Thursday, January 24, 2008

My First Investment In Multi-unit Properties

It's looking like I will be making my first foray into the world of multi-unit properties (aka apartments) this month. There is still a possibility other investors might fill up the available slots before I can get in, but I think I've got a decent chance right now.

Kenric alerted me to a deal that a local apartment investor was putting together for an apartment complex in Houston. I've met this investor a couple times, the first being at a get-together of people from the message boards in 2006, where he gave a presentation on the benefits of apartment investing. As I wrote back then, I saw the potential of apartment investing and have been looking to get into the field ever since. Of course, there are any number of differences between investing in single family homes and apartments, not the least of which is the amount of money needed to get into the game. So it was obvious I would need to partner with someone in order to get my feet wet and learn the ropes. And now it appears that opportunity has presented itself to me.

The Private Offering Memorandum for this deal is almost 100 pages long, so it will be tough to condense everything to a short entry here, but I'll try to hit the highlights.

The deal is for a 342 unit apartment complex in Houston, Texas. Investors get a 9% preferred return and anything over that is split 50/50 between the investors and the people offering the deal. The management team includes Steve, the guy I've meet. He's got over 9 years experience investing in apartments, has a current portfolio of properties worth over $29 million, and has bought and sold over $20 million worth of apartment communities. The rest of the team consists of a lawyer with extensive experience in real estate transactions, and a property management team that has been managing properties for more than 27 years. They specialize in improving the financial returns of apartment complexes and every property they have managed has increased in value.

The apartment complex itself is a B+ institutional grade property. It's about a full city block long, which means there is lots of drive-by traffic (which translates to free advertising for potential tenants). The complex has 2 pools, a fitness center, and gated access. The property, which was built in 1977, underwent a $2.9 million renovation about 4 years ago, so there is little deferred maintenance. The individual units have new appliances, two tone paint, crown molding, and some have wood floors. The complex is about 2/3 single bedroom units and 1/3 two bedroom units and has a 95% occupancy rate.

It is located in a nice district of Houston. In 2006, Forbes magazine rated Houston #1 in Texas and #3 in the entire U.S. as the "Best Place For Business And Careers." The area is seeing job growth across all sectors of the economy and there is a highly skilled, well educated labor pool there. The forecast is for continued job growth for many years.

The plan is to buy the property for $12.4 million (the property is already under contract) and invest about $100,000 in improvements. There is some maintenance to be done, such as repainting the carports, resurfacing the entry drive, and putting new carpet in some units. However, much of the improvement money will go to providing additional amenities, such as a nice water feature in the front (which helps attract potential tenants, as well as improves the overall look of the property) and a playground, to help attract tenants with children (who tend to be more stable renters).

Rents are currently at the low end of the market range and, as the improvements are made, they will be raised to the higher end of the market range, although not to the absolute top. Rent increases will be capped at $50 per month per year so as not to lose existing tenants.

As an added bonus, the recent Fed rate cut has helped. The financial analysis was done assuming a 6% loan and the managers are currently being quoted rates around 5.4%.

The investors receive a 9% preferred return, paid quarterly. What this means is profits are first distributed to investors until they receive their 9% ROI. After that, profits are split 50/50 with investors and the management team. After the second year, and each year thereafter, an analysis will be done to determine if it makes financial sense to sell the property. In the event of a sale or refinance, proceeds will be distributed as follows: all investors will be paid their 9% return, then the investors' original investment will be repaid, and then any remaining monies will be split 50/50 between investors and management. Investors purchase "units" of the investment. One unit costs $50,000 and there is a minimum of 55 units and a maximum of 60 units to be sold.

If you recall, I have said before I wasn't too interested in a 9% return because I felt could do better. I still believe that. I like this deal because it is really more about capital gains. Yes, I will get a 9% cashflow, but the real money will come from the improvements to the property and when the place is sold. At that point, the ROI should be in the 13% to 13.5% range. Additionally, I'll get some experience in seeing how investing in multi-unit properties works.

Correction: I was looking at the wrong set of numbers when I wrote the above. The annualized ROI after the sale of the property should be in the 30% - 35% range.

For future reference, I am labeling this project Multi #1.


Jason said...

This is great information. My ultimate goal is to own multi unit properties. An apartment complex or hotel would be ideal.

AllAboutVoting said...

What is the cap rate based on current rents? What is the current occupancy rate? Same questions going back a year in time.

What is the GRM?

