Matthew A. Martinez
There are three basic categories of income: earned, portfolio, and passive. (Location 244)
More millionaires have made their fortunes in real estate than in any other business. In fact, the IRS reports that 71 percent of all Americans declaring $1 million or more on their income tax returns during the past 50 years were in real estate or related activities. (Location 379)
According to Frank, the über-rich “don’t buy mutual funds; they buy timber land, oil rigs and office towers.” (Location 390)
If you’re searching for a brick-and-mortar investment opportunity, real estate is your best option. (Location 393)
You could invest in many different types of real estate assets, including multifamily (apartments), retail (shopping centers), office, and industrial buildings (warehouses). This book will deal primarily with multifamily assets. (Location 414)
Timing the market is impossible, so I never try to do it. Instead, I merely attempt to buy very good value, regardless of the prevailing conditions. Buying outstanding value is the most important factor in your future success as a real estate entrepreneur, no matter what advice is being offered by the so-called real estate gurus on late-night infomercials. (Location 419)
In my opinion, novice investors should first “cut their teeth” on small residential multifamily buildings before buying, for example, a 10-, 20-, 50-, or 100-unit apartment complex. (Location 567)
In other words, if the borrower defaults on a nonrecourse loan, the lender is likely to foreclose on the property and take control of the asset; however, the lender cannot sue you personally for any deficiencies. (Location 668)
Moreover, I consider larger properties only if I’m able to allocate sufficient funds to capital improvements, deferred maintenance, and general unit upgrades so that the property can attract good tenants who are able to pay market rents, (Location 709)
Grading of Apartment Buildings All income-producing properties are rated by a grading system: Classes A, B, C, and D. Class A properties are the newest (typically less than 10 years old). These are properties that offer superior design, construction, and finish. They usually attract the highest rental rates. (Location 713)
Class C properties provide adequate construction, design, and functionality but show some evidence of deferred maintenance. They usually earn below-average rental rates. (Location 719)
Your Farm Area (Location 732)
The man who does things makes mistakes, but he never makes the biggest mistake of all—doing nothing. —BENJAMIN FRANKLIN (Location 733)
You need to select a location that will be your target area for purchasing properties. Regardless of the size of your team and its ability to cover expansive territories, you’ll still need to focus on certain locations if you are to be successful. The geographical area (i.e., neighborhood, town, city, state, or region) in which you conduct your search for new properties is referred to as your farm area. Becoming an expert in a specific area allows you to be intimately familiar with that location’s property values, vacancy rates, comparable sales figures, market rents, future development plans, and so on. Learning everything there is to know about a particular farm area will enable you to analyze properties quickly and determine which ones offer the greatest amount of value for your investment capital. You can make a fortune if you are keenly knowledgeable about each and every property within a 30-minute drive from your primary residence. (Location 740)
Information and knowledge are critical in this business. I realized a long time ago that real estate is, for the most part, a local game in which the most successful investors pride themselves on knowing everything there is to know about their particular farm areas; because of this, they are able to create vast fortunes. (Location 749)
Whether you are a novice or a seasoned multifamily investor, I recommend that you join the National Multi Housing Council (Location 760)
I’ve received countless e-mails from individuals asking whether they should consider buying a property in another part of the country where the acquisition costs (at least per unit) are lower and the returns appear to be higher. (Location 764)
Think twice before pursuing the allure of bigger properties especially if they are located outside your comfort zone (i.e., your farm area). Don’t sacrifice your geographical expertise for what you perceive as an opportunity in areas with which you lack familiarity. In other words, never chase better cap rates if they are out of town! (Location 782)
He searched high and low in such cities as Columbus, Ohio; Raleigh, North Carolina; Austin, Texas; Oklahoma City, Oklahoma; Tucson, Arizona; and South Bend, Indiana. Ultimately, he decided against purchasing out-of-state properties because all the buildings he found that were worth investing in required intensive management to achieve stabilization, and he realized that overseeing the process would require an inordinate amount of travel and on-site management. (Location 803)
Limiting your farm area to a 30- to 60-minute drive from your primary residence will also simplify your investing strategy and improve your chances for success (especially in the beginning of your investing career). (Location 818)
