Note: I will expand and keep refining this post on a periodic basis so it's up to date
1) Low Income and Bad Demographics Mix
2) High Crime
3) Rent Roll Occupancy and Physical Occupancy don't match
4) Income in T12 and Actual Bank statements don't match
5) Flat Roofs
6) Window ACs or lack of Central HVAC
7) Wood construction issues like wood rot, decks not in good condition, WDO (Wood Destroying Organisms), Termite Damage, Stucco/ Siding issues. Overall be really careful with old wood construction. Prefer concrete block or masonry structures.
8) Water Damage inside units (Use Infrared Cameras to find out during unit walks)
9) Foundation Issues
10) Polybutylene Piping
11) Cast Iron Sewer Lines
12) Water leaks (See Pattern of water bills from past few months/ years)
13) Old Electrical Panels
14) Ignoring age of Water Heaters/ HVAC's/ Roofs while computing CapEx
15) Radon Gas
16) Retaining Walls
17) Water Intrusion
20) Asbestos and Lead Based Paint
21) Gutters, Down sprouts
22) Tree Trimming
23) They just fill in with people by giving concessions before selling. Tenants are not vetted properly and bad quality. See if there are many leases in last 3 months.
24) Always ask for seller story (We passed on several deals just because the story is not right)
25) Get Insurance Loss Runs to see any recent claims
26) Never assume existing LLC - Always do new entity
27) Go to FEMA website and verify if the property is in Flood Zone
28) Self direct IRA investments take time. So work on them first and get funds 2 weeks before closing
CBRE Research did an extensive study on Short Term Rentals and it's impact on traditional Hotels. Also, STR is also getting into MultiFamily space as apartment owners are experimenting by renting 5 to 10% of the units to STR's and getting their NOI maximized ! So lets get into some things in this space and also how Zovest is trying to capture this phenomenon in MF.
1) Why guests chose Short Term Rentals (STRs)
The main reasons guests chose STR vs Hotels is, the home feeling, kitchen, family setting, experience meeting new people and main factor is price.
2) Not just Airbnb
First STR doesn't mean only Airbnb. There are so many other providers like VRBO, Home Away, Flipkey, Trip Advisor and also traditional corporate housing.
3) Know the local laws
Laws are changing every year regarding the STR industry. It will be really difficult for operators of the STR if they only rely on STR income and underwrite the deals. What if the law changes against you and you will be in huge trouble with your money.
Here is the grading that's given by Airdna and Roomscore on the markets that are best and worst in running STRs. But you need to keep upkeep on how legislature is changing. Like what happened to Newark, NJ Airbnb law that the city is trying to pass. All those people who bought the properties with high prices assuming that they can make a killing in STR are really worried.
“We don’t make enough money to pay double insurance and to pay extra taxes. We don’t make that kind of money,” said Airbnb host Deborah King. “It’s going to hit us hard.”
4) Exponential Growth and eating Hotel Lunch
CBRE Research estimated STR's are eating 12% of Branded hotel lunch. This is huge. STR's grown 500% in last 7 years !
5) Types of properties
There are different types of properties that you can do STR like Entire House, Entire Apartments, Private Room, Shared Room etc. The most popular is entire house or apartments.
6) STR and MultiFamily
Doing STR in some of the units in MultiFamily is highly lucrative proposition that lot of operators are doing these days. For that
See the STR Market penetration.
Zovest is already experimenting Airbnb and STR in our Cleveland Apartment Properties and we will expand to other markets and also we will build new product and carve-out few units for STR to maximize NOI.
Please reach out to me for further questions.
Everyone wants to do value-add deals in Multi-Family. In my opinion these are 3 types of value-add in Multi-Family or Commercial Real Estate in general.
