How to Analyze a Build-to-Rent Deal - EP14

build-to-rent cap rate cashflow income & expenses multifamily noi real estate investing real estate market roi Nov 23, 2021

So you're looking to build a single-family home, duplex, triplex, fourplex, or 50-unit apartment complex. Analyzing a potential investment can be tricky. Where do you start? If you only had 5 minutes to look at a real estate investment opportunity and decide if it's worth your time—this episode will explain what to do...

  • Estimating Rental Income on a Build-to-Rent Property

  • CoStar Review: Using CoStar Reports to Analyze a Rental Market

  • Rentometer Review: Using Rentometer to Analyze a Rental Market

  • What to do if there are no comps (Building Rental Properties)

  • Using Neighborhood Scout and the MLS to Analyze a Rental Market

"What about all things being equal? Would you expect a new construction property built 2021 to lease for more than something built in, say, 2015? Same neighborhood, similar square footage. I don't I don't know if there's a right answer. I'm curious. I want to explore that..." - Steve Olson, B2R Show

Steve Olson: Welcome to the Build-to-Rent Show. I'm Steve Olson with Chase Leavitt and Sherida Zenger, getting an episode out of the can for you that I think you're going to find helpful, and we've got some good ideas too, to bring to bear here about analyzing your build-to-rent deal. The whole purpose of the topic is to cover more of a back-of-the-envelope analysis of a deal.

We don't pretend that you're going to go to the bank with this stuff, or that you're going to close with this stuff. It's how do I vet something out. If you're doing a lot of deals, you really must systemize that process.

 I've got a guy right now that I'll tell you guys about, he's a financial nerd. And so, once I get past the back of the envelope, then it's time to spend some money with the nerd. Dig much deeper into this, build out all the complicated models and your returns, and sources and uses and all this kind of stuff. But for our purposes here, whether you're going to build a little house, whether you're going to build 50 townhomes, this is a back of envelope—analyzing a deal quickly kind of a formula

Chase from its most basic point, where do you start?

Chase Leavitt: The rents. Figuring out what the rents are in that market? It could be a single-family hometown, home apartment building, whatever it is. Just take it one unit at a time. And just analyze the rants by calling property managers in the area of different assets that are currently being managed in the location that you're looking.

So, look at the rents, take a real close look, understanding what product type, if it's to be bill. And it's not there yet understood what you want to build there. And then look at similar comps within that location.

Steve Olson: Similar comps being the key. Sherida, or what do you do? How do you analyze?

Sherida Zenger: Well, obviously, if it's something that is existing, you're going to call property management and get those rents. So, you can back into it that way.

Obviously, that's a quick way to analyze an existing property, but the same thing as Chase. I'm going to look into the area, see what things are renting for. Visit some property managers. You know, if I, maybe if I know someone I can call around and ask them, hey, what are you currently getting for rent?

I know my kids bought some townhomes in American fork, Utah, and I had asked somebody, Hey, what are current rents? It was one of our associates just because she has leased a, quite a few units in there just to kind of see. So you can ask around people usually are pretty friendly and will give you advice.

Chase Leavitt: Let's take it a step further besides the rents. Where else are you getting income garages, um, washer and dryer? Pet fees. Uh, we have a tech package.

There's a lot of different ways you can get additional income. So, once you understand the rents pallets, you're going to get income to really understand your, your monthly gross income.

And then once you know, your monthly gross income, just times that by 12 and that's your annual.

Steve Olson: That really is the jumping-off point. And when we're talking about build to rent, because the value, what you're willing to pay. What you could potentially sell the property for, all com jumps off that.

What is the income? That's what somebody is buying, right? They want that income stream with the property. So that's what the value is derived from. So, I think we kind of get to the point where, you know what, what's a quick valuation, what's a back of the envelope for one investor versus another, right? On a high level.

You're just looking online. You might look at CoStar. We have a CoStar subscription, which I kind of like. It's a rip-off. Okay. They might cancel us because they are kind of like the soup Nazi from Seinfeld. No CoStar for you. We have it in the budget to pay Seinfeld royalty rights. Don't we on the show? We don't okay.

CoStar has a lot of good information that you can see the typical rents for one-, two-, and three-bedroom units in your area. You can pull comps at half-mile, two miles, five miles as big of a radius as you want.

You can sort it by their star rating 1, 2, 3, 4, 5 stars or so. Right. So, you can go. Pretty deep in, in the back of the envelope, and get some really good ideas. But w once again, take it with a grain of salt. Cause like what chase was saying. Um, I have, I haven't always found CoStar to be very good at telling you the rest of the story.

