Month: October 2021

Once you decide to invest outside your local area, the possibilities are limitless. This can be exhilarating and overwhelming at the same time.

A tidal wave of thoughts may come flooding in immediately. Should you consider a bustling city or a metro area? You may reminisce about a vacation you enjoyed and the gorgeous buildings you saw there.

You could dive down every possible rabbit hole, cross-referencing “best real estate market” lists, trying to make sense of current population trends, and even looking up news local to areas you’d be interested in. Honestly, this won’t really help you draw any conclusions, plus you’ll waste a ton of time and energy.

Instead, begin by assessing your personal investing goals. Maybe you want to invest in a growing market that also provides decent cash flow. Using that basic framework, this research checklist will help narrow things down:

• Job Growth
• Population Growth
• Job Diversity
• Landlord/Tenant Laws
• Taxes
• Geographical Features
• Cost of Living
• Local News
• Local Government
• Whether You Have an Unfair Advantage

 

Job Growth

Since steady job growth is indicative of a healthy local economy that’s likely attractive to new businesses, developers, and residents to the area, this is the most important metric to evaluate in each market.

Job growth is a leading indicator of population growth. The more jobs, the more residents, the more likely the area will maintain a strong tenant base. When more people are attracted to an area, the demand for housing increases, which drives up rent and real estate prices.

Population Growth

Since the population in a certain area could be affected by natural disasters, migration patterns, and more, you always want to research it after job growth.

Finding an area with long-term upward population growth trends (not a temporary bump) is key, and a major factor supporting that trend is job growth in the area.

These two metrics provide a full picture of the health and future of a given market.

 

Job Diversity

You want to find an area with a variety of industries supporting the local economy. Strong job growth is much less enticing if you discover that most of the jobs in the area are, say, in the tourism industry.

A recession or a negative news story could largely impact the number of tourists, and therefore the job growth and the population trend. A diversified job market is much more attractive since a hiccup in any single industry likely wouldn’t affect the area as a whole.

 

Landlord/Tenant Laws

Beyond the top 3 factors – Job Growth, Population Growth, and Job Diversity, the next best factor to learn about has to do with the laws governing rental properties.

Rent control, for example, is great for tenants but makes it incredibly challenging for landlords to make a return on an investment in an area where costs for contractors, pest control, and property management are skyrocketing.

As an investor, you want some insight from local property managers who are intimately familiar with these laws, so you can find landlord-friendly areas.

 

Taxes

While usually the last thing on investors’ minds, taxes can make a huge difference on the bottom line.

State income taxes and property taxes will both impact your operating budget thus, your overall return. Each state has a different tax structure and it’s good to understand what you’d potentially be getting into so you won’t be surprised later.

 

Geographic Features

Use Google Maps to check out the actual, physical landscape of the area. Look for physical barriers like a body of water, a mountain range, or any other geographical features that could inhibit the physical development of the area.

As an example, coastal cities are limited by the ocean. Development can only get so close to the water, which forces them to build upward or expand into the suburbs. This drives up the value of centralized real estate, especially in a time of job and population growth.

 

Cost of Living

By seeking out an area where the cost of living is low, especially in comparison to the median income in the area, you’re more likely to experience growth. If people can afford to live in the area easily, there is room for the cost of living (i.e., rent) to rise as more jobs and people move into the area.

 

Local News

While the other, previously listed factors are much more important, once you’re pretty “sold” on a certain area, you may want to track a few local news stories.

It would be great to have some heads-up about new companies moving to (or away from) the area, local announcements, community developments, and anything else that would allow a sense of understanding of the local economy and potential future of that market.

 

Local Government

Just as with the local news, the local government is indicative of the area’s future standings. It’s a good idea to invest in areas with strong local leaders who support new initiatives, an expanding local economy, and who’s vision includes making the market vibrant and welcoming.

Strong leadership from the local government is attractive to corporations, which means that job growth will continue.

 

Whether You Have an Unfair Advantage

There’s always the chance that you have greater insight into a certain area, more so than other investors. Maybe you have a close cousin or best friend who lives there, maybe you went to college there, or you grew up there.

Any time you possess an unfair advantage, more weight should be given to that market. Local connections or a little history with a particular area can put you leaps and bounds ahead of other investors.

 

What About Investing Passively In a Real Estate Syndication?