1) Cookie cutter value-add
This is the most common one where there is some deferred maintenance but mostly interior unit renovations that lot of the times proven by the seller. The reason lot of people get into this because of the predictability of the deal. In this climate of low interest rates, so much capital chasing deals and extended economic expansion cycle, lot of people wants to do typical and safe value-add. These deals getting skinnier day by day. The cap rate are compressing, people are overpaying and it usually end up as very thin deal unless its executed perfectly. There is no margin of error in these deals. That's why sponsors are taking 15%, 18% and giving most to investors as deals are not penciling out.
2) Deep value-add
Properties that are not renovated for so long time, high mismanagement, high vacancy, lot of down units, huge deferred maintenance like roofs are bad, sewer lines to be replaced, foundation issues etc where there is a lot of meat on the bone/ reward but at same time it's high risk. In most of the cases, people take bridge loans, refinance cash-out and move to long term loan. In this process they can return lot of their initial capital to investors and still keep them in deal for long term but with lower ownership for investors.
3) New construction
New construction is really big value-add where you are developing from raw land to great product. Its high risk but high reward to investors and sponsorship team alike. There are lot of unknows and risk but with right structuring lot of risks can be mitigated to investors. And when you are there in all the phases of rezoning, horizontal development and vertical development, sell or lease up and manage the property you will be adding most value and pass on the value to investors.
For Zovest #1 is bread and butter, but we are mostly going towards #2 and #3 these days. Please reach out to me at firstname.lastname@example.org for further questions, comments, feedback and ideas on what kind of value-add you typically execute or like to invest.
Have a great year ahead!
A typical syndicated deal for an Apartment is for a specific property. We as sponsors, identify a property (or even multiple properties) and get it under contract, do inspection, get financing and then once all the risks are removed, we raise funds from investors to close the deal and give distributions, add-value and sell at appropriate time and exit the syndication.
It's a lot of work involved and so many moving parts. Instead, we can even create a fund structure which is a blind pool, where sponsors can buy, renovate, sell properties on a periodic basis. This will help sponsors to focus on assets and not to worry too much about how to get the equity money to purchase assets.
Lot of people shy away from the fund structure as investors cannot pick and choose markets/ properties to invest on.
Zovest will be launching real estate fund which will largely focus on Small to Medium MultiFamily (30 to 70 units) which are ignored by large REIT's, Syndicators, Pension Funds and really a lot of work to buy, rehab, either keep for really long term or sell.
If you have suggestions or interest in funds, please reach out to me at email@example.com.
Last month we discussed about different loan products to acquire MultiFamily Apartments which constitutes 80%+ of the volume. There are FHA (Federal Housing Administration) loans done by HUD (Department of Housing and Urban Development) Apartments Loans which have completely different set of loan terms which are not compared to any loan products out there. For example you can get up to 40 years amortization and 40 year loan term on a loan which is virtually unheard of in typical mortgage markets. If you are doing a substantial redevelopment or a brand new construction or a typical cookie cutter value-add apartment you can tap in to HUD loans. But caution, these loans are not for every one. These loans will take anywhere between 9 to 12 months and its a long and painful process. But if you get one you will be really pleased with the terms. Lets dig in more.
1) FHA/ HUD 221(d)(4) - New Construction and Substantial Rehabilitation of Apartments
Substantial Rehabilitation Definition:
Construction work on an existing facility is generally considered “substantial rehab” when more than $35,000 per unit in work is being completed, or two or more major building systems (plumbing, electrical, mechanical, building envelope, structural) are being replaced. The latter is determined as part of initial due diligence.
In this scenario of new apartment construction or substantial rehab projects which have more than 35k per door work, you can qualify for 40 year loan term, 40 year fixed, 40 year amortized, 85% to 90% LTC (Loan to Cost), Non-recourse loan. This is extra-ordinary leverage that you cannot get anywhere in the world. Construction Interest is also capitalized in the mortgage. The permanent 40 year fixed rate term and loan amortization does not start until
construction completion. The interest rate is locked prior to closing. (Current rates are low to mid 3% !!). HUD Loans are always assumable.
