Nailing Overhead

Gathering operating expenses can be tricky when entering a new market and vary greatly depending on the location of the asset.

Everybody needs to pay their property taxes, insurance, maintenance costs, common area utilities, and budget for cap ex- but how do you gather firm estimates of these expenses to inform your underwriting?

Property Taxes- Your real estate brokers will have estimates on this, these can range from 1-2% of the property's purchase price. You won't pay the same rate as the current owner- need to make sure you have a tight projection of what these future taxes will be.

We also like to review all of the information on the the local tax assessor's website. If we have any questions, we'll call them to get further context.

These are often nice conversations with somebody who has likely lived in that city for a long time- great opportunity to ask about their experience.

Insurance- Collect references from your real estate brokers, lawyers, lenders, and/or do a quick Google search for commercial insurance brokers in X city. From here, find their website (make sure they're properly licensed and credentialed), reach out, and start to dig into their approach.

How responsive are they? Who would be your main point of contact? How do they structure policies for your asset type? What do their claims processes look like? What information do they need to pull quotes? What is the timeline to receive quotes? How many years have they worked in this market? Will they fight to save you money when possible?

Gather these inputs and then send over 2 sample listings for quotes. You're looking to nail down the costs to insure the asset and for variations in pricing across the brokers.

After pulling enough quotes, you'll have a firm idea of insurance costs and will hopefully have a great broker informing these inputs.

Maintenance Costs- Vary based on the property condition and market. These are often handled by your property management company (who can assist in finding these costs) but will be billed back to you. Important to account for both recurring and unforeseen maintenance costs.

Garbage Removal: In many cities, owners of buildings with more than 4 units need to hire a private garbage removal service. These can range from $75-$500 a month depending on the size of the complex. Broker referrals, a quick google search, or P&L's provided by sellers (which can list the name of the servicer) will provide options. Contact them and get pricing.

Snow Removal/Landscaping: Same process as the above

What preventative maintenance is needed?

Annual MEP inspections- who provides these and what do they cost? Ask your PM.

Who's replacing the air filters each quarter? Nail down every cost you can foresee. 

Common Area/Owner Paid Utilities: Listing P&L's and brokers can provide color- back in to what these cost on a monthly basis (make sure you blend these across 12 months, summer usage can be different than fall usage, be very cognizant of meter counts).

Why Sub-Institutional Multifamily?

There are many tiers of multifamily buildings ranging from duplexes to 1,000+ unit apartment complexes.

Each tier has its typical incumbents and characteristics. 

The owner of a 20 unit apartment complex is likely much different than the owner of the 400 unit apartment complex. 

As you get below the ~$25m range, these deals are deemed to be sub-institutional.

Meaning, the check size is too small to garner interest from these organizations. Makes sense if you need to deploy billions of dollars.

There are also many tiers within this sub-institutional range but we'll generalize for now.

For the most part, assets that are sub-institutional are typically owned by HNWI's, mom and pop operations, Uncle Jimmy who picked up 50 units for $100k in 1975, etc. 

So why focus on sub-institutional? 

The properties owned by institutions are operated by professionals whose full time job was to source, develop, and stabilize the asset in discussion. 

Moreover, they can leverage billion dollar balance sheets to ultimately secure property and carry out their thesis.

We're not interested in competing with these organizations.

Instead, 

We focus on the properties that aren't operated by big real estate organizations as they provide more opportunities for us to add value.

These assets often aren't optimized for performance and instead, are treated as the secondary sources of income that they are.

Some examples:

Self Management- we still see owners who go door to door to collect rent checks on the first of each month and/or elect to keep rents low to avoid turnover.

Condition- you often won't see preventative maintenance or annual inspections with these building types. This can lead to the deterioration of the property over time, especially if capital expenditures aren't budgeted for.

Exit Strategies- the owners of sub-institutional assets likely aren't working with limited partners nor do they need to exit at a certain cap rate. They're often long-time holders who will be earning a great multiple on their investment no matter the final price.

Focusing on this asset class affords us with:

1.) Limited competition and a smaller buyer pool- our niche is targeting assets that are too large for the average mom and pop operator but too small to garner interest from institutional investors, leaving us a nice sweet spot.

2.) The potential for higher returns given the prevalence of inefficiencies. Our minimum return threshold needs to be higher than most given that we're sharing ownership stakes with our partners. From integrating professional management to executing renovations, these are all outlets to increase performance.

3.) Mobility- Naturally, a 20 unit apartment complex should require a much shorter renovation period than a 400 unit. These shorter timelines allow us to return properties back into commerce and stabilize them at faster rates.

4.) Less downside risk (we're of course sacrificing scale).

Picking the Path

There are many real estate strategies- the game is finding the one that most closely aligns with you and what you're trying to accomplish.

Each outlet has its perks and drawbacks. Accordingly, flippers operate differently than those who buy and hold.

One of the best ways to generate positive outcomes is by ensuring the development strategy meshes with the overarching thesis.

We buy 4-25~ unit apartment buildings in walkable urban cores, renovate them well, and hold them for a long time.

Why?

-Longer Runway- we seek out supply constrained markets where it's incredibly difficult (if not impossible) to build any more of these properties and intend to compound growth over decades.

-Control- we don't want the outcome of any project to be predicated on what somebody else would pay for it (can't predict what the market will look like a year from now). Instead, we focus on digging out and maintaining yields that we're comfortable receiving over many years.

-Operations- we know the the internal workings of each building, being that we've likely done extensive renovations to it- positioning us well as long-term operators.

-Longevity- we hope to create a generational portfolio of properties (with like minded partners) in great locations- hard to do if you're selling good assets every few years.