Ken McElroy
Part of developing your financial intelligence is to surround yourself with people who are smarter than you and to learn everything you can from them. (Location 107)
Of the 400 billionaires on the Forbes Richest Americans list, 10 percent derived their wealth directly from real estate. (Location 164)
The two richest real estate tycoons on the list are Donald Bren and Samuel Zell. Both of these men are primarily known for their multifamily real estate investments and are proof that the best real estate investment around is apartment buildings.) (Location 167)
His company is listed on the S&P 500, and he is considered the godfather of public real estate companies. All of this was generated through multifamily investment. (Location 178)
Business creates liquidity; real estate creates wealth. (Location 196)
For example, if you are a landlord, you have the ability to manipulate rents based on changing market conditions in order to maximize income. I do this all the time in my company—both with properties that I own and properties that I manage for others. Each month my managers are required to do a market survey. A market survey is a simple study that involves calling your direct competitors and asking them what they are charging for rents, deposits, and what they are offering for concessions, if anything. By gathering this data, my managers are able to make real-time market decisions by comparing their rents, deposits, and concessions—again, if (Location 378)
any—against their competitors and adjusting accordingly. (Location 382)
If you are purchasing a property that cash-flows, appreciation is just icing on the cake. By doing a little bit of homework you can find areas that will have appreciation levels far above the national average. These areas will be places like Phoenix, Seattle, Dallas, New York City, and Washington, D.C., where the job growth and employment growth are high. (Location 403)
If you must sell, you should at least keep the property more than two years after you acquire it because your capital gains tax liability is lower. (Location 419)
For example, my partner, Ross, our investors, and I acquired a building in Flagstaff, Arizona. (Location 484)
What you see reflected in the chart is what I like to refer to as tax-free cash flow. The cash flow for the property after all operational expenses is $300,000. That would warrant a pretty hefty tax bill come April, but depreciation allows me to show an operating loss of $307,273. That means in reality since the depreciation is a noncash expense, I don’t have to pay any taxes, even though my investors and I have pocketed $300,000. (Location 495)
#6. Refinance Another advantage of real estate over other investments is the ability to withdraw cash through a refinance of the property. This, too, is a tax-free transaction. When you refinance a property you are restructuring your existing mortgage debt based on the added value of the property. In almost every instance, I will opt to refinance a property rather than sell it. In fact, I did this with two of the properties in my company’s portfolio. One of the properties is a senior housing property, located in Sun City, Arizona, (Location 505)
In acquiring the building, we employed our usual acquisition plan, which is to raise all the equity for the down payment from our investors. Almost immediately our investors were realizing very strong rates of return because our improvements to operations created substantial cash flow. The business plan was to refinance after a number of years, and we did just that. Five years later the property appraised at $15 million, and we refinanced it (two years ahead of schedule) for $12.26 million. That is a tax-free gain of nearly $5 million and over $1 million per year—just from improvements to operations and sound management. From the (Location 514)
refinance, I was able to pay back all the original equity that I collected, plus a percentage return on the equity to the investors, plus my partner and I pocketed over $1 million for ourselves. Not bad. Now my investors have all their original money back, and they continue to get cash flow from the property. My investors are happy, and we’re happy. The property’s operations more than cover the higher mortgage payment, and, best of all, the money from the refinance is tax-free. Our investment is now zero, and our return is ... infinite! (Location 519)
Each and every property that you buy should be placed in its own individual LLC. That is one of the greatest ways to protect your wealth. Imagine you own multiple investment properties and one of your residents fell in the shower and became injured. If all of your properties were under a single entity, that resident would have the legal right to pursue damages based on the entire asset value of all your investments in that entity. (Location 536)
In addition to the legal protections that an LLC provides, there are also distinct tax advantages. For example, one of my companies, MC Management, is an LLC and handles all property management services for all of our investments. My vehicle and all of its expenses, and my travel expenses to find new deals, are all paid from this company. (Location 541)
My friend and business colleague Gary Gorman is an expert in 1031 exchanges. He has over thirty-five years’ experience in real estate tax transactions, and is the author of the book Exchanging Up. (Location 548)
Gary Gorman’s Web site at www.expertl031.com, or ask your qualified intermediary to explain it to you. (Location 633)
REITs are publicly traded large portfolios of real estate that are open for investment. REITs are required by the government to distribute 90 percent of their profits to their investors in exchange for little or no (Location 733)
corporate income tax. (Location 734)
If you don’t have a property management company on your investment team—get one now. Properties that are managed well are properties that realize net operating income growth every year. (Location 748)