Zovest Properties is working with our HUD Lending partners and we will be using this program in near future.
Caution: These loans take anywhere between 250 to 350 days (Close to an year) and these are expensive loans.
2) FHA/ HUD 223(f) financing for typical cookie cutter value-add Apartments
You can use this program to get typical value-add Apartments as well. Since the loan process takes so long, people opt for Bridge-to-HUD programs where they take bridge loan first and then exit to HUD in 12 to 18 months to hold for really long term.
This program has upto 35 years term, upto 35 years amortization, fixed rate, 85% to 90% LTV, Non-recourse, assumable. Cash-out is also available upto 80% LTV. You can get upto 35k per door in rehab money as well included into the loan.
Caution: These loans take anywhere between 250 to 350 days (Close to an year) and these are expensive loans.
There are other creative ways to get 100% financing using HUD and LIHTC (Low Income Housing Tax Credits) Tax credits if you build affordable housing as per AMI (Average Median Income) rules.
Also, HUD has really good green program (energy efficient building construction) which will provide you another 30 to 40 basis points reduction in interest rate.
Please reach out to me at firstname.lastname@example.org so i can refer you really good providers for FHA/ HUD programs.
There are different loan products and also creative financing options to acquire Multi-Family Apartments. Lets go through these so as a investor you will understand what type of deals you are investing in. Every lending option will have its own pros and cons. Also these are only few popular options listed here.
1) GSE (Government-Sponsored Enterprise) loans like Freddie Mac and Fannie Mae:
Freddie Mac and Fannie Mae (indirectly using their Delegated Underwriting & Services, DUS Lenders) lends to large amounts of Multi-Family Apartment Deals in the nation. These are typically non-recourse (not personally liable in case of default except for fraud and mis-representations aka bad boy carve-outs) loans with 30 years amortization, 5 to 12 year term, 1 to 6 year interest only. Loan-To-Value is around 65% to 80%. There are some options like full term interest only for 65% LTV. Interest rates are based out of 10-year treasury rate.
GSE is only offered for stabilized properties. The property should have minimum of 90% occupancy in the last 90 days. Sponsors have to meet net-worth equivalent to loan amount and liquidity of 9 months of interest+principle.
Loan amount has to be $1 M or above.
These are extremely popular loans and in some years they exceed their quota of $100 billion per each agency much before the end of the year.
There are 2 prepayment penalties Step-Down or Yield Maintenance. For example, for a 5 year loan, the Step-Down penalty to prepay the loan is 5% for first year, 4% for second year, 3% for third year, 2% for fourth year and 1% for fifth year. For Yield Maintenance, it's super expensive to prepay the loan as its almost you are married to the loan until the expiry. Unless the treasuries go really up where the lender can lend the money with higher interest, the person who took yield maintenance is on the hook to keep the mortgage till the end of the maturity date. If you have even 10% probability of selling the asset within few years of taking the loan, better opt for Step-Down penalty option. Make sure you invest in deals which you understand the prepayment penalty of that loan.
2) Commercial Bank Loans
In case occupancy doesn't meet strict GSE's criteria or loan amount is too small or if you don't want to go through the process of Fannie or Freddie you can approach a local commercial bank who can lend on the Multi-Family property. Sometimes lot of investors have relationships with a local bank that they never get loans from Fannie or Freddie at all.
Usually commercial banks have 10 to 25 years amortization which will reduce the cash-flow but you will be paying less interest and also paying off the loan much faster. Lot of investors who only look for wealth building and do not require cash-flow also approach local banks.
These are usually recourse loans but for lower LTV they do provide non-recourse loans.
Usually the guidelines are not that strict as Fannie or Freddie and also faster processing based on relationship. Interest rates tend to be higher than Fannie or Freddie loans.