Also, if you are planning on investing in Texas multiunit properties you should probably read up and develop your own opinion about the 86-89 bust in Texas.

One resource is Craig Halls' book "News of My Death Was Greatly Exaggerated: How I Survived the Texas Depression : My Financial Strategies for the '90s"

Shaun said...

Current occupancy rate, as I mentioned above, is 95%. I forget the exact occupancy figure from a year ago, but it was within 1% of current.

GRM (gross rent multipler) is generally only used on properties of 20 or less units. Therefore, it is not applicable to this property.

Cap rate based on 12 month trailing income from Oct 2007 is 5.2%. Pro forma cap rate for the first year is 7.2%. Second year is 8.6%.

Another Investor said...

I would LOVE to see the offering memo on this one...

Using your figures and a typical expense ratio for projects with lots of amenities (pools and fitness centers) of 45 percent, I work back to a TTM AGI of $304 per unit with the 5.2 percent overall cap rate. Adding your $100,000 of capital improvements (some of these expenditures are really operating expenses...) to the purchase price and applying the 7.2percent overall rate works back to a pro-forma gross income of $420 per unit.

My analysis is quick and dirty, but the implied rent levels don't support $50 a month increases, much less what is required to bump the first year cap rate.

Doing a slightly different analysis, they are buying on a 5.2 TTM overall rate, paying 6 percent interest on 76 to 78 percent of the purchase price (assuming the capital raised comprises the down payment), and paying the equity position 9 percent cash on cash. The increase in first year NOI would be phenomenol to accomplish this.

I'm sure they did not include the appraisal in the offering memo, but I would love to see what the lender got.

Shaun said...

If anyone thinks they can judge the financial merits of his deal by the numbers I have posted here, they are sadly mistaken. There is no way I can condense a 100 page analysis to a few paragraphs and give any sort of numbers that will stand up to reverse engineering. Also, you are making too many assumptions ("typical expense ratio" and "implied rent levels"). You have to because I have not posted all the minutiae of the deal. For instance, I never mentioned the bank loan is interest only for the first three years then it converts to including principle on a 30 year amortization schedule.

I am not about to post every detail of every financial statement here. This is a public venue and I consider that level of detail to be private information. I will continue to post general information about the performance of this investment, good or bad. You are more than welcome to come back and visit and check the progress, but if you expect to be able to take the numbers I write to your accountant for verification, you will be disappointed.

Doug said...

Shaun, what neighborhood in Houston is this property located?
I met with Steve down there and we looked at a couple places, but nothing that really jumped out at me... The only one we actually liked wound up going into contract a week after our visit, so we missed the boat... A lot of the stuff we saw was in so-so area, or areas that were showing weakness...
The thing about Houston is that there are a TON of large multifamilies (amazing, really)... I'd never seen another city with a similar housing composition...
It was definitely an attractive area due to population growth, though...

Shaun said...

It's in the Westchase District.

Steve said...

Cool, Shaun. Hope this goes a lot better than the LA deal. Steve is great at finding diamonds in the rough from what I've heard, so this will no doubt be a winner I'm sure.

Do you have a ballpark figure on when the group plans to actually sell the property?

Shaun said...

No firm date for a sale. The analysis shows we'd get the greatest ROI if we sold after year 2, but of course, that's an analysis using pro forma numbers, so that's subject to change. About the only thing I can say is we won't sell for at least a year, since the first year will be when we make all the improvements to the place and we'll need time for the property to pay back the improvement costs. The deal will be analyzed each year to see if it should be sold or not.

Anonymous said...

I am an experienced multi-family investor (I own more than $65 million in apt. assets). Let me advise you against investing in Houston. I have looked at deals in this city thoroughly and it is a very bad market to invest in now... It has high vacancy (I would be surprised if the property was 95% occupied...I haven't see one in Houston yet that is). Anyone who does have that occupancy is buying it through concessions. Second, a 5.2% cap rate is horrible and a projected 7.2% cap rate is horrible too. For the risk involved, you need a much better return. Third, you will never get anywhere near a $50 increase in rents. Shaun, if you want some additional unbiased information, feel free to ask. But take it from a guy who has looked at a lot of deals (including many in Houston), I wouldn't touch a deal down there for less than a 10 cap deal.

Shaun said...

Well, it's entirely possible I'm calculating the cap rate incorrectly. As for the vacancy rate, it has been verified in person, as have the rent rolls (meaning concessions would be seen). Thanks for your advice. I will keep it in mind in the future.