The distinct advantage that apartments have over other types of real estate like commercial is that cash flow can be manipulated quickly. In commercial real estate, leases can be for many years. (Location 754)
For instance, imagine you own a piece of commercial office space and sign a lease with a resident at the going rate of $4,000 per month for three years. One year later, demand increases and the going rate is now $4,500 per month. (Location 757)
One of the biggest advantages of multifamily investment is that you can quickly and dramatically increase the value of an acquisition by increasing its net operating income with sound management principles. That means you can (Location 775)
quickly realize the benefits of refinancing the property and reinvesting the equity into other multifamily investments. (Location 777)
People always need a place to live. Shelter is one of the basic requirements of existence. That alone gives multifamily an advantage over other types of real estate investments. (Location 781)
Over the next decade the largest demographic group in forty years will be flooding the rental market. (Location 790)
Retiring baby boomers will thus (Location 805)
be an important factor in the rental market in the coming years. I’m invested in this demographic, and believe one of the best investments is active adult communities. In my first book, The ABCs of Real Estate Investing, I wrote about my building in Sun City, Arizona. I purchased this property specifically because of the coming baby boomer rental market. Today, that property is my single greatest performer and one of the greatest investments I’ve ever made. (Location 805)
We may be seeing the beginning of the golden age of multifamily housing. Numbers like those make it seem like Christmas every day to landlords such as myself. And as if that weren’t enough, there is one more demographic group that will have a huge demand for rental housing: (Location 816)
immigrants. (Location 818)
I’m effectively using the bank’s money to compound my returns five times over my actual investment. I can’t think of cheaper money than that, can you? (Location 840)
4. Business Cycles Multifamily investments are one of the only sectors of real estate investment that aren’t affected by business cycles traditionally viewed as negative like rising interest rates—if you already own the property. In fact, rising interest rates are a godsend to a landlord. As interest rates rise, homes becomes less affordable. What does that do? It makes demand for rental (Location 842)
housing even higher because it becomes the affordable option. As demand increases, occupancy and rents increase. This is not the case for single-family housing or commercial real estate. For commercial real estate investors, when housing becomes more expensive, market conditions become more strained. This is because given the choice between allocating income to housing—a basic human need—and an office, a potential resident will choose housing. They might even set up a home office. (Location 846)
In addition to the market advantages, there are also some operational advantages to investing in multifamily buildings. The maintenance is much less sophisticated than in commercial buildings. In an average multifamily (Location 850)
property, most maintenance issues can be fixed by an on-site technician. (Location 852)
In multifamily, the “turning” of a unit takes much less time and is much more affordable than in other real estate investments. Turning a unit refers to the process of cleaning and repairing the unit when a resident moves out so that it can be rented again. On a professionally managed property, a unit can usually be turned in less than three days. The cost is generally minimal. (Location 861)
Refinancing is a valid option if you have the ability to cover the new mortgage that your smaller properties will have from obtaining new loans. Chances are, however, that your smaller properties will not be able to cash-flow once the equity is drawn. Look at (Location 896)
Since appreciation on average is higher than rent growth, you would probably not be able to cash-flow on the properties anymore. (Location 900)
The bank will give you up to 80 percent of your equity in a new loan. (Location 914)
In each of the properties that follow, I will show you how we found the opportunity, what our business plan was for the property, how we executed the plan, and what happened after executing the plan. (Location 941)
Don’t be afraid to pursue a property just because it isn’t listed. Everything is for sale. It just has to be the right price. (Location 959)
There is no need for you to try to figure out what a market’s capitalization rate is; you can get that from your local broker. (Location 967)
After my team and I had determined what our offering price was going to be, we drafted a letter of intent (LOI) to the owner detailing the terms of our offer. The purpose of the LOI is to negotiate (Location 973)
the basic terms of the deal before moving to a purchase and sale agreement, the PSA. (Location 974)
accepted we moved into the purchase and sale agreement negotiations. (Location 978)
Never, and I mean never, try to negotiate a purchase and sale agreement on a large deal without the help of good, qualified legal counsel. (Location 979)
When you are using OPM (Other People’s Money) for a multifamily investment you want to be sure that the operations of the property can pay for the mortgage and still provide a good return to the investors. (Location 1014)
The goal when shopping for a loan is to find one that works best for both you and your investors. Don’t just settle for the first term sheet you get from a lender. Use those term sheets to play one lender off another. Make them compete for your business. (Location 1020)
At this point, we also contacted our lawyer so that he could begin the process of forming the legal entity that the property would operate under. I always place any investment property that I acquire into a single-purpose entity, like a limited liability company (LLC). (Location 1026)