3) CMBS (Commercial Mortgage-Backed Securities) Loans aka Conduit Loans
These are knows as wall street loans where the loans are converted to trusts and sold to investors as packages. This is really great alternative to Fannie or Freddie loans. Where you can still get 30 year amortization, lower interest rates and non-recourse loan. LTV is capped at 75% and prepayment penalty is only Yield Maintenance or Defeasance. So you are on the hook to keep the loan more time.
The advantage of CMBS loans is their rules are little lenient than Fannie or Freddie. Also their spreads on the treasury are not that high as Fannie or Freddie, so you can get better rates.
Minumum is $2 Million loan amount.
4) Mezzanine Debt
In conjunction with CMBS Loan or other loan products, the sponsors can get Mezzanine Debt which is a hybrid of debt and equity. Lot of Loan products like Freddie or Fannie or CMBS doesn't allow second mortgage. So Mezzanine debt can fill the gap by providing ability to convert debt to equity shares in the deal so in case of default the Mezzanine Lender is still protected and even sometimes they get preferred returns than the actual equity investors. This is really lucrative at the same time risky for the sponsors. And also passive investors need to carefully vet the deal if there is a Mezzanine Debt in the deal. This loan can the LTV to 90% of the purchase price.
5) Bridge Loans
These are pretty good loans for some scenarios where occupancy is really low, lot of deferred maintenance on the property, very high rehab costs, current rents or income is really low etc. These are extremely popular but at same time this is really misused to make a deal work in some cases.
You can get 80% of purchase price + 100% of rehab costs as a loan so total Loan-To-Cost is sometimes up to 86% to 90%. The term usually are 3 years with 2 year extensions. Usually non-recourse but lot of times they are recourse as well, especially on smaller loans. This product is really good for heavy or deep value-add deals where you can cash-out almost all of your money and keep the property for perpetuity if you execute the project as per the plan. If things go bad these loans become extremely risky and one end up losing all their money.
Larger deals are better for Bridge loan. The origination fee and other costs add up a lot. Bridge loans are really expensive.
Interest rates are usually 250 to 500 bps (basis points) above 1-month LIBOR.
6) Private/ Hard money loans
Sometimes on smaller deals, people do cash-close by getting private/ hard money loans and then refinance with long term loans. You need to be extremely careful as most of the hard money loans are recourse and interest rates are between 7% to 12% with usually high origination fee.
Will post about FHA, HUD and SBA loans in future blog post.
Please reach out to me for more info on any loans or i can refer you to few service providers i know that can help understand multiple options.
We mostly buy existing MultiFamily apartments here at Zovest. We are exploring avenues to do new development of MultiFamily in markets where the cap-rates shrunk so much that prices of 1960's to 1980's properties have skyrocketed, that it makes sense to do new construction instead of renovating old ones.
We are going through a process of new development in couple of markets and this is what we learn till now. 30,000 feet overview of phases.
1) Identifying the Raw Land which can be non-residential/ non-commercial
2) Entitling/ Rezoning the land to do residential/ commercial medium to high density
3) Going horizontal by grading the land, laying roads and adding utilities like electricity
4) Going vertical by constructing the building
Phase 1) Identifying the Raw Land which can be non-residential/ non-commercial
The first step to pursue new development/ construction is to select the markets/ sub-markets/ neighborhoods. Please refer to our earlier blogs to identify them. Other than that, you also need to find out the absorption rate which tells you how many new units are getting absorbed (rented) into the market with existing inventory. If absorption rate is low it will be difficult for the new units you are building to be rented. Typically if population in that market is growing more than double the national average, then it make sense to build in that market as a long term strategy.
Once you identify that location, we have to find any raw land which might be zoned non-residential or non-commercial or residential low density housing (low number of dwelling units per acre). For example, we are looking a land which is zoned a single family home for each 10,000 sq ft of land. This is really low density.