Kenric said...

Shaun, you'll find that every time you post an investment that you will get a slew of comments or emails warning you from your investment.

The truth is that people like to toss in their opinions without seeing all the data. In fact, I know I do that also.

In regard to anonymous's post. And its exactly the type of reaction that we expect. Steve's strategy is to buy in markets that people say to stay away from. I think he's proved that it works.

In fact, Anon, if you're out there reading this. Send me an email on my blog and I can get you in contact with Steve. He's always interested to how other investors valuate their deals.

In all honesty, this 324-unit is a pretty amazing deal. I have not seen many B class buildings that will give you cashflow on 20% down.

I have seen a few 10 caps in Houston and they were all C class or below and in very bad neighborhoods.

The good thing about these blogs is that people can come back in 1 or 2 years and see how these investments went.

Shaun said...

Kenric - yeah, I've noticed that for every single investment I have posted about here, there has been at least one person that has warned me against it. I look at it as the "noise" Kiyosaki writes about and I've learned to tune it out. Still, occasionally someone mentions something I have overlooked, so I do read all comments.

I also think this looks like a good deal. I am, however, finding out that Steve isn't as good a communicator as Les is. It's interesting to see the different styles of the people I invest with.

Anonymous said...

Shaun, this is "Anonymous". I posted the other day cautioning about investing in your deal in Houston. I read some additional comments on here and wanted to clarify some things. First, I commend you for wanting to invest in real estate, especially multi-family. It can be a very lucrative business. However, I have also seen people lose everything if they don't do it right. I started buying properties in 1998 and started with duplexes and triplexes and traded up. Now I buy 300 and 400 unit buildings. I buy all over the country and in about 15 different major markets. I don't want to discourage you, but I do want you to see things for what they are. Deals always look good on paper. In reality, they are much different. And there is a simple reason, sellers and brokers lie (or at least fudge the facts). That 95% occupancy is great. I am sure that the owners offered specials and concessions to boost occupancy leading up to the sale. How would you know if 2 months ago they offered 2 free month's rent for someone to move wouldn't show up on a rent roll now (that concession would have been burned off). Who says they didn't write off old delinquent rents, etc. to shpw great collections. If you would like, I am happy to give my email and you can feel free to run things by me if you wish. I am happy to give you the benefits of my successes and my failures (because I got snookered a few times too). I am not suggesting that your syndicators are anything by honest, but you need to be really careful. Let me know if you want my email.

Another Investor said...


I agree that you should tune out the "noise," but when other people that know what they are talking about advise you not to do this, you should at least stop and listen to what they say. I have analyzed cash flow for hundreds of major projects over the last 25 years, and "anonymous" knows what he/she is talking about.

This group is trying to sell you an investment, and you should at least be skeptical of the numbers presented. In addition, these people have only invested in a rising market with stable or decreasing cap rates, and have never experienced a cap rate blow-up.

Like "anonymous," I am suspicious of the 95 percent occupancy and some of the other assumptions. Everything that he/she said about what sellers do to boost occupancy is true. The returns you project are not reasonable. If this were an "investment grade" property with these levels of returns, an "investment grade" buyer would have picked up the property long before your group had a chance to see it.

Since "anonymous" offered to analyze the deal, why not let him/her do that? You have nothing to lose, and a lot to gain.

Anonymous said...

I am looking at a similar deal in fort worth the problem I am running into is that I have to be an accredited investor in order to join as a partner. Is that the case for this houston deal as well? Or any deals like this? Currently, I would just miss qualifying as one.

CJAI said...

This is truly great information. I have been looking at deals in Texas as well. I was told that this is the only place where the rents cover your debt service enabling good cash flow. According to Anonymous, this information could be incorrect. Anonymous, I would appreciate your email address to run a few deals past you as well. You don't find too many people willing to offer their advice especially after they have made it! How can we talk?

Kenric said...

"Anonymous" I would be interested in talking to you about the project. Please send me an email at

Regarding the 95% occupancy. I agree that the current owner may have done those things to get the numbers up. If so, that information will be revealed during the due diligence process.

Even so, we expect the occupancy to drop after close because the new management will increase rents and therefore we'll see some turnover.

AI, our group has access to these properties as do the "investment grade" people. This property had multiple offers on it.

Anonymous said...

Any updates about this deal? It looks very interesting, based on what you mention.

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