Step Five: Once we found the loan we were looking for, we had all the information we needed to present our investment opportunity to our investors. We had a property in escrow under a purchase and sale agreement, the start of a business plan that included a detailed construction plan for the adjoining land, and the financing terms. The only remaining task was to actually (Location 1030)
raise the remaining equity for the down payment. We do this on all our deals through an investment summary. An investment summary is a business plan that outlines all the pertinent details of a deal in an easy-to-read document for review by our accredited investors. (Location 1033)
Typically an investment summary should include the following: (Location 1038)
A description of the limited liability company. Disclose the name of the LLC and what the purpose of the entity is. This should be a single-asset entity. (Location 1046)
Once our investors committed the needed equity amount, we sent them legal documents for submitting their equity commitments and sending their money to use. We placed all funds in a trust account for the day of closing. (Location 1076)
We also had the added benefit of purchasing the building in Tucson, where the market was just beginning to take off. Once we had finished the construction of the new units and had been operating the property for a couple of years, we knew it was time to refinance the property and take advantage of the tax benefits by pulling out and distributing some of the value to our investors. (Location 1106)
We purchased Fountains at Sun City in 2000 for $9 million. The seller was a New York City billionaire that had developed the property and was selling it fairly new. (Location 1131)
It’s in one of the hottest active adult communities in the Phoenix metropolitan area, Sun City, which is the largest and first of its kind in the country. (Location 1133)
By dividing the $54,600 in extra rental income by a 6 percent capitalization rate, we can see that just by raising the bottom-floor rents by $50 we increased the value of the Fountains at Sun City by $910,000 in about a year. (Location 1151)
We instituted a resident utility billing system, commonly referred to as RUBS. The concept behind RUBS is (Location 1197)
actually fairly new in the apartment industry. It’s charging back a portion of the utilities used by the residents. (Location 1197)
I love multifamily real estate. I don’t have to worry about the value of the properties around me. All I have to worry about is operating my property to its optimal performance. (Location 1214)
As I’ve done so many times before, I gave the majority of the ownership to those who put money down to purchase it. The concept is simple: You find a great apartment investment, raise the equity required to purchase it, and give the equity participants on your team the majority ownership— keeping an interest for yourself. (Location 1244)
Here’s a secret you should know: There’s a nearly inexhaustible supply of people who are looking to invest their money in a good deal. All you need to do is (Location 1256)
find it and the hardest part is done. (Location 1257)
However, when it came time to get the multimillion-dollar loan required for our 356-unit acquisition in Oklahoma City, we didn’t have any trouble. (Location 1272)
Here is what I mean. I purchased a building in Oklahoma City. I had never been to Oklahoma before I invested there. I didn’t know a soul in the city. What I did know was that its economy was on the upswing and the apartment market there was affordable to invest in; therefore, there were some good deals with (Location 1308)
profit potential. (Location 1310)
From my office I spent a lot of time reading about Oklahoma City and its submarkets. Then I looked at broker listings and evaluated individual properties. Finally, I found an awesome deal. The first person I contacted in Oklahoma was the broker who had listed the deal. Through him I was able to get the names of local experts, as well as more up-to-date financials for my operational analysis of the property, and some helpful data on the local market. I then did some Internet research on Oklahoma City property managers, city officials, other brokers, and so on. Before I ever set foot in Oklahoma City to look at the property, and before I had ever met anyone there, I already had a number of meetings lined up to begin the process of assembling my team. (Location 1310)
The number one mistake an investor makes is that they take everything the seller, or the listing broker, says at face value. (Location 1339)
What you need to remember about a listing broker is that they work for the seller, and they are motivated to obtain the highest purchase price. (Location 1341)
For one thing, it is easy to go to a broker’s Web site and sign up to be on their mailing list for markets that you are interested in. Usually, they will be able to e-mail you new listings with flyers on the properties. By filling out a confidentiality agreement, you can obtain valuable financial information about a property you’re interested in and the market it’s located in. (Location 1345)
Additionally, larger multifamily brokerages, such as CBRE or Hendricks & Partners, produce market studies with detailed information for a variety of markets all over the United States. You can obtain these for free. I’m on many broker mailing lists. (Location 1348)
Purchasing a property that has deferred maintenance is not always a bad play, but it is always a costly one—both in time and in money. Deferred maintenance is maintenance that should have been completed but that has been put off, and put off, and (Location 1403)
Unfortunately this could have been avoided by a simple audit of the property files. My colleague’s lack of proper due diligence ended up costing him millions in value. (Location 1419)
