What Classifies a Good Rental Property Deal? - EP15

analyzing a deal build-to-rent income & expenses multifamily new build new construction proformas Nov 30, 2021

"I think that goes back to knowing what product you are buying. You don't want to buy an A-class product if you're worried about some of these things. Maybe you want to stay in a B or C range. They are more affordable."

"I talked to a guy last week that said B and C weathers recessions better. Right now, it's easy to want to do a pool like the Ritz Carlton and build a beautiful A-class community. But that's coming from a place that hasn't seen a downturn." - Sherida Zenger & Steve Olson, B2R Show

Episode Highlights:

  • What is a good cap rate?
  • Calculating the returns of a build-to-rent investment
  • Saving on taxes might make a deal worth it
  • The value of turnkey properties
  • Cashflow, Internal Rate of Return, and more...

Steve Olson: Welcome to the Build-to-Rent Show. This is Steve Olson here with Chase Leavitt and Sherida Zenger. We're excited to talk to you today. Remember to subscribe to the show on Spotify, iTunes, and Google.

We're also getting closer to getting a Build-to-Rent Show website so you can actually talk to us. But in the meantime, if you have questions, or you want to run something by us or ask us to discuss something on a show, just go to the day job. Go to www.fig.us That's where you can find us, fill out a contact us form, and say, Hey, I heard you on the podcast, and what you said about this was great, or what Chase said about that was really stupid..."

Chase Leavitt: Of course. Thank you.

Steve Olson: Subliminal Message.

Today we want to talk about something that's a little bit subjective, I think because you always hear people, especially online in forums talking about, "I've got this good deal, or I've got this bad deal." Right. So the question being, what's a good deal?

What is a good multifamily deal? I think we can answer that in two ways.

We want to kind of hit it around for a minute here to see what everybody thinks.

A good deal is often "What is in the market right now? And are you doing better than that?" That's a good deal.

But also a good deal can be highly individualized. So right now, letter of the law: What's a good deal? What do you think?

Chase Leavitt: I just heard that this was the topic, right? And so I wrote down a couple of things. I'm just gonna throw them out there. We don't have to go into them, but this is what came to my brain.

  • Tax Shelter/Tax Savings
  • Cash Flow
  • No Brain Damage
  • No Headache
  • Cap Rate
  • Equity Play
  • Location

Sherida Zenger: I think it just it all depends on what is important to you. Some people are worried about a cap rate, some people are worried about cash flow.

I'm working with a client right now that says I want to close by the end of the year, because he's able to do a cost segregation study, so he needs it for his taxes for this year. So everyone has different reasons what are driving them to invest and at different times of the year. So what makes it a good deal for them.

Chase Leavitt: That's why throughout the tax savings/tax shelter right now at the end of the year. We have a couple of investors that need to buy properties. They might not pencil the best, but we're buying a couple of properties that don't cash flow may be as much as they're used to. But if they're gonna save 100-200k, maybe more in tax savings, because they're purchasing X amount of units, it might be a good deal for them.

Steve Olson: So that's kind of the subjective side. Right now, black and white. I'll just call the shot... A good deal is probably a 5% cap rate. That's a really good deal.

Chase Leavitt: If it's already performing and built.

Steve Olson: On the open market. You'd almost be like, what's the catch?

You're saying why is this at a five cap? And that's primarily in the intermountain west, where we work. A 5% cap rate in California would be astronomical.

Chase Leavitt: And we're not talking about the ghettos for lack of a better word. I think you can probably get a higher cap, but you're gonna deal with some other problems.

Sherida Zenger: You probably have an older property in that situation.

Steve Olson: When a market is consistently delivering a 4-5% cap rate, and you magically find a 7%, you should be suspicious. Markets are very efficient. You're not getting just the seven cap. There's some other stuff that's coming with that deal. That's why it's a seven.

In Texas, different parts of Texas, A five cap is probably average. But it depends. Are we in Lubbock? Are we in Plano? It's a big, big difference.

And then if you get into the upper Midwest, some of the rust belt. I mean, you should be expecting a six on a nice clean deal, if not better. So it really does. It really does depend. And cap rates fluctuate with the market. But that's, that's our black and white answer. Well, those are good deals.

Anything to elaborate on that? What do you think?

Sherida Zenger: I've seen stuff trading below a four cap right now. I mean, 3.7-3.9%, something like that.

Know the market and make sure you're comparing apples to apples because that's the, I guess one of the biggest issues that I have with investors. they say, Well, I can get six or seven caps over here. Then go invest over there if you can get that over there. Because you can't get that in the market that we're in.

