In the last five or more years, interest in MF investing by private individuals has sky-rocketed. We occasionally get asked by new passive investors, what can I do to increase my odds of being selected into an offering? I mean, as an experienced Lead/syndicator wouldn’t you keep going back to those who have invested with you in the past?
I’ve answered this questions so many times, that I thought I would share my response for those that perhaps have thought this but not got around to asking it. Generally we do choose repeat investors – those that have invested with us in the past. However, with both the sales/purchase prices of MF increasing over time, as well as our continued desire to acquire newer and larger properties – think efficiencies of scale – then we usually need to raise increasing amounts of capital. As a result, we often take in passive investors that have not invested with us before. So, how to you make yourself standout?
Network, network, network
If you only meet us once at a busy event, and spend just a couple of minutes talking with us, then there’s a good chance that we will not remember you 6 months later. Sorry, that’s just the way it is. After making initial contact, then if you live locally follow up and arrange to meet for coffee or lunch somewhere. Alternatively, if you are not local, then arrange a time for a virtual face-to-face.
The SEC requires us to have a “substantive, pre-existing relationship” before you invest with us, so the more substantial this is, the better.
Photos
I (Steve) tend to remember faces better than names, so be sure to include a photo in your profile and/or email signature.
Dare to be different
Do or say something unique or different – find something we have in common aside from real estate, and share a story about that. Recently I meet a very out-going and fun gentleman who called himself, “The Black Elvis” because he was born on the same day that Elvis Presley died. I don’t know if “The Black Elvis” could sing, but he sure made a great and lasting impression. If he references that in his profile or in subsequent emails, I’ll immediately remember him.
Larger investments are not always the answer
When it comes time to raising funds for an investment then it is true that larger investments tend to carry more weight. But if you follow the previous suggestions, then this need not be a determining factor. This is great news for passive investors that may not have deep pockets, but do want to get started investing.
One crucial thing I have learned having been a syndicator/operator of six multifamily properties in the last 10 years is this: No matter how nice a property has been renovated or how impressive your capital improvement plan, you can never substantially change the submarket, otherwise known as your tenant base.
Over the years of owning Elmstone Group Property Management (shameless plug here), I have encountered some precarious situations and unstable individuals covering all gamuts of this business. I personally dealt with mentally-unstable and sue-happy residents.
Allow me to share some experiences with you that hopefully will preempt the same legal dilemmas from happening to you. Follow along with me as I periodically share my experiences.
Episode 1:The Knife-wielding Resident
ISSUE: A brand new owner/operator in 2011 in South Irving, Texas, we inherited with Casa Del Sol a resident, shall we say, suffered a few mental issues. I distinctly remember when we walked all units during due diligence, seeing this unit. Hung on the walls were numerous martial arts weapons, a sword, very sharp disc of some kind. You get the idea.
A month or so after takeover, our manager and maintenance guy went to collect the resident’s late rent, knocked on the door and was greeted with a hammer crushing through the door from the inside. Cops were called, entered the premises by busting the window and kicked in the door. They were greeted by the knife-wielding resident, who was promptly tased and taken to Parkland Hospital’s Psych Ward, a place he called home for two weeks.
SOLUTION: During our resident’s vacation at Parkland, our manager called the city’s Adult Protective Services to greet said resident upon his return to his apartment. We had since changed the locks and called APS to help him. Family in Florida did not reply to our requests for help.
This was a truly tragic situation that broke my heart, but this person truly was a danger to himself, our staff and other residents. We call this a legal liability, a lawsuit waiting to happen. Guess who sits in the hot seat in court when someone files a lawsuit. Yours truly. My job title requires I defuse these situations from escalating.
Multifamily ownership is not for legal virgins. Educate yourself.
Disclaimer: The views and opinions expressed here are those of the author and do not necessarily represent any organization or anyone else.
I have recently been underwriting a number of possible MF investments in the DFW area and are finding much the same thing with all of them. The prices for properties are so high at the moment that cash-on-cash yields are being squeezed to a bare minimum and the only hope of making any kind of worthwhile return is dependent on the “value-add” components. And the more viable value-add components have already been exercised over the past 3-5 years by investors looking to improve the value of their investments.
It truly is a seller’s market. Seller’s have been able to ask for and get increasingly higher prices as the influx of buyers are bidding up prices just trying to get into the market.
Ten years ago, when recovering from the 2008 crash in real estate, we were able to buy Class C MF assets in the Dallas area for $20-$30k per door. Today, similar assets in the same sub-market are selling for around $200k per door, and now they are ten years older! These changes are in part due to increased rents (resulting from inflation) but also due to the compression of cap. rates from around 9-10% in DFW in 2010-2011, to around 4% and lower in 2022.