Before you look for the building, look for the market. A big mistake a lot of new investors make is that they are looking for a particular type of building rather than looking for a particular type of market. Your instincts might tell you to purchase your first apartment building in your own backyard. But this line of thinking supposes that just because you live somewhere you will be able to know the area better. While this (Location 1430)
Markets are constantly changing. What may have been the case a year ago could be completely different today. It would be foolish to assume that year-old information would be of use in evaluating property today. (Location 1437)
The following are some things that you should look for when seeking a perfect market for your next investment. (Location 1447)
Real estate markets will have their peaks and valleys—some more extreme than others. The key for you as an investor is to be able to recognize those cycles and to buy in the valleys. (Location 1450)
How do you know when a market is in the valley? (Location 1452)
That’s a good question. Here’s the answer. First off, there are some valleys that you don’t want to buy in. What I mean is that there are markets that are just beginning to fall. The key is to find a market that is at its lowest point, find the right property, and then ride the wave all the way to the top again. This is my tried-and-true method. I’ve been able to amass huge amounts of profit by purchasing properties this way. (Location 1453)
Since the value of a real estate asset is based on its NOI, you can find the best deals in a market where rents are low, vacancies are high, and concessions are present. But a property like that is only a good deal if the market is ready to pick up again—that occupancy will get better and rents will rise. (Location 1456)
Several years ago, Las Vegas was a perfect market. With this in mind, I purchased two buildings in the city in 2004. We definitely bought at the right time; rents and occupancy have been on the rise ever since. (Location 1460)
The number one indicator that a market is ready to explode is to look at its population and employment growth statistics, which are available on the Internet and through public information services, like the U.S. Census Bureau, and are projected by a number of sources. The simple fact of the matter is that growth will beget growth. (Location 1468)
Ideally, rapid employment and population growth create pressure on both vacancies and rents, since there is no way for the supply of apartments to keep up with demand. (Location 1472)
By doing a little research, we knew that the largest expansion of the Las Vegas Strip in history was going to happen over the next decade. A number of casinos were in development and it was estimated that over the next several years over 35,000 new hotel rooms would come on-line. (Location 1476)
Now let’s compare employment and population growth with apartment rent. Here is a chart comparing the statistics: Source: Don Hendricks, Hendricks & Partners (Location 1481)
And, as expected, rents did not climb immediately. The reason is that it will always take a little more time for rents to readjust to changing market conditions because leases last from six months to a year, and rents cannot be raised until the leases expire. But once we began to see the positive trends in employment and population we were confident that rent growth would follow and began searching for properties to purchase in early 2003. (Location 1487)
In an effort to meet the demand for affordable housing, many investors and developers swooped into town. Taking advantage of the decreased value of multifamily housing, they purchased apartment buildings in order to convert them to condominiums. Maybe you’ve heard of condominium conversions. They’ve been prevalent in every real estate cycle. Basically a condominium conversion is exactly what it sounds like. A developer purchases an apartment building, works with the city to change the legal status of the building from an apartment to condominium, and then sells the units to individual buyers. (Location 1512)
We had been paying attention to the market trends by reading reports of sales activities in Las Vegas. We knew what was coming, and we knew that if we purchased an apartment building at the right time, we would be able to capitalize on this market trend. (Location 1523)
By the first quarter of 2005, the rate of apartment rent growth had spiked to over 8 percent, according to MPF YieldStar. (Location 1536)
When you are looking to pick a (Location 1538)
market for investing in multifamily housing, you should pick a market that is in the valley, not at its peak, when it comes to employment growth, population growth, and supply and demand. (Location 1538)
Besides employment growth, population growth, and demand—what I believe to be the top three indicators of a good market—there are some other indicators that you should look for that can be a great (Location 1543)
benefit to you as an investor. I’m speaking of barriers to growth, geographically or self-imposed, such as urban growth boundaries. A barrier to growth is anything that would prevent further development of apartment buildings in a certain area. There are many things that can contribute to this: • Submarkets that are fully built out or developed • Government-protected land • City boundaries • Zoning changes • Natural formations such as mountain ranges or bodies of water Las Vegas is a good example of a market with barriers to growth. The city is almost completely built out, meaning that it cannot expand further into the desert such as a city like Phoenix can. The reason is that (Location 1545)
on one side Las Vegas is surrounded by a mountain range, and on the others it is surrounded by federally protected land. (Location 1557)
Some cities have instituted their own legislated versions of barriers to growth. These are commonly called urban growth boundaries. (Location 1571)
