_p.png)
,,
While there are many roads (sectors, strategies, parts of the value chain etc) in real estate that may lead to the same destination, I choose to actively pursue multifamily real estate in the United States as the market opportunity is undeniable.
,,
If you're new to the MULTIFAMILY OPPORTUNITY you can read more about it in CBRE introductory report.
Introduction to Multifamily
Describe your image
Describe your image
Describe your image
Apartments have a long track record of having the highest risk-adjusted investment returns compared to other property types. The sector has proven to be most resilient during economic downturns, delivering superior returns during recessionary periods - everyone needs a place to sleep or settle, irrespective of trends, economic cycle or technological innovations.
Apartments typically have a much larger spread of staggered leases, creating a safer lease profile - ie. 100 units, typically have 100 different leases staggered across the year, each having their individual credit risk, so if 5 tenants default, you still have 95 other tenants paying.
Apartments have a lower cost of capital and wider availability of debt capital (special government subsidized financing to support affordable housing solutions for the country's residents); apartment investments can support more debt with the same level of risk.
Apartments operate in a favorable, transparent, and market-driven regulatory and taxation environment.
Apartment properties vary widely in terms of age, size, quality, and location, creating a broad spectrum of opportunities and possible investment strategies, thereby providing greater liquidity than other sectors.
Apartment market fundamentals are expected to remain positive. Demand is expected to expand and new supply is expected to subside, creating conditions for moderate rent and revenue growth in most locations.
Apartments have shorter leases than other property types, allowing them to adjust more quickly to changing market environments.
US Multifamily Research Brief
Introducing the
Value Add Model
It’s very important to make sure the rental market can support this new rent level, typically speaking if the rents are between 20-30% of the median HHI it should be achievable. Other indicators, like lease up periods for new product, employment growth, trendy retail developments etc should also be considered.
The next thing to look for, is determining what the rental premium (the amount of additional rent you can collect) in the market is as a function of the cost of capital to do the renovation and improvements on the property to justify them. Using the above example, if it costs us $5000 to earn an extra $150 rental premium p/unit. That would mean we are earning a return of $1800 / $5000 = 36%. When you do that across all of your units, you increase your NOI significantly which increases your assets value.
With the above elements in place, it can create the perfect environment for the strategy, however if you aren’t a strong team with meticulous attention to detail and leadership skills to be able to execute the plan effectively by managing tenders, contractors and problems along the way - this beautiful wealth-creating strategy can quickly turn into a mess.
The other largest risk in the strategy other than execution risk, is that operators over-estimate the rental premium you can achieve and suddenly you’ve spent a lot of additional funds in renovations that don’t generate the returns you thought were achievable and suddenly you stuck with an underperforming deal. Had you have just bought a steady cash flowing asset, with no value add strategy, you would probably have been better off.
Despite the risks, here’s why it’s still the best strategy for creating wealth - in my opinion.
The above allows for a steady growth environment without any additional strategies, however to speed up wealth creation, apartment investing allows for investors to create appreciation through careful execution of a value-add strategy.
Pricing of real estate assets are dependent on a number of factors, but the underlying common denominator for commercial property is valuation on the basis of the assets ability to generate income. The market uses a term called a cap rate to determine this value. It’s merely the Net Operating Income of the asset, divided by the Purchase Price (although I believe it should be the all-in cost, as often there is work to be done before the asset is back to good condition...).
So, all else being equal, the higher the NOI, the higher the value of the asset.
This is the foundation of all real estate private equity firms - buy at today’s NOI value, execute a strategy to increase the NOI, then sell or refinance at the higher value to take a profit or reduce equity exposure.
In the apartments sector, the most common execution of this is in the value-add strategy.
Essentially this revolves around 4 key elements to be effective:
-
Supply Options for tenants
-
Median HHI & other rent support indicators
-
Renovation Cost vs Rental Premium’s
-
Effective Execution Team
To explain this simply, you are creating a comprised solution for tenants looking for a desirable fresh look and feel apartment that is still much cheaper than it would cost to rent new supply (constructed within the last few years). Pricing should be between that of unrenovated products of the similar age and new product. As an example, new product might be renting at $1350 p/month and older 1980’s constructed product at $850. This would indicate there may be an opportunity to run renovation program on a 1980’s asset, and achieve rents of $1000 p/month.
Let’s bring this concept home with a financial example of the power here. Assume we bought the apartment complex and it had 100 units achieving the $150 premium, from spending $5000 p/unit in renovations on the property.
That’s additional gross revenues of $180 000 p/annum. Let’s assume 70% of that hits the bottom line - ie. the NOI, which is the basis for the asset’s value. That would mean we increase the NOI by $126 000.
If the property was producing $850 p/unit at a 50% operating expense ratio, that would mean the NOI was $850*50%*100*12 = $510 000. If the market cap rate was 6.5%, we would have purchased it for $510k / 0.065 = $7 850 000.00, let’s assume over the last 2 years we’ve managed to execute on the value add strategy, and achieve the premium bringing the NOI from $510k to $636k. All things remaining equal, the properties value now at a 6.5cap is worth $9 785 000.00.
Coming back to my favourite characteristic of property, safe leverage, we borrowed 75% of the purchase price, which means we only put down 25%, effectively $1 962 500 + the renovation cost (assuming we didn’t finance that) of $500 000 ($5000 p/unit x 100 units) = $2 462 500.
Ok - so what’s the big deal?
Well, your new value less your purchase price, less your renovation costs is = $9 785 000 - $7 850 000 - $500 000 = $1 435 000.
This means we just created an additional $1.435m on the balance sheet which could either be realised through a refinance or sale of the asset. That’s a $1.435m / $2.462.5m return = ~
60% return over 2 years.
On top of this, if you bought right and executed well, you should have achieved a steady cash flow between 6 - 8 - 12% p/annum on your down payment as well.
The above is a typical, achievable value-add example that great operators achieve on a regular basis. There are many moving variables that could improve or detract from the return, but this is a good example, which illustrates the power of the model.
Most operators execute the business plan over a 3 - 5 year horizon, achieving a return around ~ 20 to 25% on these deals when you account for transaction costs and fees if you do it yourself.
As a passive investor, you can expect a burden on your return between 5 - 7%, which depending on your personal situation is a small price to pay to participate in a passive manner.
