If you remember, a few weeks ago I wrote an article entitled The 3 Types of Buyers of Multi-family Buyers: Idiots, Jerks, and Me, in which I explored the underlying issue of why it is so hard to find a deal in this space that makes a damn bit of sense.
Finding a syndicatable opportunity is truly akin to finding a needle in a haystack…
The main problem with finance and acquisition of income-producing real estate is underwriting of financials – process by which we assess income and expense structures of an asset in order to back into the valuation.
The underwriting process is a difficult thing indeed, specifically in large syndication-level opportunities.
The reason I would not typically “classify” as syndication-level any asset comprised of fewer that 100 revenue streams is because anything, put very simply, it’s difficult to manage small properties because there’s not enough money to facilitate payroll for the right caliber/number of personnel.
As you know, or should know, management is the absolute key to success in real estate, and good management systems, run by good people, with good folks on the ground to execute costs money – more money than what’s available in a 60-unit.
Well – looking at the P&L of a six-plex is one thing, but looking at the P&L of an 165-unit community is something entirely different.
Why – because the level of meaning which needs to be extrapolated from the numbers and the magnitude of assumptions one has to make require a level of fluency which is uncommon – most investors do not have it! And the reason most people lack this perspective is because it is a function of the images in one’s rear view mirror…
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Case and Point
In an earlier article I had mentioned that I was considering an acquisition of and180-unit.
I had underwritten the opportunity and had made several trips to the property, one of which was with a property manager (you know – the guy at the top of a company that manages 5,000 units in the area – a property manager, not to be confused with a mom and pop rep).
I was days away from submitting an LOI. This will have been a multi-million dollar acquisition and my underwriting was about $600,000 apart with what the seller wanted. Close enough – I figured we’d meet in the middle some place and that will have been good enough…
However, knowing that proper due-diligence in a deal of this magnitude is a multi-thousand dollar proposition (between engineer’s reports, environmental, and management company audit of physical premises, lease, and contracts), I was busy looking into things preliminarily as much as I could.
This was a good thing, because as I kept digging unfortunately it became apparent that some of the assumptions I had made in my underwriting relative to operations of the building were off by a slight margin. But, what is a slight margin spread over 180 units and capitalized at 9% – $1,000,000!
Without going into great detail, I was off by an average of $40/door in my assumptions of EGI. EGI stands for Effective Gross Income, which is Gross Income discounted for Loss to Lease, None-circulation Units, etc.
Effectively, this little miss-assumption took a million bucks out of the deal, and therefore took a million bucks out of my strike price – who remembers the formula for Capitalized Value:
Value = Income / CAP Rate
Income = $40 x 180 x 12 = $86,400
Value = 86,400 / .09 = $960,000
Yep – I had to discount this purchase by $960,000. I communicated this to the broker who, by the way, is absolutely top shelf in my opinion. In the world of idiot brokers running around with pro-formas that aren’t good enough to pass for toilet paper, these guys really are impressive… His answer to me was – I can not argue with you Ben, but this early in the marketing process the seller will not respond.
Crap – there goes the deal…
Are You Ready For This?
You better sit down for this.
Do you remember an article I wrote a few weeks ago titled The 3 Types of Multi-family Buyers: Idiots, Jerks, and Me, in which I described to you, eloquently as ever if I may say so myself, exactly why it is so hard to find a deal that makes any sense – remember?
Well – what’s a broker’s job? Yep – in short, to find an idiot or a jerk that will pay way more than the thing is worth. So, a couple of days ago I called to follow up and get a little guidance as to where this deal stood, and the broker says to me – Ben, I think that we are going to reach our guidance of $3,600,000; there are a couple of groups in the running…
Idiots or Jerks – what do you think guys? These people are in the running to pay $1,000,000 more than I would or than it’s worth! So – idiots or jerks?
This Is The Best Part:
So I say to him – That’s great! Do you have anything else in the works that would be of interest for me? To which he answers – we are a couple of months off on this, but we are working up 3 foreclosures for Fannie Mae…
Hahahaha!!! I hope the irony of this hits you in the nose as hard as it did me. Why is it that there are foreclosures in the multi-family space? Could it be that it’s because idiots pay too much and jerks don’t even care how much they pay.
I think in a few years I may get another run at this 180-unit…buy it from the bank this time!
As my partner loves to say: Being good does not help us get good deals, but it does help us stay out of the bad ones!
Have you ever had experience with people like this?
Be sure to leave your comments below!