No matter the reasoning behind it, there is little doubt that urban growth boundaries contribute to (Location 1576)
rising hosing costs. More than three-quarters of the people living in the Flagstaff area say the cost of living is unaffordable—with housing as the number one concern. (Location 1577)
Though they are not a sure sign of a great rental market, barriers to growth and urban growth boundaries are something that you should keep an eye on when looking at a potential market. Coupled with the other indicators that I’ve talked about in this section, they can be a potent catalyst to growth. (Location 1581)
Another indicator to look for when evaluating a market is urban renewal. This is a trend that has been catching on more and more across the nation. Basically, urban renewal is an effort to reestablish cities’ downtown areas as thriving civic centers where people live, work, and play. (Location 1584)
areas. Portland, for instance, enacted its urban growth boundary specifically to encourage people to move into the city center rather than out. Other cities that have undertaken major urban renewal projects are Austin, Texas, and Seattle, Washington. Why is this important? In areas where urban renewal is just beginning, there are huge opportunities to purchase real estate at an exceptional value. Once an urban area starts to realize a surge in population, the price of housing in that area soars. (Location 1587)
They have to rent because according to Bizmapbc.com, housing prices in the neighborhood average over $590,000—significantly higher than Vancouver’s average housing price of $364,033. (Location 1600)
I’m going to give you my secrets to help you develop your own personal Top Ten list of markets for the type of real estate you’re looking for. I use these principles every day (Location 1609)
when evaluating where and when to invest. (Location 1610)
show you some positive patterns that will help you make an informed decision on where you want to invest. Where Are the Jobs? (Location 1611)
When we decided to look at Texas for investment purposes the very (Location 1616)
first thing we did was take a look at what specific cities were doing to encourage employment—and boy where they different! For example, Austin was heavy into Technology and Government and boasts one of the largest universities in the country, the University of Texas. The Dallas city planners were focused primarily on Finance, like banking, as well as in the Oil and Gas industry. San Antonio was booming in the Healthcare field and heavy in Military. Houston was Oil and Gas too, but mostly refineries, which attracts a different type of employee. The list goes on and on. The point here is that each municipality has strengths and weaknesses when it comes to job creation. Some industries are cyclical and tied to demand or even government funding. If you pay attention to these things you can increase your chances of success and these cities need to be monitored regularly before and after (Location 1617)
you invest in a market. (Location 1623)
Why Are People Moving There? Pay attention to the factors that influence why people move. Among the 80 million baby boomers looking to move, the most important factors in deciding where to relocate weighed heavily toward an area’s cost of living and access to preferred healthcare programs—81 percent and 66 percent for the younger boomers. Surprisingly, cultural and recreational amenities, as well as a more favorable climate, ranked higher than being close to family members, including parents, children, and/or grandchildren. (Location 1624)
According to a recent Del Webb survey, nearly one third of older baby boomers plan to move in retirement, with more than 50 percent planning to move to a different state, about 25 percent of them planning to move to a different city within the same state, and less than 20 percent of older boomers planning to move within the same city. (Location 1634)
Migration Patterns of the Baby Boomers and Echo Boomers Pay attention to migration patterns of retirees, these trends will create supply and demand imbalances in certain areas which can often be very helpful for your investment choices. (Location 1637)
Historically people have also moved to areas with moderate climates, like California, Arizona, and Florida. (Location 1641)
The same type of demographic information exists with the echo boomers, so start your research to get educated and gain a competitive (Location 1643)
advantage with your investing. Another huge reason in the decision on where to live is a low cost of living. People want to stretch their hard-earned dollar as far as it can go. This will become more and more of an ongoing concern as we get into a period of higher inflation. (Location 1644)
A great website to monitor the cost of living across the United States is www.bestplaces.net. (Location 1647)
We own apartments all over the western United States and the properties we own near major universities have high occupancy rates—and some even have waiting lists. The universities’ on-campus housing is typically outdated and in high demand. Pay attention to which colleges are actively increasing enrollment and you will find a boom in the local real estate. For more information look at www.stateuniversity.com (Location 1653)
America. This company is called USAA and it employees over 14,000 in the Northern area of San Antonio. Following these types of industries is precisely the reason we bought nearly 1,500 apartments in the Northern area of San Antonio, Texas. (Location 1674)
Pay close attention to these trends. If you invest in a market with a strong military expansion you can do very well. But of course the outcome can be the exact opposite with a base closer, like the one I mentioned in Denver, Colorado. (Location 1681)
government in some form or fashion. If you watch the political moves you can be ahead of a market or a submarket before the demand begins. These industries are usually accompanied with large tax incentives created to fuel investment into these alternative industries. (Location 1688)
