Latest / Real Investor Radio Podcast / Mini BreakDown | Are These Multifamily Deals Actually Profitable?
Transcript
- Craig (00:00) Hey, welcome back to Real Investor Radio. Doing a quick one for you today with Jack BeVier. Jack, it's good to see you, sir. Hey, listen, you've been talking of, think, Jack, for at least a quarter now, maybe more about more opportunity that we're seeing in small to mid-sized multifamily. I will tell you from a loan officer standpoint, you could you let this, you you have a whole bunch of loan officers that work for you, but at least for me, from an anecdotal standpoint, Jack BeVier (00:05) Yes sir, yes sir, you too. Craig (00:28) I I've gotten, I bet I've received no less than a half a dozen calls in the last month of guys that, hey, I'm generally a single family guy, but we're seeing some multifamily opportunities where we are and we're thinking about, you know, they always say stepping up into multifamily. I'm like, ⁓ you know, is it, it's definitely a step up, you know, but it's a whole different beast, right? It's not like, I don't know that that single family Jack. can the way you underwrite single family can always translate over into the way you that you underwrite a 52 unit property, right? And so one, I'd love for you to speak about some of the emerging opportunities that you're seeing in small to mid-size multifamily. And then two, some of the tells that we're seeing with folks in the underwrite, Jack, that like when we get the pro forma and they want us to underwrite the loan, What are we seeing on that performer that's like, you know, might not be putting the numbers in the spreadsheet in a way that really tells the story the right way. So yeah, go ahead. Jack BeVier (01:26) Yeah. So we're definitely seeing more opportunities on the multifamily side, whether that's a function of syndications from 2021 to 2023 that are resetting finally and being put back out into the market and prices are being kind of reset to just a, guess like more of a balancing of cap rates relative to cost of capital. So we're just seeing fewer fewer buyers. That's just As a result, money dries up and money dries up, cap rates expand, go up. So we're seeing, I think on a relative basis, better cap rates and multifamily than we have in a very long time, particularly in that kind of like sub-institutional, know, sub $25 million price point. So. Craig (02:11) sort like B to C assets share. Jack BeVier (02:14) Yeah, yes, exactly. Yeah. Smaller unit counts and B2C assets. Yeah, exactly. We're seeing some some bridge lending in the marketplace pick up as a result as well, because people are like, yeah, yeah, we had, there were some issues with multifamily running underwriting a couple of years ago. But, you know, but the prices have reset. And so now the new deals are, you know, they make sense. So and I agree with that. I think that there is more opportunity in multifamily today than I've seen in. 10 years, a long time. So it's definitely something that we're keeping tabs on ourselves to look for deals in Baltimore, which is our backyard. But as you mentioned, with these deals that we're seeing and folks get back in, we're starting to see some, well, we're seeing a variety of pro formas and some of them, the numbers are just good and yes, this has been a reset and some of them are, they're getting back into the market, but you know, but I don't know if they've actually learned, you know, maybe they're new to the space. Maybe they didn't realize that they were part of the problem when, you know, their, their poor underwriting was part of the problem. I've seen particularly in the lower end of the market. I think that that's the most difficult place. It's the easiest place to, to trip and trip and fall from a, an underwriting assumptions perspective. And. Craig (03:30) So, yes, the thesis is that we've got either new investors in the space of the asset class that may not understand all of the line items that go into putting together a Performa for the deal, or we have experienced guys who really know how to jockey a spreadsheet to make the numbers work out. Jack BeVier (03:31) I think... Craig (03:53) to make the Performa marketable from a lending standpoint. And I'm being kind there. So yeah, go ahead. Jack BeVier (03:58) Yeah. Yeah, and the question yeah, and the open question remains like, are the assumptions in the pro forma reflective of reality? Like are they actually? What's going to happen? Craig (04:11) And where are you seeing, where are you seeing like the sort of the glaring tells Jack that like maybe they're not being realistic about the asset, the asset that they have B or C, small, small multifamily. Jack BeVier (04:24) Yeah, the mistakes that we most often see folks make are around those underwriting assumptions. You know, if there's a story about value add to the property where you can increase the rents by doing some renovation, I'm going to leave that out. Like that's a case by case. Maybe you can, maybe you can't, but like the sponsor can make that argument and the investor can make that assessment. You know, they can make that judgment call and reasonable parties can disagree. So I won't even get into the top. where I see the mistakes being made of the expense underwriting assumptions. the expense under underwriting assumptions I think are on a multifamily unit. When you get presented with a pro forma, right? Like of a, you know, it's a five year, 10 year cashflow statement. They're kind of difficult to underwrite because it says utilities $8,463. Is that the right number? I don't know. how, you know, like I don't know like I don't know if $8,463 is the right number or not. If you show me a house pro forma, I know how much a turnover costs. I know how much my utility bill, you know, I know what my BG my gas bill was last month. I know what my property tax mill rate is in this area. And so it's a lot easier to