Phase 2) Entitling/ Rezoning the land to do residential/ commercial medium to high density
Once you find that raw land from #1 above, you need to go to city/ planning commission to apply for rezoning or entitling the land to make it medium to higher density. First, you need to identify if the land is suitable for development, make sure any environmental issues or grading issues that prevents new development. Second, you need to setup a neighborhood meeting to take their concerns of a new development. Third, submit an application with city to request for rezoning to medium to higher density or ask for commercial from residential or other ways of rezoning based on requirement.
Phase 3) Going horizontal by grading the land, laying roads and adding utilities
Once the land is rezoned then we have to grade the land to make sure the land is flat for development by removing all high and low spots, lay the roads based on site plan, add utility connections like electricity, water and sewer lines, make the land pad ready so we can do actual construction of buildings.
Phase 4) Going vertical by constructing the building
Since each building pads are ready, we can start constructing each building or construct multiple buildings at a time. Usually there will be phased approach so homes/ buildings can be constructed to sell or rent in a timely manner. This will help in not waiting till end of completion of the project to start selling/ renting.
Zovest will be doing new developments in future. Please reach to me at email@example.com to know more about the phases of development.
There are 2 types of renters. Those cannot afford to buy home and its their necessity to rent a house or condo or apartment or mobile home park. Other type is who can easily afford a home but their choice is to rent due to several factors like mobility, single and haven't formed household yet, don't want to deal with home owner issues, make it as an expense etc. We will dig deep into each category of renters and how to analyze them as an investment/ operator perspective.
Renters by Necessity:
1) Mostly working professionals. Gray collar house holds such as policemen, fire fighters, teachers, people working in government. They look for reasonable amenities, good location, good schools, transportation facilities. (B, B- class properties come under this category)
2) Another segment for Renters by Necessity are blue collar workforce, who look for lower rents who primarily go after older assets and may be fewer amenities. (C-, C, C+ properties come under this category)
The reason for renters in this category are due to not adequate credit score, not much saved for down payment, single income households, just started family, affordability etc.
There is another segment in renters by necessity which are in affordable housing, where their income is lower than AMI (average median income) in that area and depend on subsidized housing.
Renters by Choice (Lifestyle):
1) Working professionals, lifestyle renters, high income earners, DINK (Double Income No Kids) households who require high end finishes like in condos with more amenities to fit the social experience, common areas etc. (B+, A- properties come under this category)
2) Renters who command resort style living and amenities, exceptional details, luxury single family home level quality. They can easily afford homes but chose not to buy due to several reasons like lifestyle, don't want to deal with owning a home, mobility, rental expenses paid by company, proximity to really good location etc. (A, A+ properties come under this category)
We as a value-add syndicator wants to be in Renters by necessity space but only in higher class like C+, B. We also look into renters by choice in B+ space only if the rents are really low, if there is a possibility to add more amenities and increase the level of interiors to say Gold level package.
Overall rent growth is higher in renters by necessity segment from past few years. Some graphs for our analytical readers:
1) Find the number of Class A vs B/C apartment units in the market over time.
2) Renters and their income scale.
3) Renters and their households.
Sources: Yardi Matrix, Zillow, US Census, Harvard Renter Study
Interested to learn about MultiFamily Investments, please setup a quick call to go over your investment strategies.
Last two month we saw how we select our markets and sub-markets. This is last part of the series where we list all aspects of how we select our properties.
Note: The information is provided only for education purpose only. Don't make any purchasing/ investment decisions based on the blog or any content in this website. Please consult professionals in every area before proceeding.
1) Property Characteristics like Year of construction, Roofs (Pitched or Flat), Type of construction (Concrete Block or Brick or Wood Frame), Exterior Deferred Maintenance
2) Location/ Area Characteristics like School District Ratings, Crime in the area, Proximity to Major Retail, Vehicles per day (VPD), Single Family Home Prices nearby, Median Income in the census block, Demographics mix in the census block
3) Number of Units
4) Unit Mix
5) Number of Renovated vs Classic units and Rent Difference
6) Rent Roll, move-ins and Occupancy History
8) FEMA Flood Zone
9) Rental and Sales Comps
10) Ability to add/ update amenities
1) Property Characteristics
The first thing we get a deal in our desired market/ sub-market as per our previous 2 months blog posts to our desk, we look at the property characteristics.