Another great resource that monitors markets is the Urban Land Institute or ULI. They conduct an annual study of various markets that goes into much greater detail, it’s called “Emerging Trends.” When I select my Top Ten markets, I utilize the things I’ve (Location 1697)
mentioned here plus a number of other reports. Everyone’s list is different and each list will be based on an investor’s own individual criteria driven by the asset class on which they choose to focus. For example, a student-housing provider would be interested in the migration patterns of the echo boomers and affordability of housing in those areas, whereas the single-family homebuilder would be interested in employment patterns, existing unsold supply of housing, interest rates for homeowners, vacant land, etc. (Location 1699)
Lastly, your Top Ten markets can change. I know this first hand. The markets I was investing in five years ago are quite different today as these economies continue to change and evolve over time. So make it a point to review your markets annually and continue to ask questions of the (Location 1704)
locals in those markets, they typically have a good understanding of what’s going on. (Location 1706)
when you are making your offer, obtain all the actual financial documentation for the property operations that you can. Don’t rely on what is initially supplied to you by the seller. Doing so could blow your deal out of the water once reality sets in and could literally cost you millions of dollars. (Location 1744)
The non-binding letter of intent is meant to be a document that engages the seller in conversation. It is not the final offer on your part, nor will the seller generally accept your first offer. The offer in the letter is meant to be open to negotiation. Generally it will detail at a high level the basic deal points such as offer price, due diligence time frame, escrow deposit amount, and any contingencies time frames you might have. (Location 1763)
The sooner you can get a letter of intent into a seller’s hands the better. I usually email it over. The negotiation will take some time—in fact, don’t be surprised if it takes weeks, so the sooner you can start the better. Time is money after all. You can view sample letters of intent on my Web site, kenmcelroy.com. (Location 1766)
Here is a list of the items that should be included in the purchase and sale agreement: (Location 1788)
As I mentioned earlier, due diligence is one of the most essential parts of the purchase process. This is your one shot to find out every little detail there is to know about the property, and it’s the process that will ultimately lead to your decision to move forward with the acquisition or to move on to the next deal. (Location 1826)
During the due diligence period, there are two aspects of any property that you will dig into—the operations and the physical property, both are vitally important. Performing due (Location 1830)
diligence of the operations requires you to thoroughly review every aspect of the property’s books and records. You want to verify everything that you based your original purchase offer on. (Location 1832)
Physical due diligence requires you to inspect every nook and cranny. That means you will need to walk every square inch of the property and physically observe the exterior and interior of the buildings. You will also need to have professionals take a look at things like the roofs, pavement, plumbing, and so on. (Location 1835)
While in my case I have my own employees to perform this work, there are also property management companies that can do it for a fee. Utilize the property manager on your team to assist you with this process. A little up-front investment of money in this area will save you money down the line. (Location 1845)
The List On each and every property that I perform due diligence on, I have a list of all the items that need to be (Location 1850)
addressed. Having a list is vital to the process. There are far too many details and variables to be able to keep them all in my head, or even on a piece of yellow legal paper. (Location 1851)
Here is a list of the items that I generally require from the seller: • At least three years of actual annual financial statements • Certified rent rolls • The most recent balance sheet • The year-to-date general ledger • Current year budget • Delinquency report • Prepaid rent report • Month-to-date collections report • Current vacancy report • Security deposit report • Twelve-month potential renter traffic report • Bank statements and (Location 1910)
reconciliations for the last twelve months • All loan documentation • A signed affidavit attesting that all the above are accurate You will want to use these reports in order to verify the information that was initially provided to you by the seller. Additionally, these reports will be a valuable resource as you are preparing your financial forecast for the property and determining the operating budget you will use once you own the property. (Location 1930)
Here is a list of all items related to expenses that I verify when I am purchasing a property: • Utility bills for the last three years with account numbers • Staff names, positions, salaries, and benefits • Three-year history of capital improvements, and list of items replaced in the last three years (refrigerators, carpets, and so forth) • List of any and all advertising and marketing contracts (Location 1955)
Management agreement for the property • Property tax information • Insurance information and premium amount, as well as information on any past losses • Three-year work order history • List of recurring maintenance issues • List of required homeowners association memberships and dues • List of personal property to be transferred • Office equipment leases (copiers, computers, and so on) • List of supplies purchased in the last twelve months (Location 1964)