look at a pro forma and be like, yeah, that makes sense. That's reasonable. That's reasonable. And then look for the expenses that they didn't account for. You know, your classic like wholesaler presents, you know, real estate taxes, insurance, property management, repairs and maintenance, we're done, right? Like you can call on that like pretty quick, right? But the multifamily one's a little bit harder. Like how much is trash removal? You know, like, I don't know what trash removal is. Like where is it? You know? And so where, when you break down the pro forma though to per unit. So I think it's very important to when analyzing a multifamily deal to break it down to a per unit per month basis and convert that annual number for the whole complex into a per unit per month. Cause then your brain can start to like connect dots a little bit easier and eyeball whether that number is realistic or not. And so some of the, some of the places where we've seen like misses are allocations for bad debt, know, like credit write off, you know, how much, know, what percentage of rent are you going to get stiffed on basically, right? Like who's going to skip. and not, you with a three month balance, who's going to get evicted and a judgment's worthless. So bad debt is one of the line items that I find most often under allocated. ⁓ Craig (06:42) And Jack, think one of things that I've noticed from you is that that that that number could vary wildly between where you're located and sort of what type of asset you have. I'll just break it down to Baltimore. If I've got a multifamily in a really tough section of Baltimore, that's going to perform a hell of a lot differently from an expense ratio. If I've got the same type of asset up in a much nicer section of Baltimore where people make more money and have more stable jobs. Jack BeVier (06:50) yeah. And even within the same location, like what's that property manager's tenant screening criteria and how strict is Janice in the office about enforcing it? Like it's, you can, you could have the, you could have two wildly different approaches to tenant screening, you know, most often, know, most often none, you know, and just like, let's, know, did they apply? Do they have, you know, a W two great, them in. versus somebody else who's like doing background searches and. validating other household expenses to make sure that these folks can really afford the unit. And that's not something that's easy to audit when you're looking at an offering memorandum for a multifamily property. There's no information that speaks to that. But that concept could make your credit loss vary by 10%. Someone good at it versus someone bad on it, even within the same location. It's a tough, you know, that's one of the tougher line items, I think, to get right. But, you know, you got to then dig in with a sponsor and really understand, you do they have like other properties that are in similar locations that they're currently managing? And what's your bad debt on that? Right. Like you make them, you know, unfortunate, hey, they got to work for it a little bit in terms of valid, you know, justifying the assumptions that they're putting into these, into these Excel spreadsheets. Craig (08:24) So it all comes down to sort of the expense ratio, right, Jack? Like all of these numbers go into your expense ratio. And I think in speaking with you about it, it always feels to me like folks that are looking at these types of assets are wildly underestimating their expense ratios. prior to the call today, we had a company call where we went through a scenario where the borrower, I don't recall what they thought their expense ratio was, Jack, but you are more of the mindset that it's probably like 65 % of total revenue. And I don't think they were even close, but you made a case in a very short amount of time that you were probably right and they might be thinking Rosie. Jack BeVier (09:05) Yeah, the I mean, so when we're underwriting deals, I've got like some just like back of the envelope heuristics rules of thumb basically to help me make sure so I don't waste my time. Right. Like underwriting a deal that like is just dead. So like developing those heuristics is very useful to so I can not waste time. And so generally speaking, when I'm looking at, for example, when I'm looking at a property that's got a thousand dollars or less. rent per unit per month, right? If it's to less than $1,000 a month rental. I have never seen a unit, a building actually operate at better than a 50 % expense ratio in that category. That's kind of your B minus C, C minus like locations and, and a tenant profile. You know, it's folks, folks who make 15 to 25 bucks an hour. You know, that's who rents a unit for 8.50 a month. And there's tons of it. And they look cheap on paper. Those multifamily buildings look cheap on paper. But I think that they're often not because the expense ratio, when you're only collecting 8.50 a month and the toilet costs what it costs and the painting the place costs what it costs and the trash removal and the Craig (10:19) Perfect. Jack BeVier (10:22) grass cutting and snow removal cost what it costs. Well, that means a larger percentage of your, and you have a lower rent to pay those expenses. A larger percentage of your rent is gonna go to just fixed expenses that are gonna exist regardless of the class of the property. And so the idea that a class A building is going to have a 35 % expense ratio and a class C building is gonna have a 35 expense ratio. doesn't make common sense. That doesn't make any sense. You're going to have a higher expense ratio. The lower the class of the building, the higher the expense ratio is going to be. And in that category that we were talking about, I'm used to seeing in real life 50 to 65 % expense ratios. So every dollar of rent you're collecting, you're spending between 50 and 65 cents on expenses before the