May 12

Finding The Right Market In Which To Invest (Part 1)

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Trying to find the right market to invest in can be a monumental and confusing task. Remember, the goal of market analysis is to minimize the risk of your investment while maximizing the opportunity for you to earn a higher return. Below is a list of Seven Steps I perform whenever I am looking to invest in any market. (This post has steps 1-4)

Step #1: Find the Market:

In order to find the market to invest in, I start with basic economics. I look at the supply versus the demand.

To Determine the Demand I look to see:

  • Who are the Users?
  • Where are they located in comparison to the subject property?
  • What is the income level in comparison to the rental amount charged or the tenant mix of the property? It does not make sense to locate a designer boutique retailer near section 8 housing. Likewise, if your income level of your potential tenants is around $12,000 per year, you can not expect to charge $800 a month for rent.
  • Who are the main employers? This is critical because jobs bring people to an area and people like to live and shop near where they work.
  • What are the commuting patterns? If your potential tenants need public transportation, then you need to focus on a property that has convenient access to bus routes. Also, accessibility to major highways is always a positive attribute to a property location.
  • Lastly, to determine demand I look at the overall demographics. If your target population is families with 1.5 children, then buying an apartment with all one bedrooms is not going to be a wise decision.

To Determine the Supply I look to see:

  • Who is my Competition? I want to not only look at the current competition but I want to find out who is planning on coming on line in the future. If I am looking at a retail strip center and next year a new highway exit is going to open up. I need to research what impact that will have on my potential property. If I find that immediately off that highway exit is a new strip center that all potential customers for my tenants will have to drive by in order to get to my location, this will be important information as to my ability to lease my space.
  • Find out what is the current market vacancy. If the potential property has a vacancy of 25%, initially I might think there is great up-side potential. However, when I do my research on the market vacancy I find that market vacancy is actually 30%. Now I know that the property is performing above the competition and there may be little room for improvement.
  • You want to find out the types of tenants. As I mentioned earlier, if you have all families in the market area, one bedroom units will not meet their need.
  • You also need to determine what amenities your property has to offer versus the competition. If all of your competition has on site work out rooms then maybe you need to convert a unit to a work out facility or make arrangements with a local gym for your tenants. It is always a positive if you can differentiate from your competition.

Step #2: Gather Data and Verify Information

It is important to not just go off your gut instinct or what the broker is telling you. Remember the broker’s goal is to close the sale. They are not going to mention to you the new competitor up the street and may even bring you to the property from a different direction just so you don’t see it. I use sources like the US Census Bureau, The Economic Department of National Associations of Home Builders, The National Housing Center Library, The Chamber of Commerce, I will meet with the Economic Development Director, and I will utilize the internet searching on the market area.

Step #3: Pick An Area

The next step that I take after I verify supply and demand information is to pick a site or pick the area I am interested in investing in. When finding a city to invest in I look for Population growth, vacancy rates, growth in the economic base and the population mix. The next thing I do is to pick the target sector. I determine if I will be investing downtown, in the neighborhoods, and what I want to be located near. Do I want to be near colleges, retail, highways, etc? Some retailers will only locate near other larger retailers. This is because they know that they have the same demographic requirements and that they target similar markets. Next time you are shopping at Target, make note of the other tenants in the plaza. I am sure you will see a lot of the same ones no matter what Target you shop at.

Step #4: Determine Your Timeline

Now it is time to figure the timeline for meeting the investment objective. If it will take me 18-24 months to renovate the property, then I need to determine where the market will be in 18-24 months. If 400 units are coming on line two years from now I know that I need to have my units completed prior to that so that I can get my building filled prior to the newer units coming available. I also need to know that I may need to offer concessions or lower my rental rate in order to keep the tenants that I will have. What ever the case, the timeline of your project is a very important aspect of any Market Analysis and is often the most overlooked or forgotten all together.

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May 12

Commercial Real Estate Accounting Tips

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After you have acquired your commercial property, managing your finances becomes one of the most critical aspects of property ownership. Even if you only have a five suite building, you are still the owner of a business and you must run your finances accordingly.

Remember keeping good, organized books isn’t just to keep you out of trouble with the IRS; it is also to keep you out of trouble financially. Without good records you will not find inefficiencies with your properties and therefore will not be able to maximize cash flow and value.

As an example, if you have one tenant paying $400 per month that you did not notice was past due for 60 days, you have not just lost the $800 but you also will now lose another $400-800 during the eviction process, the $800 that you would have gotten from a new tenant, plus the cost of eviction is around $300-$500 per occurrence. So, one delinquent tenant can cost you thousands of dollars if you are not managing your finances.

It is also important to keep good records for when you want to sell your property. If you have accurate records you can normally generate a higher price since the new buyers feel more comfortable with the books and knowing exactly what they purchased.

Documenting the Income Received

With today’s technology in banking there are many ways that you can make available to your tenants for them to pay their rent. They can use conventional means of a check or money order but you may decide it is easier to accept credit cards, electronic funds transfers, or on-line banking. These methods give you more immediate access to funds which helps you know quicker which tenants are past due and which tenants are current.