Steve Olson: I mean, is that valuable based on the asset? Based on the market.

Chase, you were sitting by me. This was years ago, we were at a trade show. And I think it was in Vegas and brokers from all over the world came in. I don't know if you remember this, this guy from Toronto. What's the cap rate in Toronto? He said zero. There isn't a cap rate in Toronto. You are buying and you are hoping that it goes up. I think it was like 2017 maybe.

Sherida Zenger: Almost sounds like California, right? You're buying just in hopes that you have appreciation, you're not buying for cash flow, you're buying that you know that property is going to appreciate.

Steve Olson: And that goes to what you're saying? What's a good deal? Is that what your capital is suited to? If you've got a whole bunch of capital, and you don't have anywhere to put it, you're almost forced to put it in something--that, well I hope it appreciates. better than being in the bank, Right?

Chase Leavitt: Right now a good deal is getting your money out of the bank to where you find something that has some things we talked about the tax savings, the cash flow, cap rate, good location, where you can get some equity in that property, most likely, we don't have that crystal ball, most likely, we're probably gonna see rents continue to climb and property values from that will continue to go up.

Sherida Zenger: I mean, even those 1031 exchange buyers, right. some of those investors get kind of picky with, I want this or I want that. And it's like, you have 45 days to identify, you don't have a lot of time to pick and choose. So pick something.

And then like we had chatted about in the last episode, maybe you go into an area that, you know, rents are increasing or have increased, and you know, there's going to be some renewals coming up.

Chase Leavitt: So what is a good deal?

I think that's going to vary depending on the investor and what their goals are. for me, I like to chase or understand cap rate. I like to understand cash flow, I chase cash flow. I want to make sure that there's a healthy cash flow.

So if rents do soften, I'm still getting the rents to pay that mortgage down, if I'm taking out a loan on it. So cash flow is big for me.

Location. Analyze location. That's not a deal-breaker for me. at one point, we had a project in Magna. And at that point, three years ago, people were kind of iffy about Magna. Now Magna is a huge home run. So I kind of ignored the location factor there. That was three years ago and bought the duplex for 400k. And now it's probably worth 650k. And that area is just booming and getting better.

So location. Look at it, it could be huge, but it's not a deal-breaker for me.

The one that I will mention is "no brain damage".

Understanding, who's going to be managing the property? I'm a little biased. New construction, I like newer stuff. That's kind of what I've been born into. I'm not opposed to buying something older apartment complex, that's the 1990s 80s. Whatever the case is, I'll look at it if it makes sense. But I like the idea of no brain damage because my time is valuable.

Sherida Zenger: Yeah, there's gonna be more hair on something like that.

Steve Olson: That's interesting you say that the no brain damage thing. I'm working right now with a client you guys know. He's from the Middle East and we're raising money for a few different projects.

When we talk about new construction, go all the way from the close on raw dirt all the way to lease-up...

We have to look at it from the perspective of those clients that we raise money from overseas. To them, a good deal is an IRR of the north of 20%. internal rate of return.

And for those of you that don't know what IRR is, we'll do an episode on that.

But that takes into account everything the time value of money and what happens to it over time, the increase in the value of the property, the rents, tax benefits, everything.

That's what a good deal is to them because they view it as "Oh, I can get my money into the states," but it's going to take a while to start making money. So we need a better IRR to take into account the time.

He and I were talking the other day because as you guys know, it's extremely frustrating to get new projects now. One day you think you have it and the next day you don't. So we were experiencing some of that just delays and we thought we were going to close in December. Now it's May, right, and it just keeps getting pushed.

So he said to me, could we look at some existing assets to be able to broaden our ability to acquire more deals? Faster? My answer him, Yeah, But they're expensive. You guys know, existing apartment complexes are crazy expensive right now.

And he said, "Well, yeah, but they might not care". What do you mean, they might not care? Well, if it's performing for day one, and they got their money into America, and so we came down to a figure of, if we could get him a 14% IRR, they would be willing to do that. Because think about it like this, they wire their money, we close on the deal within 30 to 60 days, and their money's working! Lower IRR, but no brain damage factor.

I have other clients that he'll buy a couple, fourplexes from me for a year. He will never buy a pre-construction deal. He doesn't want to wait 18 months or the two years that it's going to take for this thing to exist. So he'll take that 4% cap. he's got some money, just sold some land needs to put it to work somewhere. So it's extremely individualized.