EXTERIOR INSPECTIONS (Location 2049)
When you are doing your exterior inspections you should be engaging the expertise of people who specialize in installing, maintaining, and repairing every aspect of a property. You should create a list of categories that will need inspecting and organize meetings with subcontractors to inspect the property and obtain bids for any work that will need to be completed. The best part is that obtaining bids is (Location 2051)
typically free. It’s considered a normal process for earning your business. Here is a list of general categories you will want to inspect: • Plumbing • Electrical • Roofs • Paint and siding • Landscaping • Asphalt and concrete work • Heating and air-conditioning units • Pest problems • Fire protection systems When you are obtaining bids for these items, don’t just rely on one company. Take the time and effort to meet with a number of companies and obtain competing bids. This will save you money. (Location 2053)
condition. I’ve found that the most efficient way to do this is to use a unit inspection form I call the “Vacant Unit Condition Report”. Once you have finished your interior inspections, you should take all the unit inspection forms and compile the data you’ve collected into a spreadsheet. We prefer to use something like the form on the next page to indicate the condition of each aspect of a unit’s interior. That way we are able to simply mark the column that applies and tally up the numbers at the end. It makes it much easier to estimate the dollar amount that will be needed to fix any interior issues. (Location 2085)
At the same time you are performing your due diligence you will be actively engaging lenders and potential investors in order to raise the money necessary to purchase your property. Generally you will have a loan that ranges from 70 to 80 percent of the sales price, so if you are going to purchase the property you will need to raise 20 percent or more in investor equity for the down payment and capital reserves, (Location 2109)
pony up the money yourself. If you’re anything like I was before I purchased my first apartment building, you’re probably scoffing at the prospect of being able to make a multimillion-dollar investment. Well, I have good news for you. As the old saying goes, there’s more than one way to skin a cat. In large multifamily investing there are a couple things that are in your favor. First off, loans on investments like multifamily properties aren’t entirely based on your credit. They are based on the asset itself. That means you don’t have to be a millionaire. You just have to find a property that will make you one! If you have a solid property and an excellent business plan, you will be able to find a loan. Secondly, money adds up quickly. If you have a solid business plan there will be investors that will want to be a part of the acquisition. (Location 2112)
Don’t have a network of people who are looking to invest? Well then you’re out of luck. Close the book ... just kidding. There is a great option available to you, one that will enable you both to invest in large multifamily investments and start to develop a network of investors. You can invest in a limited liability company (LLC), a single-purpose entity that can be formed to purchase a multifamily investment. In many cases you can participate in such a joint venture or syndication with as little as $25,000—that’s basically a down payment… (Location 2121)
memorandum. This is the required legal document for offering syndications and joint ventures in real estate. If they can’t offer you such a document, stay away; they are amateurs you don’t want to place your money with. But if done properly, with the right documentation… (Location 2126)
We formed an LLC—as we do for every property we acquire—and asked our equity members to invest in the new LLC. For the Oklahoma City property we have a total of twenty investors. Some of them have only $25,000 invested. Others have over $1 million. What they now all have in common is that they own a… (Location 2130)
Whether you are planning on being part of the equity position in an LLC, or planning to form one and raise equity for your own acquisition,… (Location 2134)
When we formed our LLC for the Oklahoma City property we consulted our attorney. He was able to get all the paperwork in order to form the entity. He was also essential in the drafting of the operating agreement. The operating agreement is a vital document in a transaction like this. It spells out who has the… (Location 2137)
company, and lays out the structure for the distribution of profits, among other things. The way we structure our deals is to find the property and get it into escrow with our own funds. If you do not have the money required for escrow, then find a business partner who does. Once we have the property secured, we begin soliciting our investors. In the case of the Oklahoma City property, we had all the equity we needed in literally one day. We earned this, however, over many years of relationship building and a proven track record. Your first deal will take some selling and work, but if you have a solid deal you’ll be able to find investors. My team helps me develop an investor summary, which is… (Location 2140)
Kim Kiyosaki have to sign one for each deal. The lesson here is to never give… (Location 2147)
Once we receive the confidentiality agreements we send out the investor summary/business plan for review. (For information on how to prepare one of these plans on your own, see Garrett Sutton’s The ABCs of Writing Winning Business (Location 2152)
Plans.) (Location 2153)
Financing a multifamily property is not simple. You will need the help of your mortgage broker. When we are purchasing a building we always turn to our mortgage broker. They will be able to obtain multiple quotes for you to review and help you find the best financing available for your business plan. When you are purchasing a property there is one of two ways that you will obtain financing: (Location 2164)