That having been said, Marcel Arsenault, an investor who built a real estate empire worth more than $200 million, once told me, “You don’t learn how to ride a bike by falling off it. You learn how to ride a bike by staying on.” (Location 837)
“Never regret. If it’s good, it’s wonderful. If it’s bad, it’s experience.” (Location 842)
A farm area is a specific location (neighborhood, town, state, or region) where an investor will consider properties for acquisition. Institutional investors might buy assets throughout the country or the world but they, too, have specific areas in which they prefer to buy. It is recommended that you define the boundaries of your farm area and remain concentrated on that location. You must be intimately familiar with all of the properties in your farm area. You can make plenty of money in real estate regardless of the economic climate if you know every property within your farm area. Do not chase cap rates in other areas that you know little about. A property that might appear to generate a superior return can quickly become a money-losing proposition. Owning property outside your farm area is extremely challenging for a novice, or even a seasoned investor if you don’t have trustworthy, dependable, and experienced local resources to help. (Location 856)
For instance, comparisons between similar properties can be made using the price per square foot, cap rate, price per unit, or gross rent multiplier (GRM). Pipeline or Comparative Market Analysis Report During any property search, I always create a simplified report for all of the properties under consideration. In this report, I list the property name, its address, the year it was built, the number of units, the asking price, total square footage, cap rate, GRM, price per unit and per square foot, monthly base rent per unit and per square foot, and other such information. This report allows me to compare and contrast all of my potential acquisition targets so that I can more readily determine which ones provide the best value. If you really want to get sophisticated with your analysis, you can assign weights to each criterion to arrive at a numerical value for each property. Ranking the properties in this manner will help you to determine which properties (from the ones on your list) offer the greatest value for your capital. (Location 904)
You should begin by touring at least 25 buildings. Refrain from making any offers until you have toured all the properties. This is a simple exercise and a worthwhile investment in your real estate education. Don’t pressure yourself to find the ideal apartment building for your portfolio. Input all of the information previously mentioned into your pipeline or comparative market analysis report. This simple analysis provides you with a means for ranking the properties and better understanding your market. (Location 929)
First thing to remember is, we don’t pay retail!!! That also means we don’t pay the seller for future value. That said, the main thing to look for and consider is future value, but that depends on what you do to it. As I have always said, every time I sell a building, the buyer sees something I don’t. Of course, sometimes the buyers are blind. I still say, and I think you’re now saying it: pick your turf and know the values—not just property values, but rental values. You might find a property where all you have to do is install dishwashers and disposals to increase income and value. You may find an area that to most people is depressed, but to you has a future. (Location 950)
Sometimes the market gets overheated and good value-add deals are hard to come by. The numbers rarely make sense in compressed cap rate environments. When that happens, don’t chase deals in faraway places. Instead, just be patient and continue searching for opportunities. Don’t force a deal that will ultimately cost you in the long run. Pass on projects that don’t make sound financial sense. Look for and buy only good value. (Location 956)
Defined: A value-add deal is one in which the property can be improved in a way that increases the property’s net operating income (NOI). If the project is well conceived, the value of the property will increase by more than the amount of money spent improving it. (Location 971)
There are several things we do to every property we purchase that add certain costs to the project, but we believe they also add significant value. We completely revamp the clubhouse (new design and furniture), add a gym, add a theater, redo the model unit (new furniture, accessories, and so on), new exterior sign, landscaping, buy new furniture for the pools, and get new computers for the clubhouse. We believe these upgrades attract more residents who are willing to pay higher rents so it’s worth the extra money. (Location 1006)
Value-add deals are properties where the NOI can be improved, most often by raising rents after renovations are made and/or reducing operating expenses by intense property management. Both initiatives positively influence a property’s net operating income and, of course, its market value. Typically, a value-add deal is one that is not achieving its full potential, and with a well-designed capital infusion, rents can be raised, vacancy rates can be decreased, and operating expenses can be stabilized or reduced. (Location 1012)
A friend of mine is a principal of a small real estate investment company that acquires distressed property, renovates and rehabilitates them, and sells them for a profit within two or three years. (Location 1026)