As a passive investor, you’ll focus on finding a strong sponsor first. Once they let you know about potential deals, you can use these 10 factors, in combination with your personal criteria and goals, to conduct your own thorough research while avoiding overwhelm.

Any time a potential investor is reviewing real estate syndication investment opportunities, they’ll likely come across the term “equity multiple”. Even if they’ve purchased a primary home or a residential rental property before, it’s unlikely they’ve heard of equity multiples.

When it comes to passively investing in real estate syndications, however, it’s an important phrase to know and understand.

What “Equity Multiple” Means for Investors Interested in Real Estate Syndications

As a new or seasoned real estate investor, it’s important to know what you’re getting yourself into. Part of that awareness comes from understanding the metrics presented in the investment summary prior to agreeing to the deal.

As passive investors review potential real estate syndication deals, the term “equity multiple” might seem confusing or even daunting if no one’s ever explained what exactly that means.

Alternately, our investors have shared with us that, after they grasp the concept of equity multiples, they are able to more confidently compare projected returns and make wiser investment decisions.

Defining “Equity Multiple”

The initial amount invested into a deal is an investor’s capital. That capital equals the amount of equity an investor has in the passive investment. Thus, the term Equity Multiple simply means the amount your capital (or equity) will be multiplied by the end of the deal.

If a real estate syndication deal has an equity multiple of 2x and a projected hold time of 5 years, that means investors can expect to double their capital (original investment) in that 5 year period.

The equity multiple is the total of the cash flow distributions plus the returns after the sale of the asset.

A Little Math to Help Demonstrate

How about we explore an example deal with a 2x equity multiple?

The investment (capital, also referred to as equity) is $100,000 and this deal has a projected annual rate of return of 8% with a 5 year hold period. This means the investor may receive about $8,000 per year for 5 years.

In other words, over a 5 year period, the investor will have received a total of $40,000 in cash flow distributions. Then, when the asset is sold, investors receive their initial $100,000 back, plus another, say, $60,000 in profit from the sale.

When the $40,000 in cash flow distributions and the $60,000 from the sale are added up, that’s $100,000 in total returns. The investor began with $100,000 and, not only got that back but also earned an additional $100,000 cash.

In this example, the investor has doubled their money, which is what it means to have an equity multiple of 2x.

How Passive Investors Might Look at Equity Multiples

In real estate syndication deals, it’s actually quite reasonable to expect to double your investment over the course of 5 years, but that doesn’t mean these deals are easily found. Here at New Level Investments we aim to present our investors with a 2x equity multiplier over a 5 year hold period.

Remember, the equity multiple, just like any other projected return or rate, is projected. That means it’s estimated using formulas, algorithms, and expectations of the market, and it’s not guaranteed. The actual returns may be below the projections shown on the investment summary, or they may far exceed what was thought possible.

All in all, investors should be reviewing the details of any presented deal with a discerning eye and ask any and all questions that come to mind until they feel comfortable with the information presented and confident that they are ready to move forward.

Now that you fully understand equity multiples, you can approach the next deal with confidence around that term.

Imagine spotting an old bookshelf sitting out on the curb. You pull over to check it out, and since it’s in good shape, you proceed to lug it home and give it a fresh coat of paint.

A few years later, you sell the shelf to someone else who claims to have the perfect spot for it.

You took something that had been overlooked, committed some sweat equity, and breathed new life into it. This is the essence of value-add, and it’s a commonly used strategy in real estate investing.

The Basics of Value-Add Real Estate

In the case of single-family homes, the process of buying a run-down property, remodeling it, and then selling it for profit, is commonly referred to as fix-and-flip. Your sweat equity and ability to see a diamond in the rough is rewarded monetarily, and the new owner gets an updated, move-in ready home.

Value-add multifamily real estate deals follow a similar model, but on a massive scale. Hundreds of units get renovated over years at a time instead of just one single-family home over a few months.

A great value-add property may have peeling paint, outdated appliances, or overgrown landscaping, which all affect the curb appeal and the initial impression that a potential renter will form. Simple, cosmetic upgrades can attract more qualified renters and increase the income the property produces.

In value-add properties, improvements have two goals:

• To improve the unit and the community (positively impact tenants)
• To increase the bottom line (positively impact the investors)

Value-Add Examples

Common value-add renovations can include individual unit upgrades, such as:

• Fresh paint
• New cabinets
• New countertops
• New appliances
• New flooring
• Upgraded fixtures

In addition, adding value to exteriors and shared spaces often helps to increase the sense of community:

• Fresh paint on building exteriors
• New signage
• Landscaping
• Dog parks
• Gyms
• Pools
• Clubhouse
• Playgrounds
• Covered parking
• Shared spaces (BBQ pit, picnic area, etc.)