You want to make sure you always keep your rental properties separate from your personal records. It is also helpful to separate income by each property if you own multiple properties or if you are running a management company, then make sure you have accurate percentages with which to allocate the income and expenses to each property.

Documenting the Expenses Paid

It is beneficial to hire a good real estate tax advisor even if you do not own a large commercial property. The reason for this is that the real estate tax laws are various, complex and numerous. There are certain expenses that can be expensed immediately and other expenses that need to be capitalized and expensed over a longer period of time.

By owning commercial real estate you not only get to expense operating expenses such as payroll, management fees, repairs and maintenance, etc but you also have the ability to expense non-cash expenses such as depreciation and amortization. Depreciation reduces your current income but is recaptured at some point in the future. A good real estate tax advisor who is familiar with such items as cost segregations and 1031 exchanges will help minimize your expenses.

Documenting Security Deposits

A lot of novice property owners consider security deposits as income and therefore record it incorrectly on their financial statements. Security deposits are considered a future liability that is owed back to the tenant if they comply with all the terms of the lease agreement. If the tenant does not comply with the terms of the agreement then the security deposit may become income later, however this is normally not determined until the point where the tenant vacates or moves out.

Using Budgets and Managing your Cash flow

Just as in your personal life, it is important for you to use a budget on your commercial property as well. Budgets allow you to monitor the income and expenses on the property to make sure that you are operating in a positive cash flow situation or at least making the necessary steps to operate in a positive cash flow situation.

Budgets also give you an idea of how much money you need to set aside in order to cover any large expenditure such as repairs or rehab costs. Budgets will show you how long you will need to save up in order to be able to pay for this expenditure out of cash flow or how much you will need to finance in order to pay for this expenditure now.

Budgets are also helpful in comparing historical income and expenses to current income and expenses. If you have historically been paying $12,000 per year for insurance and now your premiums have jumped to $16,000; it is most likely time to shop your insurance with another provider.

Likewise, if your physical occupancy has remained the same but your income has decreased, you may have a property manager that is skimming off the top, the market may have dictated that you decrease your rental rate or you may have a high delinquency rate and need to do a better job screening potential tenants. Again, this is all information that your budget will help you analyze.

Recording your Accounting Manually vs. Using an Accounting Package

With today’s technology and the economical accounting packages that are available for small business owners, I would highly recommend that you use a computerized accounting system. A manual system not only makes it difficult to share information with other parties (your banker, accountant, broker) but it also can become a huge waste of time if there is ever a posting error and you have to re-calculate the numbers. Quicken, Peachtree and QuickBooks all work with spreadsheet programs such as Excel which will help make analysis and property tracking a lot simpler.

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May 12

The Apartment Market – Recession or Re-Calibration?

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The State Of The Apartment Market

Even in this strange economic climate, the fundamentals of the apartment market are solid. The national occupancy rate for apartments is in the low 90’s. Supply is still relatively low at 1% inventory overall. This means that, on a national basis, there is not a huge oversupply of units. Rental revenues continue to grow at 3-3.5%.

A lot of the positive trends you see in the apartment market are the opposite of what is happening in the home ownership market. People need a place to live and as people lose their homes to foreclosure, they are moving to the most obvious alternative which is apartment complexes.

The apartment market has also been strong for investors. The banks have continued to offer low interest rates and spreads.

Most investors feel comfortable investing in apartments so apartments have become the preferred product class for investment. Returns from alternative investments have not had as favorable returns on a national basis.

Also, the supply and demand of apartments is stable and therefore supports increasing rents and appreciation of value.

This is caused by:

  • Development costs are expensive and sites are difficult to find
  • With gas price and fuel costs increasing, construction costs are high
  • In urban municipalities, it is difficult to get the density needed to give the investors economies of scale
  • Because of the strength of the apartment market, investors have been willing to accept lower yields (cap rates), which has allowed prices to appreciate.

Historic Recessions in the Multifamily Market:

THE EARLY 80’S:

  • Interest rates spiked to the high teens (15-19%)
  • Properties with adjusted rates experienced foreclosure as investors felt the impact of negative cash flow

THE LATE 80’S:

  • Congress changed depreciation rules
  • Syndication investors were destroyed so there was a shortage of investment capital
  • Savings and Loans went into default
  • There was a high number of foreclosures and write-downs of loans

What Lies Ahead

As demand for apartment units increases, analysts are not sure the US apartment industry will be able to meet the demand. Land is scarce and construction costs are more expensive.

Development in urban areas, where demand is more reliable, is inherently more expensive. Complexes are leaning towards mid-rises or high-rises versus garden-style.

Current rents with density allowances do not justify the cost of developing more apartment units. This will cause absorption to increase and put more pressure on rents to increase. These factors should cause increased value of apartments in the long-term.

Because of the overall financial climate, as investors we will need to accept LTV’s in the 70-75% range. The valuation, marketing, and management phase will be more critical than ever for banks. Banks will be looking for greater liquidity of the sponsors and stronger global debt coverage ratios.

Overall, the fundamentals of the apartment market are stable or improving in most markets, thereby demonstrating that the apartment market is not going through a recession, but merely a recalibration.

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