Getting Granular

One thing we've experienced in expanding into a new market:

A learning curve.

Every city has countless sub-markets and within those are corridors that are unique and bring their own quirks/amenities into the picture.

It's very easy to drive a city over the course of a few days and occasionally pop out for a coffee.

But this will leave us with a baseline experience and unsure of our own underwriting.

We need to source the local’s perspectives on the location(s), integrate them, and then create our own thesis with this information.

Meaning, we need to understand:

-we can't go past X street without experiencing crime

-X corridor is the lifeline of the neighborhood

-what bars/restaurants are favored/hated by residents

-what areas are transitioning (and in what direction)

-how walkability decreases after X avenue

-where are target tenant base lives and why

-plans for future development or infrastructure (these can often take 10 years to materialize, don't be too early)

-the streets between X and X present a parking nightmare for residents

Our Process:

1.) Take extended trips to fully understand the market, sub-markets, and the residents within them. A lot can change in 100 yards and the quiet neighborhood we toured on a Wednesday night might turn into an NFL pregame location on Saturday.

Source the landmines in that market: Corridors plagued with crime, areas of low density, retail dead zones, and whatever else could antagonize our strategy.

2.) Create our baseline: Pull countless P&L's from listings, insurance quotes, assessment records, and old permits to form expectations for operating costs.

3.) Validate operating costs: contact local trash/landscaping/property management companies to confirm the $X charge listed on the P&L is on par for a building of that size (most of the time it isn't ha), leverage the assessor's office to nail the future tax bill amount, splice through insurance quotes to ensure competitive pricing, confirm permit processes and typical timelines (each city is different), source renovation costs on a per sq. ft basis (this takes time), etc.

4.) Take reps: create our map, source the assets within it that fit our menu, see who owns them, and underwrite them (even if they're not for sale).

5.) Assemble the team we'll need to operate.

6.) Keep our ear to the ground on local politics, property transactions (even if they don't fit our menu, it's good to know who's doing what in the city), new developments, and don't stop talking to brokers.

With enough reps, these processes get refined and ultimately allow us to move quickly (good things don’t sit).

How We Underwrite Potential Rents

Correctly predicting gross rental income is one of the most important parts of underwriting real estate- hard to nail it to a T but we get quite close.

Market rents will tell us a lot, but we need to blend:

-Where exactly the property is vs. market rates in this area (you can get $3.50 a sq. foot in a prime location and half that if you're in the same neighborhood but on the outskirts)

-Condition/Amenities (how do you or will you compare to surrounding inventory?)

-Sq.footage (tiny rooms and low ceilings will always make units tougher to lease)

-Floor plan (open lay-outs do best)

Whether the property is vacant and/or needs renovations- we need to source the rates we can achieve given the above and ensure we're not making apartments "too nice" within the scope of the project.

If we execute a luxury renovation to a bunch of 1 bed units, we'll be capped on rents if they're each 400 sq.ft.

After pulling enough listings and talking to enough people, we're able to tailor rates based on the product we’re dealing with.

Every property is different (we once looked at an apartment complex that got zero natural light), just need to account for how and adjust strategies accordingly.

Keep Your Supply Lines Open

One of my favorite books is “How to Stop Worrying and Start Living” by Dale Carnegie.

A famous concept in the book is to “keep your supply lines open,” which alludes to always maintaining a backup plan.

In the context of the work, the open supply line was a job at home that the character could always return to if he was ever in a bind.

For us, keeping supply lines open applies to several verticals:

Network: Treat people well, keep in touch with them, and look to provide value where you can.

-Contractors, potential investors, brokers, attorneys- If you cross paths with good people but couldn’t work with them at that point in time, it doesn’t mean you won’t in the future.

-The foundation guy whose bid was too high might be the perfect person for small masonry repairs down the line.

-The attorney you crossed paths with might be a fit for your friend’s new ground-up development, make the referral.

-The broker who sent over countless deals that didn’t work for you might source a home run in the future- keep lines of communication open.

Underwriting/Asset Protection: You don’t know what’s behind the walls of the property you’re about to buy or what the market will look like 12 months from now.

- Have a plan for when things go wrong and a process to handle each issue (which will likely involve tapping your network).

-Get your renovation costs priced out during the inspection period but account for the issues you can’t see so your budget doesn’t get whacked when they find rotted framing.

-Be conservative with leverage (debt can either amplify returns or crush you).

-Stress test your property and make sure you can survive a ~25% decrease in rates (this also points to conservative leverage).

-Place appropriate insurance coverage on assets and make sure the replacement costs listed in the policy are accurate (construction costs are different today than 10 years ago) – if the property burns down, at least you’re not losing everything.

-Buy assets in good locations- related to the concept above, if you lose everything, you still have good dirt.

Reserve Capital: Processes will take longer than expected, things will break, and hang-ups may occur.

-Account for holding costs (then extend your projected timeline) so you don't run out of money during the renovation period and take guys off your job site.

-Maintain cap ex, vacancy, and maintenance reserves- If you're not budgeting for these, a major repair could incinerate your returns.

We can’t predict everything but we can better position ourselves to take the punches and still execute.