mortgage, by the way. Craig (11:14) I was going to say, like, how do you even that so you lever that thing up with debt and now you're underwater? And and I think that's what we that is literally what we saw over the last several years. Right. And and you know, those chickens are coming home to roost. Jack BeVier (11:20) quickly. Yeah. Yeah, and some of those folks blamed the interest rates went up by 400 basis points. Yeah, but you also never had a chance because you bought an $800 a month unit for 80 grand and it didn't matter what interest rates did. You were always going to fail. And you know, if we're not honest with ourselves about how this thing actually operates, then we'll just repeat the sins of the past. So I mean, you see this in that credit, that credit loss ratio being incorrect. You see it because investors pretend like real estate, they're going to do a value add project, but the real estate taxes aren't going to go up. Like you're going to go add value and your ad valorem taxes are pretty, you property taxes aren't going to go up. So leaving taxes alone or growing them at a small percentage instead of marking them to the new ARV that you're, you know, that you're projecting is probably the biggest one. I see that the most often. And know, and investors will tell themselves and they'll tell their investors, they'll tell their LPs stories like, yeah, we, you know, the county, the county doesn't reassess. Like they just, you know, we've been operating here for 20 years and the county doesn't reassess. That you've gotten lucky on the two houses that you own in this particular municipality does not mean that the politicians are not interested in collecting their ad valorem taxes. You just haven't hit their radar yet, but You absolutely run the risk of having a mark to market on real estate taxes at any point in time. And so it's really irresponsible underwriting to pretend that the county's stupid. that's why I'm like, you're just paying too much. You're paying more for this house or more for this multifamily property because you're convinced that the county's bad at collecting taxes. That's a bet that I'm not willing to make anyway. Craig (13:11) Jack, what about the guys that like they're in it for sort of the finders fee, the admin fee, the management fee, and then really they're looking to hold the thing for like five years, get the value added, get the rents up. So two questions. What about the guys that are just playing for the fees? And then second, how do you project what a cap rate is going to be on a sale without looking into a crystal ball? Jack BeVier (13:37) Yeah. So the alignment of incentives issue is still an issue, right? The syndicators that were active from 2014 to 2021 had a combination of rising rents and lower and decreasing interest rates that bailed out every single one of them. Everybody who did a deal during that period of time road that wave and calls themselves smart and think that there's a problem. And then 21 to 24 happened and a lot of sponsors failed and not all of them were introspective enough to realize that and they blamed the market, right? So they didn't blame, they didn't give the market credit. When the market was, when everything went well, it was them. When everything went bad, it was the market. And now we're resetting the deck again. Craig (14:07) There's the guys in the room, Jack. Jack BeVier (14:31) And they haven't learned in the past 11 years. there's still, and there's, yeah, they're still making the same mistake. They're still making the same underwriting mistakes as they've done for the past 11 years. And they just never been introspective enough to, you know, there's always a story as to why it wasn't, that's just the way the building operates. And anyway, so that, or that misalignment of incentives between general partners and limited partners is still, still a thing. Craig (14:33) Preach, Jack Levere, preach. Come on, go. Let's go. Jack BeVier (14:59) you know, acquisition fees and overrides and, know, and promotes on IRR upside is what the GP is there for. And, and when they're not putting in, when they're not putting money in at first loss, they're not even putting in very much money of their own. you know, if you, you look at the, when you, when you do the math on the GP's IRR, they put in, they put in this 5-10 % even, you if you've got a good one, they put in 5-10 % and then they get acquisitions fees, asset management fees, property management fees, and then promotes on IRRs if it works out. You look at the IRR on their economics and you can have a crap deal, right? A deal can go poorly and yet their IRR was excellent. And that's a, you know, that's a misalignment of incentives that we've never really gotten comfortable with. We've never... We just not our gearing to like be able to get comfortable with that misalignment of incentives. And nothing has changed about the industry from that perspective. The LP, the GPLP fee structure and promote, you know, math is the same as it has been, even though, you know, we've gone through a little bit of a cycle here. Craig (16:06) I'm gonna ask a crazy question right now and put you on the spot. You can tell me to piss off if it's out of line. How hard would it be for us to put together a really killer spreadsheet that like a person could use if they were evaluating such a deal, Jack BeVier (16:22) Oh, I have it. I have a single form. I have a single family pro forma. It's the same thing. That's the thing is it's the same thing when you break it down to per unit per month. That's you just have to then like put your head in the mind of like, oh, yeah, but it's a it's a single thing. But it's a house that I have where the owner of the property has to do the snow removal and grass cutting. And I also have to pay for trash removal. Craig (16:23) I thought you might, but like... No, small to mid-sized Maltese. Jack BeVier (16:49) And