Right. Do you know? Well, w is there a $50 parking fee? Some of the listings say that some of them don't CoStar is only as accurate as of the diligence of the animal. Right. We, I know the three of us get calls. This is Bob from CoStar. Hey, you got this property that just went to the city. Tell me about it. Or, Hey, you sold this one and we have to give the information.

So, it can be a case of garbage in garbage out. Right? If somebody didn't give the CoStar analyst, very good information. You got to take that into consideration. So, it's a high level, but you're definitely going to need to drill down onto it later.

Sherida Zenger: But if somebody doesn't have the funds right to pay for a CoStar account, they can use resources like,

Some of those I know locally different places have their own platforms that they use as rentals. So that's a good place to start too. Usually, those are a little more detailed because they're looking for the tenant, right? So, they're looking at the tenant saying, Hey, come rent from me. So, they'll give a little bit more information. You know, maybe some they have on CoStar.

Chase Leavitt: This whole episode is doing it within five minutes or less. It's quick and dirty. And so, the way that you do that is yeah. The CoStar or the Rentler, when you start to call different places, that's going to be more time-consuming.

Steve Olson: We're probably off the back of the envelope and onto the spreadsheet by then.

Chase Leavitt: Yeah. So, the quick and dirty Rentler, Zillow, any place where you can just get an understanding of what the rents are going to. And then once you understand what the rents are going to be, we can talk expenses and we're not going to dive deep on those quite yet.

Cause this is quick and dirty. Right. And so, you just take an expense ratio for our performance. We're anywhere between about 30 -33%.

Steve Olson: Yeah. I've done a few 35s for what we do together. And we're not claiming that that's the universal expense ratio either. Right. But you need to come up with one that you feel captures everything.

You add everything up and you say, okay, 35% of my monthly income is going to be pushed over to expenses. We're not so concerned about the makeup of those expenses yet. Right. Well, what percentage of that is taxes? What percentage is maintenance? Right. We just need to know what our net operating income is.

Sherida Zenger: We need a placeholder, so that, and that's a pretty conservative placeholder that we found.

Steve Olson: Now I wanted before we got into that for a second, what do you guys think about Rentometer?

Sherida Zenger: I actually like Rentometer. I paid for the pro subscription, I think, to rent a meter. I think there are some good things. I know I've used it when we've analyzed a few properties or projects, I guess I should say. So, I think they have some good information.

Sometimes not as detailed, as a CoStar would be, but I think they all bring, I guess, have their own benefit to it, but I found it useful.

Steve Olson: Well, CoStar would give you what, what big property managers and apartment complex. Have listed or have reported as closed. Rentometer, if you're in a market that has a lot like a hodgepodge of inventory, right.

Where people are listing it online through some of these places, Rentler or whatever, it's a good way for you to see am I reasonable? Right? I love the little diets, like a speedometer, right? When, you say I have a three-bedroom unit, uh, two and a half baths, here's the street address. And I want my rent at $1,800 rent.

Rentometer will tell you the little speedometer says very affordable, very unaffordable, right? And they're analyzing everything that's listed and available. So that's a good, valuable perspective because you go, if I'm a tenant and I Google a property to rent, what am I going to see? And then myself as the builder/developer, what am I, what is my target going to see? In relation to what I'm advertising.

Sherida Zenger: You must be competitive. You can't be the lowest rent, but you can't also be the highest

Steve Olson: rent. What do you think? And we didn't talk about this before. I don't think the listeners be despised. We don't talk about it a lot before the show. All right.

But what, what if you don't see a lot of comps at all mean? What if there isn't any data? What, what alarm bells or what green lights go off in your heads when you say.

Sherida Zenger: Well, obviously I would think if there's not a lot of rentals, then maybe it's an area that doesn't need rentals. But again, you're going to have to dive a little bit deeper to see, is there a need there?

It could mean that there is no need to, so right. Going to the red side saying, oh, maybe this isn't like alarm bells, this isn't the right area. So, I mean, that's going to be talking to the city. That's going to be a little bit more due diligence.

Chase Leavitt: But for the five-minute, take an estimate, take an estimate of what you think it's going to be, or expand to another city.

That's maybe one to two that's, five miles, whatever it is, your best next comp. And then take that one. And then when you dive deeper beyond the five-minute. That's when he started to call the city and say, okay, what's the need here in you really dive into it?

