Emilio Ramirez that the learning curve is steep. I am a10 yr multifamily owner and am also looking at hotels. If you know how to look there are deals. I had a 100 unit extended stay under contract recently with SBA financing in place. It was a submarket where I am already in business and own 100+ units. I've underwritten several deals and know owners that are turnaround specialists. There is extreme value add opportunities and many a motivated seller. My deal ultimately did not work out but I am still actively working with brokers and underwriting deals in very specific marketts

@Jonathan Twombly Congrats on your sale. I agree with your sentiment, best case scenario is flatline but a whole lot of scenarios where multifamily gets hurt. Safety and locking in gains, I'm right behind you, slowly liquidating at this end of the cycle. I don't particularly want to be sitting on 500 units in 2021 when Bernie Biden abolishes 1031 exchanges, interest rates are 7% and agency debt requires 65% LTV and investors begin to clamor for 7% cap in markets not in CA or NY. I understand that there is no money to be made waiting on the sidelines and a syndication needs to buy to keep the lights on so its pretty easy to be bullish in that scenario. I am also not in the Robert Kiosaki camp predicting global meltdown for the last 7 years straight! I am just uncomfortable projecting 3/5/10 years out and am even more uncomfortable being tied to A Class rents. Many markets are getting saturated and overbuilt on a promise of never ending rent and population growth. Syndications have never been more popular.

I had a 24 yo kid call me asking for advice on AZ multifamily. His experience consisted of a few flips and he is raising $2.5M to syndicate a 60 unit in PHX after attending a seminar. He had no problem raising money. I know the property well and this deal was a POS in 2014 and an even bigger POS today and I told him so. He closed last week. If your sponsor was in diapers during the last recession or sitting on the sidelines waiting for prices to fall further then please move on to the next. I want someone battle tested and scarred managing my cash not some Putz rolling the dice with my money.

@Shannon Phillips found myself in a similar situation two years back looking at a portfolio of nearly 50 SFR units in a very high equity position. The key metric here is return on equity. If your cash flow is 3% think about how measly your return on equity is. With the SFRs you have very little in the way of tax avoidance, the same cash flow derived from a large multifamily would produce virtually no taxable income through cost segregation and other means. I have been selling and exchanging out of SFR and hope to own none by the end of next year.

@Mike M. 1% rule is very rough BUT can be a very good 1st filter. Underwriting a 10 unit is not so much different than a 50, 100 or 200 unit. 1% gross rents to purchase price is a ghost in just about any growing market today. The tax advantages of rental income are now unmatched and this has made multifamily a preferred investment asset class. What if I was to tell you a deal was buying at .5% gross rents to purchase price combined with a 1:1 debt coverage (meaning all NOI went to pay mortgage) and for that privilege you had to remodel 100 C class units just to sniff 1% and only then hope to resell to the next sucker for .5% again. And I'm not talking about SF or LA I'm talking PHX, Denver, etc. Thats pretty much what a lot of syndication deals are looking like today. I have a lot of difficulty projecting past 3 years right especially in terms of rent growth. Population growth is a given in the short term but so is supply growth. Will incomes keep up? I need safety in cash flow and sustainable debt. Average rents the working class will flee too not only fickle millennials. Downturn becomes a buying opportunity, continued growth additional gravy.

I'm not sure about investing in "legacy assets" but I purchase large multifamily for my own portfolio and can tell you that my underwriting looks very different than a syndication model. Right now the name of the game is safety. DSCR is important on multiple fronts as I am investing for real cash flow and not a projected exit that relies on multiple unknown inputs. I'd like to be closer to 1.5 DSCR 20% minimum CoC by year 2, 8-10% cap by year 2; yes this exits and I've done it.

I'm still underwriting to an exit but an admittedly cloudy one as I do not believe rent growth will outpace inflation indefinitely. We forget that supply always catches demand and particularly in RE over corrects and out supplies demand eventually. I believe we are already in that part of the cycle as value add unremodeled C class sells for $150/sq foot in anticipation of renovated rents at $1.50-$2.00/sqft. Well how long does that last when I can build new A class with unmatched amenities for the same $150/sq foot. Relying on top market rents post renovation means that you are perpetually tied to the gyrations of the A class market. Look hard at A class concessions and the dominoes fall from there. 

Originally posted by @Jay Vance:

I think that @Ben Leybovich brings up a very good point. IRR forces you to focus in on what your ultimate exit strategy will be. But, that's also one of the risks I see some syndicators (especially in low cash-flow, high appreciation markets) falling into because the future is tough to predict. If you are projecting cashing-out at a 4-cap five years from now, your IRR's may look great but your future may be grim.

One question that I don't fully understand is how one should think about IRR when there is no exit strategy, i.e. some of the super high net worth family offices in Manhattan real estate. These guys buy properties and never sell. Obviously you can use terminal value of future cash-flows after a certain point, but I can't see their IRR's being very high. Although I'm a long ways away from being wealthy enough for this to be an issue: how should people who are planning for legacy assets (ones that they'd like to pass down to their children's children) evaluate IRR and deals?

It’s not so much confidence; rather I have projects that have reached the end of the value add cycle. I have Multifamily purchased in 2014 and feel as though the majority of the value add has been achieved. Time to lock in gains and move on. 

I love Multifamily but these valuations In my market Are not sustainable in my opinion. Dropping $1M+ to turnover units over 2 yrs to get a significant rent bump is certainly a tried and true strategy but at this stage of the cycle I believe this to be the riskiest of all strategies. Not all value add has to be done one way. I also think there ate better markets than AZ. 

@Andrew Syrios it’s been quite a run that’s for sure. I was looking back recently at OMs that I had been considering in 2014-2105. I could have purchased any of them and made millions. None of those deals were good enough for me. I’m glad I did get in the game though I’m confident that 2019 is the year to sell rather than buy.

https://www.forbes.com/sites/forbesrealestatecouncil/2019/02/21/multifamily-outlook-and-the-interest-rate-conundrum-in-2019/amp/

Interesting article regarding Multifamily into 2019. Sounds bullish on Sunbelt Multifamily in particular though it feels like this article could have been written in 2006.

@Jay Hinrichs funny article. I’ve been calling BS on the death of home ownership among millennials since it was first a story. For that matter the death of millennial homeowners was supposed to be the driving force on multi family rents growing perpetually. Don’t hear that pitch so much any more. Now it’s more that population will grow perpetually as will rents and therefore its wise to pay a cap rate below interest rate. Just raise rents to where you need to be and poof 4 cap turns into 6. I do think multi family has been an ideal investment for maybe the last 7 years. Past performance is not an indicator of future returns. I am selling all my SFRs acquired over the last 10 years and selling my multi as well. I’m not doom and gloom and don’t think the next recession will be like the last but it will effect commercial real estate and multi family in particular. I’m feeling good being a seller in 2019.