So, what next?
The compression of cap rates over much of the last decade has made it very easy for some investors to make money by just “riding the cap rates down” without even having to put much capital into the property. Typically they will buy a property, turn it over to third-party property management, invest minimal capital into improving it, then sell 1-3 years later at a profit. Note that this is not our model.
We are now at a point in the market where many believe that cap rates cannot go down any further. So, can property values continue to increase? What about inflation? And what will happen to cap rates? While we do not have a crystal ball and cannot predict the future, we can apply various models to explore different scenarios and illustrate what happens in each of those.
As an example, let us consider a property that we recently underwrote. The name of the property is not important here, but a few key facts about it are:
256 units in Irving, TX, built in 1980.
The property had received a series of large capital injections over the past couple of owners and was in excellent condition.
It was brought to us “off market”, rather “pre-market”, because of our prior relationship with the seller. We were told that he’d been working with a broker and was expecting it to sell for $54-56M. But if we could match the low-end of the range at $54M, then it was ours. That is $211K per door. To be fair, the seller wasn’t trying to push the property on us. In fact, he even made the comment that as good as the property is, “I wouldn’t pay $54M for it!”
With a T-12 NOI of $2,007,047 and a purchase price of $54M, that gives a cap rate of 3.72% for a 1980 property.
Incidentally we had actually toured and underwrote another property just down the road from this one, about a month earlier. It also had 256 units and they were asking $51.2M, or $200K/door. That property was in far worse condition and needed a major capital injection. So, on the surface of it $54M seemed to be a fair asking price in the current market.
After much analysis, and back-and-forth with lenders we just couldn’t get the numbers to work for us. But as we discussed the exit strategy for this property, there were (obviously) plenty of unknowns. This got me thinking, what effect would a small increase in cap rates have on the property? What about a larger increase in cap rates over multiple years?
For each of these scenarios, I considered an increase in NOI as per our business plan. If we assume that the plan would be executed no matter what the market did, then the only variable(s) would be as introduced in each scenario.
Baseline scenario
As a baseline, we assumed the cap rates would remain largely the same as today. As such with our increasing NOI, we felt that we would be able to increase the value from $54M today to $66M at the end of Year 3, and almost $74M by the end of Year 5. The projected asset value over the next five years is shown in the chart below.
The projected increase in value sounded very attractive to us, and would be to potential investors. But, in the current environment, is this likely? What if the cap rates were to increase somewhat slowly, but steadily over the next 5 years?
Slowly increasing cap rate
For this scenario, we assumed that the cap rate increased by 0.1% each year. Assuming the same increase in NOI as described above, this would still result in increasing property value though at a slower rate than with a constant cap rate. These projected values are illustrated in the following chart.
At the end of year 3 we felt that we’d be able to increase the value to around $61M from the purchase price of $54M, then to $65M by the end of year 5. In this scenario, the cap rate increase – which generally results in lower valuations – is more than offset by the increases in NOI by following our proposed model. So the property value would still increase but just not as much as with a constant cap rate.
Beware of the previously mentioned investors who are just trying to “ride the cap rates down.” They would struggle in this scenario. If they did not do any major enhancements to improve operations and increase NOI, then they would see the asset value diminish over time.
In order for them to survive the slow increase in cap rates, they would have two options. Firstly, a quicker than expected sale, possibly at a small loss. Secondly, try to force an improvement in NOI outside of the original business plan. This would either mean cutting back on expenses and/or pushing rents and increasing income. In general, cutting back on expenses without a plan can result in a diminished customer experience. This then makes it difficult to push rents and drive income higher without a lot of turnover, and this becomes a recipe for disaster. A shorter term hold and “fire sale” is the most likely outcome.
Rapidly increasing cap rate
What if we did all of our planned improvements to improve NOI but then the market cap rates increased at a faster rate than discussed above? Purely from a mathematical point of view, this would force the asset value down. This is likely the most concerning outcome.
For this scenario, we assumed that cap rates would increase at a steady 0.5% per year, so after 5 years they would be at around 6.2%. This might seem a long way from where we are in today’s market. But think back five years to 2017 when the cap rates for Class C products were around that same level. If cap rates fell that quickly, it seems conceivable that they could also recover as quickly.
This scenario is illustrated in the following chart.
Again using the increasing NOI that we had projected, but a 0.5% increase in cap rate each year, the asset value would drop off to $47M by the end of year 3 and $44M by the end of year 5. That’s a $10M drop below the current asking price in just 5 years and after improving the asset performance over this time.
Now layer on top of this the fact that many properties being bought today are being financed with a 3-1-1 bridge loan which will need to be exited before the 5 year mark.