1. Obtaining a new loan or loans 2. Assuming the existing loan (Location 2167)
Once you have picked the loan, the lender will provide you with a document called a loan term sheet. (Location 2182)
review. It will have the following items detailed: (Location 2183)
Use your attorney to (Location 2218)
review the loan term sheet. He or she will be able to tell you the legal implications of the various clauses. (Location 2218)
It’s not uncommon to find a property that has an assumable loan. That means you’ll assume the existing financing on the property after close of escrow. There are many reasons this might be to your advantage. The biggest is that you have the opportunity to obtain a lower interest rate than what the market is offering. Additionally, you’ll be able to review the loan documents during the due diligence process. (Location 2232)
Something you have to be leery of, however, is when assuming a loan, there may be an assumption fee. Make sure to have the mortgage broker on your team analyze (Location 2237)
whether it is more beneficial for you to assume the loan and pay the penalty, or to get new financing completely. Additionally, when you assume an existing loan, you may be facing a large gap between the purchase price and the loan amount. In these cases, you will either have to raise more equity than the standard 20 percent of the purchase price, or you will have to try to obtain a secondary mortgage—if possible. (Location 2238)
One quick note on finding the players for your team. Don’t just flip open a yellow pages and start calling companies who sound professional. That is probably the least productive way. Start asking around for referrals. You will be surprised by the wealth of knowledge that is all around you in your friends, family, and business relationships. They will be able to refer you to many of the people you will need to have an effective team. (Location 2326)
Often your property manager will be well versed in the due diligence process. Utilize him or her. It will make life much easier. Property managers are, just like your broker, a wealth of information. They will know intimate details about the rental market in their area. You can obtain market surveys from them. They will be able to keep you abreast of any changes in the rental market. (Location 2333)
Not just any lawyer will do. Make sure the attorney on your team is an experienced professional practicing real estate law. (Location 2343)
ask your broker who he or she has worked with in the past and who they might recommend. Also, you can check local multifamily trade associations. They often list members who provide legal counsel in a directory of services. (Location 2346)
When interviewing a lawyer it’s important to ask questions that will make them a good fit for your team. Ask what kinds of deals he or she has been involved in. You will be looking for the size of the properties and the number of deals. (Location 2349)
Unless you want to spend your days inputting accounts payable and (Location 2353)
receivables, making journal entries, and producing financial statements, I would hire an accountant. (Location 2353)
As we discussed in the chapter on financing, a mortgage broker can be a valuable asset to your investment team. They will have industry contacts that will be able to find you the best loan possible. (Location 2361)
Make sure that you use a reputable broker who is licensed, bonded, and insured, and who specializes in large multifamily acquisitions. You can’t just go down the road to your local mortgage company. The financing is too complicated. (Location 2363)
We’ve discussed the many uses for commercial brokers throughout the book. By now you should already understand the importance of having one on your team. (Location 2370)
Besides being a useful resource in your search for investment multifamily deals, your broker can (Location 2374)
be a wealth of information. Make sure to consult him or her frequently on market conditions. He or she will be able to pull reports on comparable property sales in your market, provide you with rental market comparable studies, and help you determine the capitalization rates in your market. (Location 2374)
The problem is that insurance is extremely expensive. In fact, it is one of the biggest expenses associated with operating your property. That is why you want to get the best deal possible. Your insurance broker will be instrumental in obtaining the best policy for your buck. (Location 2382)
Again, you can’t just call your local agent for this and get the high level of expertise necessary. You will need to find a firm that specializes in policies for large investment properties. The firm you choose must understand the unique needs and nature of multifamily investments. A qualified firm will be able to provide you with quotes from a number of carriers. (Location 2385)
Having an appraiser on your team will help you when you are determining the value of a property for loan purposes. Additionally, he or she will be able to help you identify sales trends in the market. Appraisers, like brokers, make their living by having an ear to the ground. (Location 2400)
Taxes are one of the biggest expenses your property will have. Looking to appeal your taxes should be an annual exercise. Each property should be evaluated to be sure that it is in line with the surrounding properties. (Location 2410)
You will want to find yourself a good engineering company. It will be useful in the construction of new properties and often for existing properties, as well as during the time that you own your investment. You can utilize your engineer to perform inspections during your due (Location 2421)
diligence periods in order to investigate any troubling things you may find in the studies on the physical nature of the property about which the seller may not even be aware. (Location 2423)