On top of all that, adding value can also take the form of increasing efficiencies:

• Green initiatives to decrease utility costs
• Shared cable and internet
• Reducing expenses

The Logistics of a Multifamily Value-Add

The basic fix-and-flip of single-family homes is pretty familiar to most people, but when it comes to hundreds of units at once, the renovation schedule and logistics aren’t as intuitive. Questions arise around how to renovate property while people are living there and how many units can be improved at a time.

When renovating a multifamily property, the vacant units are first. In a 100-unit complex, a 5% vacancy rate means there are five empty units, which is where renovations will begin.

Once those five units are complete and as each existing tenant’s lease comes due for renewal, they are offered the opportunity to move into a freshly renovated unit.  Usually, tenants are more than happy with the upgraded space and happy to pay a little extra.

Once tenants vacate their old units, renovations ensue, and the process continues to repeat until most or all of the units have been updated.

During this process, some tenants do move away, and it’s important for projects to account for a temporary increase in vacancy rates due to turnover and new leases.

Why We Love Investing in Value-Add Properties

When done well, value-add strategies benefit all parties involved. Through renovations, we provide tenants a more aesthetically pleasing property, with updated appliances and more attractive community space. By doing so, the property becomes more valuable, allowing higher rental rates and increased equity, which makes investors happy too.

The property-beautification process and the fact that renovated property is more attractive to tenants is probably straightforward. But let’s dive into why value-add investing is a great strategy for investors.

First, Yield Plays

 To fully appreciate value-add investments, we must first understand their counterparts, yield plays. In a yield play, investors buy a stabilized asset and hold it for potential future profits.

Yield play investments are where a currently-cash-flowing-property that’s in decent shape is purchased and held in hopes to sell it for profit, without doing much to improve it. Yield play investors hold property in anticipation of potential market increases, but there’s always the chance of experiencing a flat or down market instead.

In a yield play, everything is dependent upon the market.

Now, Let’s Get Back to Value-Adds

 Value plays and yield plays are the opposite. In a value-add investment, significant work (i.e., renovations) takes place to increase the value of the property and doing such improvements carry a significant level of risk.

However, value-add deals also come with a ton of potential upside since the investors hold all the cards. Through physical action steps that improve the property and increase its value, value-add investors don’t just hold the asset hoping for market increases.

Through property improvements, income is increased, thus also increasing the equity in the deal (remember, commercial properties are valued based on how much income they generate, not on comps, like single-family homes), which allows investors much more control over the investment than in a yield play.

Of course, a hybrid yield + value-add investment is ideal. This is where an asset gets improved as the market increases simultaneously. Investors have control over the value-add renovation portion and the market growth adds appreciation.

Now, before you get too giddy about the potential of a hybrid investment, there are risks associated with any value-add deal.

Examples of Risk in Value-Add Investments

 In multifamily value-add investments, common risks include:

• Not being able to achieve target rents
• More tenants moving out than expected
• Renovations running behind schedule
• Renovation costs exceeding initial estimates (which can be a big deal when you’re renovating hundreds of units)

 Risk Mitigation

When evaluating deals as potential investments, look for sponsors who have capital preservation of the forefront of the plan and who have a number of risk mitigation strategies in place. These may include:

• Conservative underwriting
• Proven business model (e.g., some units have already been upgraded and are achieving rent increases)
• Experienced team, particularly the project management team
• Multiple exit strategies
• The budget for renovations and capital expenditures is raised upfront, rather than through cash flow

Value-add investments can be powerful vehicles of wealth, but they also come with serious risks. This is why risk mitigation strategies are important – to protect investor capital at all costs.

Recap and Takeaways

No investment is risk-free. However, when something, despite its risks, provides great benefits to the community AND investors, it becomes quite attractive.

Properly leveraging investor capital in a value add investment allows drastic improvements in apartment communities, thereby creating a cleaner, safer places to live and making tenants happier.

Because investors have control over how and when renovations are executed, rather than relying solely on market appreciation, they have more options when it comes to safeguarding capital and maximizing returns.

Sounds like a win-win!