Summary
So which scenario is most likely? No one can answer this with 100% certainty and I’m not going to try to predict that here. The intent of this article was simply to share some sensitivity analysis that I performed on a property I was evaluating recently.
So please weigh the options and make your own decisions. There are so many external factors influencing the market from inflation, the war in Ukraine, changes to US (and foreign) government policies, interest rates and printing money, the possibility of a new strain of COVID or another pandemic.
Personally, I tend to believe that cap rates cannot go much lower. But then I’ve thought that before and was proven wrong! So, I do believe that we will see cap rates increase. The big unknown – for me – is how soon, by how much and for how long will they increase?
Irving, TX — Nov. 13, 2020 — The Monterey apartments, recently sold by Elmstone Group OP2, LLC, successfully allowed its investors to realize strong, double-digit returns on their original investment in four years. In spite of the recent economic unrest associated with a pandemic and the US elections, the profitable sale of The Monterey proves that the North Texas market is still strong and thriving and demonstrates the possibilities in this market.
Focusing on Class B and C properties in the Dallas/Forth Worth-area, the Elmstone Group has developed a reputation for delivering both quarterly cash-flow to investors in addition to a very respectable equity gain upon sale. The Monterey, which the Elmstone Group purchased in October 2016, completed the group’s fifth multifamily sale, while still holding other properties for cash flow and potential future equity capture to investors.
“The Irving market offers incredible potential for investment opportunities. It has proven to be highly beneficial to Elmstone Investments and their investor group”, said Shari Gould, CEO, Elmstone Group Property Management, LLC. The sale was another sale facilitated by Chris Deuillet, Senior VP, CBRE. The Elmstone Group properties, managed by Elmstone Group Property Management, LLC, continues to thrive in the multifamily arena as a result of hands-on, local management and ownership.
About the Elmstone Group
The Elmstone Group is a collection of fully integrated, specialized Real Estate companies. The Elmstone Group is a regionally recognized leader within the Texas Real Estate industry with a full spectrum of services, simplifying acquisitions, asset management, rehabilitation, repositioning and disposition of multifamily assets.
Disclaimer: I am not a CPA, financial adviser, tax planner, lawyer or anything close to any of these things. Rather than do exactly what I say here, you should consult with your own CPA to determine how you should distribute funds from a sale.
Note that different companies and different individuals distribute the sale proceeds differently. This is just a high level description of our general approach. Generally there will be three separate payments, as follows:
Return of your initial investment amount
Return of a major portion of the gains
Return of any final remaining funds
Return of your investment
We like to do this as soon as possible after the sale and usually within a week of receiving the cleared funds.
Return of a major portion of the gains
In the 30 days following the sale, we make sure that the major vendor accounts and utilities have all been settled up and closed out cleanly. Any pro-rations due from the buyer (depending on the sales contract) should also be addressed at this time. Once this is done then, working with our CPA we determine how much to distribute while holding back a cushion to wrap up the business.
Within 30-45 days of the sale we estimate the amount of money needed to wrap up the business and return the rest. Depending on the specific details of the investment, this is usually the biggest single distribution and the main one people get excited about.
Return of any final remaining funds
In the final stage of the wind down, we need to:
Ensure that any remaining utilities deposits have been returned.
Unused escrow should be returned by the former lender assuming that the loan was paid off in full. [In the case of an assumption then the unused escrow generally stays with the loan.]
Unused insurance premiums should also be returned from the insurance provider. This one can take a couple of months after cancellation.
The CPA can then prepares the final tax return and associated K-1s.
Prepare, file and possibly pay any Franchise Taxes (depends on the State in which the company operates).
As a rough rule of thumb, the funds needed to wrap up the business are approximately equal to the monthly operating expenses of the property under normal operations.
After preparing the final tax return, distributing 1099’s and preparing investor K-1s we work with our CPA to come up with an amount for the final (usually small) distribution. At this point our CPA is able to provide us with a final bill so we hold back enough to pay them and any other monthly recurring payments as long as needed. Then we distribute that final amount – usually about 1% additional return.
Irving, TX — Nov. 15, 2019 — Silverado apartments, recently sold by Elmstone Group OP1, LLC, successfully allowed its investors to double their original investment – a return of 100% – in around 3½ years.
Focusing on Class C properties in the Dallas/Forth Worth-area, the Elmstone Group has developed a reputation for delivering both quarterly cash-flow to investors in addition to a very respectable equity gain upon sale.
Silverado, which the Elmstone Group purchased in April 2016, completed the group’s fourth multifamily sale, while still holding other properties for cash flow and potential future equity capture to investors. The Elmstone Group properties, managed by Elmstone Group Property Management, LLC, continues to thrive in the multifamily arena as a result of hands-on management and ownership.