One of the best ways to succeed in this business is to buy a Class C property in a Class B neighborhood and upgrade the property from a C to a B. This strategy also works for a Class B property found in a Class A area. (Location 1035)
Other Income or Ancillary Revenue There are several strategies that investors can employ to increase a property’s NOI. One very effective way of achieving a higher NOI is to increase the property’s ancillary revenue or “other income.” Ancillary revenue is any income that isn’t rent-based. This includes laundry income; storage; parking; cleaning services; pet rent; renting roof space for cell towers; sharing revenue with cable, Internet, and phone service providers; and revenue from vending machines. (Location 1039)
The current owner was paying far too much for insurance, maintenance, electricity, and water. After closing on the property, I quickly renovated the units and leased them to tenants who paid much higher market rents. I then went to work on all of the operating expenses. My plumbing company fixed all of the dripping faucets and leaking toilets, and repaired several hot water heaters. This resulted in a 25 percent reduction in the water bill. I reduced the insurance expense 22 percent by using my preferred insurance carrier. I even saved on common electricity by installing fluorescent lightbulbs with timers throughout the property. (Location 1080)
What You’re About to Learn How to work with real estate brokerage firms How to find the very best properties How to avoid the competition Where to obtain research reports How to use information to your advantage Why real estate investing is a local game (Location 1101)
Contacting all the real estate brokers (both local and national firms) that specialize in multifamily assets within your farm area is the most logical first step. Introduce yourself as a serious investor who is eager to close deals. Don’t make the mistake of implying to a broker that you’re interested only in “good” deals. Instead, explain your specific acquisition criteria in detail. There may be several very good local firms that can assist you, however. Table 5.1 gives the country’s leading national multifamily brokerage firms. (Location 1111)
Having intimate knowledge of your farm area, leveraging your network to gain access to off-market deals, and using local resources that can provide valuable real estate information before competitors are made aware of it will allow you to leapfrog everyone else. Avoiding the competition permits you to be the only investor at the negotiating table . . . and that can translate into significant savings at the closing table. (Location 1143)
National and Local Conferences Several organizations such as the National Multi Housing Council (NMHC) sponsor national, regional, or city-specific meetings for investors who are interested in multifamily housing. Also, your local real estate investment association (REIA) probably has monthly or quarterly meetings. Active involvement in these groups is extremely beneficial to your search because you’ll expand your business network by meeting other active investors in your farm area who might introduce you to deal flow. (Location 1150)
A creative way to find new properties that aren’t being marketed is to look at the “for rent” listings on Craigslist. Because everyone else is looking at the “for sale” page, you should think and act differently if you want to avoid the competition. Perusing the “for rent” section will lead to an ample supply of apartment owners with vacancies. Send them an e-mail or call them to inquire about their interest in selling their property. Perhaps they may be interested in selling now or at some point in the future. If an owner has vacancies and is searching for tenants, perhaps he or she would be willing to sell rather than spend the time required to find new tenants. Timing is everything, so leave no rock unturned. (Location 1164)
Mortgage Lenders When an investor defaults on a loan, the lender might accept a short sale of the property or attempt to sell it after the foreclosure takes place. Either way, mortgage lenders are an outstanding source of opportunities for investors who want to acquire real estate assets at favorable prices. These types of opportunities are divided into the following three categories: Distressed properties. The owner is unable to continue paying the mortgage and is in danger of default. Perhaps he has already missed one or two months of mortgage payments. Default. Typically the owner is 90 days late in making mortgage payments. The bank/lender considers this a nonperforming loan. The lender might sell the note, and in that case the buyer of the note must foreclose on the property to gain control. Foreclosure. The lender has foreclosed, and the property is considered real estate owned (REO) by the lender. The new buyer has much less risk, because he can typically buy the fee-simple interest in the property from the lender. In other words, acquiring property after the foreclosure process has been completed offers the purchaser a variety of benefits. These may include obtaining the property free and clear of liens and other interests. (Location 1189)