What is the year of construction of the property? Is it in the 1960's or 70's or 80's or later is really important because of several reasons like 60's and 70's have higher maintenance costs, asbestos, wiring and plumbing issues because of materials used at that time.
Flat roofs have lower life expectancy than pitched roofs.
Is it concrete block or brick or wood frame construction. Concrete block will stay for really long time where as wood frame has lot of upkeep.
What is the exterior deferred maintenance on the property? As an operator you want to see if all external issues are fixed and go ahead and renovate the interiors of the property to increase rents to the market.
2) Location Characteristics
The next thing we see is the exact census block and see how the crime is, can median income support the rents you are planning to increase to, demographic mix, nearby single family home prices, school ratings, vehicles per day in nearby freeway/ street, proximity to major retails and some even do the Starbucks rule.
3) Number of Units
The number of units makes really important difference on how you want to operate the property. If its less than 80, you might not have ability to put onsite staff and you have to find a property manager who can operate without onsite staff. If its 80+ and preferably 160+ you have greater economies of scale to operate it efficiently and economically.
4) Unit Mix
The unit mix is crucial as you don't want to buy a property with 80% of 1-bed room units. Ideally you should see a even unit mix of 1, 2 and 3 (or even 4) bedroom units.
5) Number of renovated vs classic units and rent difference that is achieved
If higher number of units are already renovated, its a turnkey property and you have to rely on market rent growth or burning the loss-to-lease to increase value. Instead having lot of classic units with ability to increase rents to market will give you enough cushion to play the game effectively.
6) Rent Roll, Move-ins and Occupancy history
Analyze the rent roll diligently or outsource this to a financial due diligence company. Because of lot of the times when you see lot of move-ins in the last 2 to 3 months, there might be a chance that seller just filled in people with concessions and/ or even bad quality tenants to reach higher occupancy before selling. Historic occupancy will give you lot of insights of the property performance.
Utilities and how they are charged is key component in selecting/ future operations of the property. Is electricity directly paid by tenants? Is water/ sewer is directly paid or sub-metered or rubbed back (RUBS - Ratio based Utility Billing System) to tenants? Is RUBS already implemented or can be implemented? (Because RUBS is market/ sub-market driven and you cannot enforce it if everyone else is doing all-bills-paid system). Do they charge for trash or can you implement value-trash feature? Utilities is one of the biggest expense in operating a MultiFamily. You shouldn't dabble or take a wrong decision in underwriting a property in this aspect.
8) FEMA Flood Zone
Please take 10 seconds to go to FEMA website and put the address to see if the property is in flood zone or not. This will save you a lot of time/ money/ effort.
9) Rental and Sales comps
Analyze Rental comps using Costar, Rentometer, Zillow, Padmapper, Craigslist etc tools to make sure the current rents are below market.
Analyze Sales comps using Costar, Reonomy, Assessor websites to verify if you are buying in-line with sales happening around the area
10) Ability to add/ upgrade amenities
If you especially looking at workforce housing and renters by necessity, you have to make sure what amenities that you can add/ upgrade. Can you add washers/ dryers in each unit? Do you have space to add children play area, bar-b-q, dog park?
With Gen-X, WiFi area, co-working spaces, bike parking, gym and fitness center, game rooms, hangout spots, vending machines, laundry drop off, mailbox pickups etc are getting popular.
Hope you enjoyed our series. We will do a webinar and also a mini-course on these 3 parts.
Happy the 4th,
We at Zovest Capital, invest in value-add and new development of Apartments in growing markets to provide passive cash-flow to our investors.