About the Elmstone Group
The Elmstone Group is a collection of fully integrated, specialized Real Estate companies. The Elmstone Group is a regionally recognized leader within the Texas Real Estate industry with a full spectrum of services, simplifying acquisitions, asset management, rehabilitation, repositioning and disposition of multifamily assets.
Something about you looks different. Have you had some work done?
What might be impolite to ask for people is more than acceptable when it comes to property! Manchester House certainly does have a new look, and thanks for asking!
The
unique and well-established apartment community (formerly Salem Ridge)
located in Denton received new management in early 2019 and has spent
the last several months getting an updated, upgraded look – from the
inside out.
Still tucked into a quiet nook – close enough to I-35
for great access but far enough off the access road to protect its
residents from intrusive freeway noise – Manchester House has always
been a great little community. Now, improvements are underway for every
aspect of this 97-unit apartment community.
“We’re excited to
offer a solution to the classic dilemma – whether to live in an older
property with lots of charm and a quiet location or in a newly
constructed apartment with a more updated and modern feel,” said Shari
Gould, CEO of Elmstone Group Property Management, LLC. “With Manchester
House, residents can enjoy the best of both worlds – an upgraded and
renovated apartment interior with original charm in an eminently
convenient location.”
Improvements range from the less-sexy but
much-needed improvements to plumbing, boilers, drainage, HVAC systems,
windows, building exteriors and fencing to more aesthetic upgrades like
new flooring and interior paint in all units as well as the addition of a
community gazebo, built-in outdoor grill and firepit near the renovated
sport court (coming soon!).
Manchester House apartment community
offers studio, loft and one and two-bedroom floorplans. Premium
Apartments, in a variety of floor plans, offer contemporary interiors
with new cabinets, quartz countertops and all new fixtures. The
community offers easy access to I-35E, lots of dining options and is
located just a few miles from some of the area’s major employers,
including Acme Brick, Peterbilt Motors and Ben E. Keith Beverages.
Manchester House is located at 501 Londonderry Ln., Denton, TX 76205.
For information on leasing, ongoing renovations, an open house planned for early fall and a generous move-in special, visit http://manchesterhousedenton.com/ or call 940.600.4449.
Denton, TX — Feb. 27, 2019 — Elmstone Group XII, LLC announces the acquisition of Salem Ridge apartments, a 97-unit Class C property comprising 74,484 square feet on 4.6 acres. The community has a very favorable unit mix for the Denton area with 45% of the community being 2 bedroom, 40% 1 bedroom and 14% efficiencies. Located on the south side of Denton, just off of I-35E, Salem Ridge is the firm’s 6th acquisition in the Dallas-Fort Worth area.
“Salem Ridge represented an increasing rate opportunity to acquire an under-performing asset with considerable value-add upside at a price point that made financial sense and offered our investors some strong returns even in the current market,” said Steven R. Gould, Co-Founder of Elmstone Investments and CFO of Elmstone Group Property Management, LLC. The property will immediately undergo a $750K renovation plan to include rebranding, significant exterior and amenity improvements, and dwelling unit upgrades featuring a selection of granite, quartz or resurfaced countertops, stainless steel appliances, faux-wood flooring, and designer fixtures.“ In addition to the upside from our planned renovations, we look for properties with multiple ways to add value. We identified a major opportunity to increase rents back up to and above market with a strong management team in place and bill back residents for utilities. These two things alone will deliver 12% revenue increase in year 1,” said Gould.
About the Elmstone Group
The Elmstone Group is a collection of fully integrated, specialized Real Estate companies. The Elmstone Group is a regionally recognized leader within the Texas Real Estate industry with a full spectrum of services, simplifying acquisitions, asset management, rehabilitation, repositioning and disposition of multifamily assets.
Irving, TX — Oct. 24, 2018 — The Village on West Irving, recently sold by Elmstone Group TV, LLC, successfully provided its investors a total return on their investment of more than 185% in little over 3½ years.
Focusing on Class C properties in the Irving market, the Elmstone Group has developed a reputation for delivering both quarterly cash-flow to investors in addition to a very respectable equity gain upon sale.
The Village on West Irving, which the Elmstone Group purchased in January 2015, completed the group’s third multifamily sale, while still holding other properties for cash flow and potential future equity capture to investors. The Elmstone Group properties, managed by Elmstone Group Property Management, LLC, continues to thrive in the multifamily arena as a result of hands-on management and ownership.
About the Elmstone Group
The Elmstone Group is a collection of fully integrated, specialized Real Estate companies. The Elmstone Group is a regionally recognized leader within the Texas Real Estate industry with a full spectrum of services, simplifying acquisitions, asset management, rehabilitation, repositioning and disposition of multifamily assets.