To find REO deals, you should have a contact within the bank who can make you aware of opportunities as he becomes aware of them, or you must know representatives at the brokerage firms that have deals assigned to them by the banks. To make inroads with a financial institution and to learn how this process works, you first should contact the bank where you conduct your own business. Introduce yourself as a customer who would like to speak with the person in charge of the REO or special assets department. The vice president of commercial lending or credit officer at smaller banks or the director of the special assets or loss mitigation division at larger banks is the person you’ll want to meet. Make sure he knows precisely what you are searching for, and express your eagerness to work with him as well as your ability to close. (Location 1211)
Chapter Summary To find the very best opportunities, you must conduct an exhaustive investigation of your farm area. Thinking and acting in ways that are unconventional will lead to extraordinary opportunities. Never be satisfied with the traditional means employed by your competitors who also are searching for properties. You will be rewarded with superior properties only if you work harder and smarter than everyone else. Leverage the Internet and your personal network to find properties. Real estate is a highly localized business, and information will always be this industry’s most valuable commodity. (Location 1280)
As a Boulder, Colorado, business reporter once wrote: “Sell your investments that are going great, and buy what everyone else thinks is going down the tubes.” The most successful and experienced real estate investors I know wholeheartedly subscribe to this contrarian investment philosophy. (Location 1300)
price lower than that of other overpriced apartment buildings in your farm area or buying at a price that allows you to obtain average returns on equity. Buying low means buying good value based on the return on capital that you hope to achieve. Buying low gives you an opportunity to generate above-average returns on your hard-earned investment capital. (Location 1305)
When you are searching for an apartment building that provides outstanding value for your capital, you always should base your analysis on the property’s current income and expenses (preferably the last month’s rent roll and the 12-month trailing operating expenses) rather than on the owner’s pro forma (projected) numbers. The owner or his broker will create pro forma financial statements to show how the property could perform given ideal conditions. However, the owner’s estimates of future performance are rarely accurate; in fact, most often they are highly exaggerated. You’re better off using the property’s current financial statements and not the ones being promoted by the owner. (Location 1319)
After you leave the closing table and are the proud owner of the property, you should be collecting an amount similar to the previous month’s rent roll. Ask for a copy of the last three months’ deposit slips, because the numbers stated on the rent roll can differ dramatically from the actual amount of rent that was collected. (Location 1334)
I always ask the owner or broker who drafted the pro forma, for example, how he expects a new owner to obtain these higher rents if the current owner has never has been able to achieve the amount of rents being forecasted. (Location 1355)
cost. Your analysis should consider only current, actual numbers and future projections that are conservatively based on what you believe are reasonable expectations for the property’s financial performance. (Location 1359)
“We would hang banners on buildings offering below-market lease rents,” Marcel Arsenault, author of How to Build a Real Estate Empire, (Location 1377)
Cash flow is based on the following basic formula: Revenue Less: Vacancy and collection costs Less: Operating expenses Equals: Net operating income (NOI) Less: Debt service Equals: Cash flow Buying low and obtaining favorable financing will have a positive effect on debt service because the principal amount of the loan (and thus the monthly mortgage payment) will be less than it would have been if you had paid a higher price. (Location 1382)
I have friends (much savvier than I) who troll around banks and law firms searching for apartment buildings that they can obtain at 50 or 60 cents on the dollar. (Location 1395)
To accomplish this feat, you should obtain answers to the following questions during the negotiation: What’s the absolute lowest price that the seller or lender (in the case of a nonperforming loan) will accept? How much can I purchase the property for if I close quickly (assuming that you have the ability to do this)? What is the debt on the property? (How much does the seller owe to his lender(s) or what’s the outstanding debt to the bank?) How much did the owner originally pay for the property? How much has the owner invested in property improvements while owning it? Why is the property being sold? Is the owner/lender motivated to sell? (Location 1406)
Once you have agreed on a price and signed a sales contract, it’s time to perform your due diligence on the apartment building. If in fact you find anything materially wrong with the property, you should return to the negotiating table with substantive reasons why you require a further discount. Use estimates from your general contractor indicating the cost to remedy a problem or make specific repairs. The more time you and the buyer spend negotiating a deal, the more committed he will be to seeing it closed and the less likely he will be to walk away from the negotiations. Plan your strategy wisely, and take your time. (Location 1420)