Sherida Zenger: Well, it kind of reminds me of our Nampa project.

We didn't have anything where there were no comps, like literally nothing there. And we thought, okay, we've got to be a little bit lower than Meridian. Where do we want to be? And we kind of shot from the hip and luckily, we shot low. And so, rents are quite a bit higher, which is amazing for us, but that was one of those markets that again, we were like, what do we do?

We don't want to be overly aggressive.

Chase Leavitt: You bring up a good point. We estimated, but we were conservative. We felt we were conservative. And at that time, I think we're probably we're or spot on. And then over a period, we found out that there actually about a $100-150 per unit higher.

Sherida Zenger: Now that brings up another point. I was running a proforma. The cap rate was a little bit on the low side and, the seller who is my client said to me, Hey, what if we projected rents? And then this also came up in a conversation I had with Steve Olso,n, where he said, Hey, right now where these rents are for this existing property are a little bit on the low side.

Property management thinks when they renew, these are going to be a little. Again, that's a gamble and a risk that you're hoping that the market is still pushing up, which it should in the climate we're in right now. But again, it's kind of an unknown. So some people may purchase something that's at a lower cap rate knowing, Hey, I can hold for six months until these leases renew and actually get a couple of hundred dollars more in rent a month per door.

Steve Olson: True on that deal that you are, you're talking about. They have existing leases getting signed for like 150, maybe 200. And where this particular unit is at. So, it would take the market really suffering because we're not hoping we know where they're coming in at. Right. And that's, uh, that's tricky based on time of year there are some variables that, that can get you there.

Chase Leavitt: It's a value add. It's an easy value add if you understand and do your research.

Sherida Zenger: And you figure out when the leases are up, right. Hey, when are these Lisa's going to be up? Is it going to be up in December again? And they're going to not get me as much as they could, maybe in a summer month, depending on what market

Steve Olson: yeah, yeah. Do a six-month renewal and then take that thing all the way up to the full market.

 I have a little bit of experience on this right now. You guys know I'm working on a deal in Indiana, and I've pulled all the data on it and there's not a lot of data. So, the question is, is there an opportunity here?

Or is there not a lot of data for a reason, right? Because there is no opportunity because markets are efficient markets find the money, right. There's nothing they do better than that. But, uh, one thing that I did and disclaimer, kind of like what chase said, we're getting off the back of the envelope to a certain degree, but uh, if, if something is close on the back of the envelope, you're like, ah, I got to dig deeper than it passed the initial smell test.

How many deals have we had on the back of the envelope. We don't need to spend one more breath on this deal. It's dumb, but something that I found valuable, and I think I've said this on the show before. Um, if I don't, if I see a low vacancy rate, this market, I'm looking at as a 2% vacancy rate right now that tells me, okay, there's got to be a need for more inventory.

I looked at comps, the newest apartment complex was built in the early nineties. Right. So, I'm going okay. They got it there. Our unemployment rate is low vacancies, low housing stock, old. Right. I'm looking at all these things. So, what I wanted to be careful about is there fish in the pond?

Right? So, I used a website called neighborhood scout and I, and you can get this information from a bunch of other places, but I use neighborhood scout to find the median and. For the area. And you know, when we had lane Aldridge on a couple of weeks ago, he would tell you lenders to gauge whether somebody can afford a mortgage or a rent payment.

They like it to be what I think, 33 to 35% of the monthly gross income. So, I'm looking, what is the median salary for the area, and are the rents that I think I can get that are a little fuzzy because I don't have a lot of. Are they more than that? Are they more than 30 to 35%? And if they are, there's probably not a lot of fish in that pond, right?

There's probably a reason why some other developer or builder hasn't come in there and put up a bunch of units. But if the average salary can afford what you want, I, to me, that might be a very bright green light where you say the market is wanting more in inventory. What do you think about that?

Sherida Zenger: I agree, and I also think even maybe looking if there's. A lot of data looking at what single-family homes are selling for, what are people purchasing? And then what would their mortgage roughly be on that now kind of back into it that way and say, okay, so they're willing to pay this to owner occupy something, right.

To live in this property and own this. And there's a lot of people that are tenants that can't quite qualify, but they do make some good income. So maybe just saying, okay, maybe we need to be a little bit below what that is or close to, but I think, I mean, that's another avenue to go down.

Steve Olson: The MLS is good too.

Yeah. Now, nowhere our MLS in Utah for leases is garbage. Okay. It's completely useless. But yesterday, I was doing a little secret shopping on a property manager we use in Texas. And I had w well, John, one of our key contacts pull the MLS data. They have a great MLS for leasing data.