Chase Leavitt: So just getting in is a good deal for a lot of investors. Because the point is that you're saying is, where's that property going to be in 10-20 years? Where were values in 2000, 2005, 2010? Yeah, we had our ups and downs, right. But most likely over a 10-20 year period, we're gonna see some ups and downs, but it's most likely going to go up.

Sherida Zenger: It continues to rise. You're gonna see the peaks and valleys, but overall, it's still rising.

Steve Olson: It's easy for us to say that right now when it's been rising like a crazy, crazy person. That's a harder thing to stand by When you're in the trough, or when days on market are going up. When we didn't get a renewal or when we had to renew lower. That's when you find out what you're made of.

I just read a great book, The Psychology of Money, by Morgan Housel. T hat's a great book about keeping your nerve in down markets and understanding the overall long-term picture of what's happening with your money. So I recommend it and he did not tell me to, plug it in fact, he doesn't even know who I am.

Sherida Zenger: Slow and steady wins the race. If you're gonna get in, get in and just know, it's gonna take a little bit of time.

Steve Olson: So a client told me, "I want a good cap rate, how do I get one?" I said, kind of sarcastically, buy a property in a good market with low unemployment rates, and wait. And in two years, and three years or whatever, it's gonna be a really good deal because your rents have crept up and, and you were in the market.

Sherida Zenger: I think another thing is we chatted about this a little bit before, we're different approaches to financing. You can do an interest-only loan, we were just chatting with Chase about doing, you know, a 15-year loan versus a 30-year loan. And I had mentioned that I had Lane run a 15-year loan for me and a 30-year loan, I ended up closing on a 30-year loan, but I'm paying it as if it was a 15-year loan just to pay that down. But I have that option.

If something were to get tough. I'm not stuck with that 15-year, that bigger payment, I still have that flexibility to go back to that lower payment if that makes sense.

Steve Olson: Yes, it absolutely does. So taxes, cash flow, brain damage, appreciation, just some of the reasons and that's going to be different. For everybody. It's really important, you know, if you're listening to this show because you're syndicating deals, right? What what's a good deal for your investors? Right? You need to know that. And it's all in how it's calculated, right?

How many times we get somebody comes to talk to us and says, Well, I can get to 20%. I don't even know where to start with 20% of what when how, right. It's an important conversation to dig into the nuts and bolts of it. Yeah, yeah, definitely. Okay, cool. Well, um, what do you think? And this is off the cuff? Our deals going to get better, you know, because at the beginning of the show, we kind of just humored the question. Well, a good deal is a five cap here and a four cap there, right?

Are deals gonna get better anytime soon?

Chase Leavitt: I don't think so. I think the cap rates are going to continue to get compressed and go down. I think rents will continue to climb. But as far as what you have to pay to get in the purchase price that's going to go up as well.

Sherida Zenger: I agree. I think if you get in now, you're going to just be banking on rents increasing that are going to help provide more cash flow. I think that they're coming down, like, Yeah, I think cap rates are coming down.

Steve Olson: I agree with the two of you. The linchpin is the renter, and what they can afford. If things begin to happen in the economy where jobs soften, wages stagnate, because they've actually been going up for the first time in a long time. Right, that then the economy is awash in the stimulus.

Seems like every week, the government is talking about a new trillion-dollar bill that they need to pass of some kind. So if you compare a low unemployment rate, you know where we are right now in Utah is one of the lowest in the country, I think, is two something percent.

The last I checked, the highest unemployment rate was Los Angeles County, it's like seven-ish percent. There are a few small areas that are higher. But markets with low unemployment rates are probably going to pull jobs, raise rents. And that's what I'm watching it because it all depends on this is the last episode we talked about, what's the gross income.

If that doesn't continue, to be healthy, then you could probably see a situation where things back off a little because of those rents and the salaries that people are getting, they've been absorbing these crazy building costs and land costs increases. They continue to do it as soon as the as long as the renter is strong.

Sherida Zenger: And again, I think that goes back to knowing what product you are buying. You don't want to buy an A-class product if you're worried about some of these things. Maybe you want to stay in a B or C range. They are more affordable.

Steve Olson: I talked to a guy last week that said B and C weathers recessions better. Right now, it's easy to want to do a pool like the Ritz Carlton and build a beautiful A-class community. But that's coming from a place that hasn't seen a downturn.

Thanks for listening/reading the Build-to-Rent Show. We appreciate having you listen to the show. Don't forget to subscribe on iTunes, Spotify, and Google. We'll catch you next time.

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