I also have to pay for common area utilities. when you just, but the, well, this pro forma is flexible enough to have allocations for those kind of common area expenses. And as long as you put in those common area expenses, then the math on a single unit versus the math on 52 units is the same thing. It's just times 52. So like, I don't, don't perceive that you need like a different pro forma for it. Craig (17:11) Let's have some fun, man. Let's tell people if they want access to that spreadsheet, they can shoot me a text. Shoot me a text. No, not a text, because I'm not going to give my phone number on this podcast. But you can leave a comment, or you can email me at craig at thedominiongroup.com. Jack's a pretty busy guy, so I won't bother him with that. You can email me, craig at thedominiongroup.com, and we'll make that spreadsheet available for you. Maybe even make it in a cool AI way, Jack, that they can Jack BeVier (17:17) Yep, she knew. Craig (17:39) They can just fill out some numbers and they can get Jack's advice on whether or not their numbers are correct or not in AI form. Jack BeVier (17:39) to get in fancy. Yeah, and what's on this spreadsheet that I think is important is a lot of the expenses that just the wholesaler leaves out of it, Like a lot of the expenses that the wholesaler leaves out of it, you know, like the turnover expense, the releasing fee, the actual drivers of vacancy rate. People just put their finger up in there and they're like 5 % as if it was just a random number. Like it is not a random number. Vacancy rate is a function of average tenancy duration, Craig (18:05) Yes. Jack BeVier (18:12) down and then the downtime between between tenancies. So like there, you know, how long does it take you to turn the unit over? How long does it take you to release the property and how we add those two together and then the denominator and then divide it by and what's your average tenancy duration in that locate in that that property? So that is what vacancy rate is, you know. Craig (18:30) Jack, how if. If but if Jack if I'm doing a pro forma let's just drill in there real quick and then we'll finish. If I'm doing a pro forma and I'm and I'm trying to pick what my vacancy rate is going to be and let's say I'm doing some C class in Kansas City. How do I how can I how do I know it's going to be 5 percent is it going to be 10 percent like how many units are going to turn over per year. How do I. Jack BeVier (18:55) Yeah, you have to tell me you just tell me three things you tell me how long when a property goes vacant, how long until it's rent ready again? Give me a number of days. And then how long is it going to take you to release that unit given the quality of its location, which by the way is a function of things right like well if I put it out there at 950 a month, it's different than if I put it out there at 850 left like it'll it'll lease faster at 850 a month and it will at 950 a month. So like there's There's like you have to look at the totality of the assumptions and make sure that they are all congruent with the narrative of this property, the location, the renovation quality, the quality of the property management, the aggressiveness of property management in terms of setting rents. All of those things have to be congruent with the set of assumptions. Right. There's only one, you know, business plan for this house, right. For there for this for this property. So vacancy rate is just Hey, how long does it take you to turn over a unit? Plus, how many days does it take you to release that unit divided by what's your average tenancy duration? Which is, you could just say, how many turnovers do you have a year? You have 10 turnovers a year in this 40 unit complex. Craig (20:04) That's my question. How can you make assumptions on how many you'll have per year? Jack BeVier (20:09) I mean, the well, the you have you, you need to have you better have an opinion on that. You'd be like before you buy before you tell you before you tell the world that you're a qualified sponsor in this location, you better have an opinion on that. Exactly that. Like I think the answer is because I have managed properties in this zip code. And I know that given that on a relative basis, like Craig (20:29) There you go. Jack BeVier (20:32) You know, in this nicer location, we have a four year average tendency duration and then this little tougher location because we're on a double yellow, we have a two and a half year tendency duration. If you don't have that opinion, you shouldn't be a sponsor in the first place. So that bet, you know, that that better be a question that you just know. Craig (20:47) Good job. Well, ⁓ obviously we hit a nerve, which I love. Love that. Wish we would do more of that. Well, folks, seriously, the reason why I thought it would be a great podcast topic today is one, we're seeing more of those opportunities in the market right now. And two, we're seeing some questionable underwrites. And Jack ⁓ and Fred both shared on a previous call prior to this podcast. We literally broke down a case study on a deal that we're underrating. Jack BeVier (20:49) you You Craig (21:14) underwriting right now for a potential borrower. And so I just thought it was great ⁓ to get into the minutiae of that. And if you're interested in getting that spreadsheet that Jack is going to prepare, it's going to be the most amazing spreadsheet ever. ⁓ Jack BeVier (21:29) I've been using it for 15 years. It's the same spread for 15 years. Craig (21:32) Pick me up at craig at the dominiongroove.com and I'll make sure that Jack gets me a working copy and I might even make it cooler with some AI tonight if I have the time. I'll make it nice and fancy, Jack. So that's it for today's quick episode. I hope you guys got a lot out of that. Looking forward to hearing your comments and we'll see you on the next one. Jack BeVier (21:42) Make it fancy.