I can see average days on market to rent. This unit in this project is 24. Right? Here's the price you can see it's all right there. So, you might have a very robust MLS in the market that you're looking at as well, which could tell you where these rents are going to come in.

Chase Leavitt: Just talk to people as well.

Talk to the city. Talk to people in the area and see, they know them, they know their market. They know what demand or need there is. And so just talk to them and they can probably spill a lot of beans to you.

Sherida Zenger: Let's go back. So really what we have now is we have our rents, we have our expenses, right?

So, we're going to try to do this in five minutes or less. So where do we go next Chase?

Chase Leavitt: Finding your NOI. If you can find your net operating income, this is the formula net operating income. And then if you want to divide that by. What you think the value is, then that's going to give you a cap rate, the cap rate of what it, what it's performing at.

If you find your NOI and then divide that by the cap rate of where you want to be, let's say it's five and a half or 6%. That's going to give you the value of the property or what you should pay for it.

Sherida Zenger: Are you seeing a 6% cap rate right now?

Chase Leavitt: No. And that's the other trick too, are you need to understand what the going cap rate is for that market.

And there are ways to look into that as well. We've seen in, in the know that it's about a 4-4.5% cap rate right now. That's what things are trading or selling for.

Steve Olson: Depending on the market. Right. But most of where we operate is, is yeah. I mean, that's not a Toledo, Ohio cap rate, Salt Lake, Phoenix Metro. Even Boise, Boise might even be less crazy.

Chase Leavitt: Yeah. I skipped ahead a little bit. I want to back up. I said, NOI, net operating income. We didn't talk about that. The thing that we talked about before that was the gross annual rents, the yearly gross rents. Right. Let's just take an example.

Let's make it really easy. Let's say we're looking at either a single-family home. Or a townhome one unit, one property, let's say it rents out for a thousand dollars per month. Well, that's what we know per month, it's a thousand dollars, right? What's the yearly, you just times it by 12. Okay. So where are you at?

12 grand, 12 grand. We need to back out the expenses. What is our expense ratio going to be? If it's newer, newer property, less maintenance, the expenses are probably going to be lower. This is something that you'll dive into deeper later. But for the sake of time, we'll just say it's 35%.

Let's go back to the one unit. Thousand dollars per month. Times 65% is $650 times 12 times 12. This is just a simple example. $650 is what someone's going to be netting on that one unit per month. Times that by 12. 7800.

That's your yearly or that's the net operating income. So NOI is the secret. Once you can estimate quick and dirty NOI, then there's a couple of different ways you can, you can figure it out. Cap rate by just taking your NOI and dividing by the purchase price or what you want to pay for it.

And that's what your cap is going to be. Or if you want to figure out what you should pay for it, you take your NOI divided by the cap rate. If you want. It is six cap. Hey, I know what the net is. This is my quick and dirty. The what'd you say seven grand 7800 7800. And I want to, I want to buy this townhome or the single-family home at a six cap.

Then divide it by 6% and that'll give you a price.

Steve Olson: We'll get into this on the next episode, but just because you want to buy it at a six cap, doesn't mean that's what the market will give you.

Sherida Zenger: That's right out of our "to be built" are between a five and a six cap.

That's to be built construction. You're going to have to wait a lot longer for that. Let's just clarify that. Those deals are out there, but there are things that you're going to have to wait for or in different markets, not the markets that we're currently in right now.

Steve Olson: Well, that's the point.

If you want to do a cap rate better than what the market will give you, well, what are you going to give the market? What risk are you going to take? Yeah.

Chase Leavitt: Once you understand that and say, okay, well this is going to be a six cap or yeah, this, this is the value of my property, whatever you're looking to do. Then just dive a little bit deeper and make sure you have all your facts straight, the rents, the expenses, et cetera.

Sherida Zenger: And kind of like Steve and I were talking about, hey, if you know that those rents are going to go up a little bit, you can have, Hey, this is what my cap rate is right now. And this is what I projected at and maybe that makes sense too.

Steve Olson: Excellent. That's it. That's all she wrote. We'll catch you on thenext episode on the build-to-rent podcast. Thanks for listening everybody. And remember to subscribe on iTunes, Spotify, and the Google store.

Submit A Question To Be Covered On The Show!

Let us know what topic(s) you want covered in a future episode.

*Submitting this form opts you in to receive news and updates from our team.