You cannot survive in the apartment building business if you waste your time dealing with owners who are not motivated to sell at the discounts you’ll need. (Location 1428)
Buying from Lenders In down markets, opportunities abound (directly or indirectly) to buy from banks and other mortgage lenders because they are inundated with nonperforming loans. (Location 1429)
To be exposed to these opportunities, you must befriend loan officers, REO personnel, and special asset managers. You must know which banks made loans to investors in multifamily assets and who within each bank is responsible for the disposition of these assets. Once you have access to these deals, you’ll be able to work directly with the lender to acquire properties at potentially steep discounts. Also, you might be able to work out a deal with a bank if the owner is willing to introduce you to his loan officer and negotiate a favorable sale before it is escalated to special assets, assuming that the borrower is in trouble and can no longer meet his financial obligations. (Location 1524)
In fact, Freddie Mac has created a Web site to sell some of its troubled properties: Web site: www.homesteps.com. REO opportunities are difficult to finance through conventional sources. (Location 1534)
There are five major components of real estate investing: Finding deals Evaluating (or underwriting) deals Financing deals Managing properties Selling properties (Location 2133)
Before a bank approves any loan, it must review the loan application and apply several financial models that measure risk. (Location 2138)
If you are having trouble obtaining real answers from the property manager or doubt his honesty, consider hiring a “secret shopper” to tour your property. Such a scout can give you a report on the performance of your on-site manager. A secret or mystery shopper poses as a prospective tenant and contacts your manager, inquiring about available units. He then tours the property, enters units, asks a host of questions, and reports back to you regarding his overall experience. (Location 2388)
To begin, you should create a rental survey, or what is known as a comparative market analysis (CMA). You or your on-site manager must review competing properties regularly and log that information into the CMA (Location 2415)
Leasing Agents Be sure to ask every person who calls the office how he heard about the property. A great deal of time, energy, and money goes into creating advertising and outreach campaigns designed to generate phone calls to leasing offices. (Location 2453)
Note: Given that tenants rarely call about leaking toilets but will call immediately when a toilet isn’t working, I instruct my property managers to install a product called the Fluid Master with leak prevention in every bathroom. A leaking toilet can waste up to 200 gallons a day and can cost you thousands of dollars each month. For about $9, the Fluid Master shuts off the water to a leaking toilet, thereby prompting the tenant to call maintenance if he wants to use the toilet again. Web site: www.fluidmaster.com. (Location 2520)
All of the work associated with making a unit rent-ready should not take more than a week unless extensive repairs are required. The manager should inspect the vacant unit once a tenant moves out as well as during and after cleaning. Units that are clean, newly painted and, by all means, smelling good will rent much faster. Your goal is to rent the unit as quickly as possible, so make sure it shows well. (Location 2550)
Owner Involvement All investors in apartment buildings need to be involved. You must read your monthly financial reports. You must inspect the property regularly. You must make sure that you and your property manager are on the same page and approve a management plan each year. You must reinvest enough money into the property to keep it competitive in the marketplace. No property will operate to its full potential without constant supervision from the owner. Absentee owners should expect problems and must implement failsafe strategies to avoid complete failure. After all, no one will care as much about your investments as you do. You are at a distinct disadvantage if you are unable to tour your investments periodically. If you decide to acquire properties outside of your immediate area, you still need to be actively involved. Try to visit your properties as often as possible. In fact, it’s best if you don’t inform your property managers when you plan to visit. This way, they are always kept on the alert. Unless a property manager has consistently performed well for you in the past, he should not be trusted 100 percent—he must earn your trust. (Location 2558)
Reporting At the beginning of each month, your property manager should prepare a management report for each of your buildings. Because rent is due by the first of the month and is late by the third (depending on your rules, it could be the fourth or fifth), management reports should be e-mailed to the owners no later than the fifteenth. These reports detail all rents received and expenses paid for the previous month. They also should include the following: An income statement showing the gross revenue and operating expenses for the month and year A comparison of the monthly income and operating expenses with the budgeted amounts for the month and year Copies of all invoices paid A summary of maintenance activity, delinquent rents, and new and expiring leases and a list of any other problems or management concerns, along with suggestions for how management intends to resolve each problem Sophisticated management software is available that helps managers update everything from rent rolls to operating expenses to invoices paid. The leading property management software companies are Yardi: http://yardi.com Rent Manager: http://www.rentmanager.com MRI: http://www.realestate.intuit.com/products On-Site: http://on-site.com/ (Location 2567)
