The national apartment market may have shown some ever-so-slight signs of softening in 2017, but that doesn’t mean investors have soured on the multifamily sector.
Apartment sales in the U.S. during the first half of 2017 totaled $55.3 billion, according to commercial real estate brokerage firm JLL. Granted, that figure represents a 22.3% decline from the first six months of what was a record-setting year in 2016. However, apartment executives say that, in a broad sense, the sector remains an alluring one for investors of all stripes.
“There’s a lot of demand for multifamily investments and a lot of equity chasing it,” says Jay Madary, president and CEO of JVM Realty Corp., an Oak Brook, Ill.–based owner–operator that acquires and manages Class A and B apartment communities in secondary markets in the Midwest. “We’re also seeing that lenders are active. Financing is plentiful for the types of communities we target.”
In such an environment, it might be tempting for apartment companies to plunge headfirst into the buying process. But multifamily veterans say there are some fundamental components of acquisition preparation and execution that all buyers should heed. Five of the most notable are outlined below.
1. Do Your Homework
According to multifamily executives, you can’t do too much due diligence when evaluating a community before agreeing to acquire it. As the buyer, you need to know a property is poised to deliver the returns it and its investors are seeking. Or, if the community currently isn’t in shape to deliver those returns, you have to know what steps are needed to position the property to do so.
In summary, do your homework. And when you think you’ve completed your homework, do some more.
Andrew Kadish, president of Rockville, Md.–based CAPREIT, says his firm undertakes a wide array of steps to vet a community before making an offer on it. CAPREIT owns and manages about 14,000 apartment homes in the Mid-Atlantic, Midwest, Southeast, and along the West Coast; the company has both market-rate and affordable housing communities in its portfolio.
“We perform internal market studies and review all the comps in the submarket, both for monthly rents and investment sales,” Kadish says. “We have our staff walk every unit when we do on-site visits. We’re also commissioning third-party engineering as well as environmental studies. That’s not only a great benefit to a prospective buyer like us, but often your lenders require that too.”
JVM undertakes a similar due diligence process, according to Madary. Like CAPREIT, the company performs an exhaustive study of the surrounding submarket. The quality of nearby schools, the vibrancy of area retail centers and entertainment options, and the health of the job market all are factors that come under close scrutiny from JVM and CAPREIT.
Evaluating a for-sale community’s competitive set can be a tricky process, Madary adds, so a prospective buyer should exhibit extra thoroughness in this area. “Sometimes, the competitors within the submarket are not who the property thinks they are,” he says. “The on-site team will often think they know who the competition is, but maybe they’re missing a couple of properties.”
2. Secure Options for Debt
When it comes to obtaining debt financing for an acquisition, it pays to have options. That way, you can be sure you’re securing capital in the most cost-effective manner.
“We like to have multiple choices for each debt financing opportunity,” Madary says. “We use an intermediary to take our properties out to the market to solicit multiple bids. We have numerous relationships with lenders and life companies, so we typically see them bid, but it’s always good to have options.”
Likewise, CAPREIT has worked tirelessly to cultivate a reliable network of lenders. “We’ve been able to establish relationships with several different lenders: local, regional and national banks as well as life insurance companies,” Kadish says. “We don’t have one simple dedicated lender source. We like to farm it out and not put all our eggs in one basket.
3. Establish Your Deal Breakers
When evaluating an apartment community for purchase, it’s critical to identify the factors that would make you walk away from the property. For many owners, factors such as the condition of local schools and the surrounding job market are typical deal breakers.
For JVM, one of those deal breakers is current and projected real estate taxes, which buyers sometimes don’t consider carefully enough, according to Madary. “We’re very cautious when it comes to these taxes,” he says. “They’re one variable that could make or break your returns if you don’t budget for them properly. I would urge potential buyers to look at those very carefully.”
CAPREIT has a general wariness of properties that are older than 25 years, Kadish adds. “Anything older than that, I start worrying about my exit assumption,” he says. “Can I really, truly sell this 1960s vintage community for what the broker is saying I can?”
4. Be Conservative in Your Underwriting
Both Madary and Kadish say buyers should be conservative in their underwriting—be cautious and pragmatic in your projections of a potential acquisition’s revenue growth and returns.
But in today’s competitive market, buyers often feel pressure to get aggressive in their underwriting, which paves the way for returns that disappoint investors, Kadish notes. “Sellers have really been fortunate in recent years in that they can simply choose between four or five qualified buyers who are offering extremely high purchase prices,” he says. “Unfortunately, in order to reach and justify these really high prices, you’re seeing some pie-in-the-sky underwriting on the part of buyers.”
Similarly, buyers sometimes don’t sufficiently fund their capital expenditure (capex) reserves. “We take pride in knowing that, no matter what might happen, we’ll be in good shape whether the real estate world blows up tomorrow or there’s political angst or there’s something on the world stage that might affect the real estate sector,” Kadish says.
5. Don’t Skimp on Property Management
Another common mistake buyers make is hiring a third-party property management firm on the cheap.
“A lot of owners aren’t fully integrated, and they don’t manage their properties, and that’s totally fine,” Madary says. However, those owners often “commoditize” the management of their communities, he adds.
“Going for the lowest-cost property management firm can be a shortsighted decision,” Madary warns. An ineffective manager can have an extremely negative impact on a community’s operations, which in turn harms operating fundamentals, revenue, and returns.
“Place as much scrutiny and value on who’s managing your property as your investors do in who’s managing their equity,” Madary says. “The choice of a property management provider deserves serious attention and consideration.”