Population Trends According to multifamily housing professionals, the 10 most likely locations for future population growth are Phoenix, Arizona Los Angeles, California Las Vegas, Nevada Houston, Texas Orange County, California Miami, Florida Riverside County, California Fort Lauderdale, Florida Dallas, Texas San Diego, California (Location 2617)
He parlayed those profits into a real estate company that today manages a portfolio of assets in excess of $200 million. (Location 2653)
Mr. Arsenault’s unique vision for real estate investing: “He purchased distressed commercial real estate, nurtured it to health, and resold it at a higher market value in the 1980s . . . diversifying his portfolio in the 1990s—purchasing what he calls ‘boring but stable’ properties, maximizing cash flow, and strengthening the quality of its tenant base.” (Location 2656)
horizon. To begin predicting real estate trends, however, you must develop a keen understanding of the industry’s most influential economic signals: Employment growth Vacancy rates Interest rates Rental rates Mortgage rates Consumer confidence Inflation rate Apartment mortgage delinquency rates Housing affordability Retail sales (yes, even retail sales!) (Location 2661)
Given the complex nature of the real estate industry, it is extremely helpful to search for trends that indicate the direction in which the market is moving. Here are some of the most important ones: Population. A growing population means greater demand for housing. Greater demand usually results in higher rents and lower vacancy rates. Rental rates. Are the rents in your area going up or down? Are concessions being made? If so, how much are landlords offering as incentives to entice prospective tenants to sign leases, and what’s the effective rent? Interest rates. Whether you’re a renter, a buyer, or a seller, interest rates affect the cost of obtaining capital. Higher interest rates make it more difficult for families to buy homes and thus can limit them to renting. However, higher rates also make it more costly for investors to finance the acquisition of new apartment buildings or to sell to prospective buyers. Employment. Rising local employment and job growth are good signs for the rental business. When the rate of employment increases, higher population growth, lower vacancy rates, higher rents, and fewer concessions follow. The opposite is true when unemployment is increasing. New home starts. More new units create additional housing supply, which can affect the demand for rentals dramatically. Check with the local homebuilders’ association, local chamber of commerce, town hall, or economic development office about construction permits, housing completions, and new home starts. (Location 2673)
For instance, contact a moving company’s local facility manager to determine whether more people are moving out of the area than are moving in. (Location 2689)
Also, talk with your local builders to determine whether they are experiencing any changes in the market. (Location 2692)
Buy properties that can generate positive cash flow in the near term and outstanding returns in the long term. Acquire properties from motivated sellers and place them under good, aggressive management with the goal of improving their net operating income (NOI). Focus on locations with high barriers to entry, but always concentrate on a specific farm area regardless of where you decide to buy. Dispose of a property when it attains its target NOI and the returns you desire can be achieved. You’ll never go broke selling for a profit! Buy for the long term, but be prepared to sell when it makes good financial sense. Develop multiple exit strategies before buying a property. Run the numbers for the worst-case scenario, and if they still work, then by all means proceed. (Location 2709)
Other investors, myself included, subscribe to a different investment philosophy. Investors should continually reevaluate their portfolio, and if the sale of a property can achieve the return on capital that you require, or if there’s an alternative investment opportunity that could generate higher returns with the proceeds from the sale of a currently owned asset, then by all means, you should consider selling. (Location 2728)
Obtain a written marketing plan before you commit to an exclusive listing. Know how your Realtor is going to actively market your property. Otherwise, he will just list it on LoopNet and field phone calls. (Location 2747)
Lesson learned: To accumulate wealth, investment in assets is required, and consumption, at least for the short term, must be sacrificed. In other words, don’t buy that 65-foot yacht. Instead, invest that money in an apartment building or other appreciating asset so that one day you truly can afford to buy those luxury items. (Location 2775)