Active real estate investors who are in – or moving up to – the large (100+ units) segment of the multifamily housing (MFH) market, can find some good ideas about how to score off-market opportunities. Most “top five tips for multifamily acquisitions” lists probably include some variation of these suggestions:
- Build up your contacts in the industry
- Join online forums and groups
- Dig into county property data and other public records
- Drive around and keep your eyes open
- Don’t be shy about cold calling
All good advice. But what we haven’t seen in the articles we’ve scanned and podcasts we’ve heard is a true off-market multifamily acquisition deal flow process. During the past several years, we’ve refined our efforts into a 5-step deal flow process, which we are going to share with you. But first, some background:
Like many active real estate investors, Smartland founder Vadim Kleyner started off in the single-family renovate-to-rent (SFR) business with the purchase of a single home. In fact, he was one of the first to build an SFR business on a large scale. In 2014, he sold off a substantial portion of those assets to focus on multifamily properties under the Smartland brand.
Smartland is more than a real estate investor – our in-house services include construction, architectural design, property management, and marketing — and that dictated our Value-add & Opportunistic focus within the MFH space. Here is what we look for:
- 100+ units property size
- C to D current property ratings
- A to C property location ratings
- Rents 15% or more below market
- Opportunities for adding community amenities
We initially focused on our home market of Greater Cleveland. But we are confident our strategy and deal flow process will translate to plenty of other markets. Of course, you may need to tweak our deal flow process for multifamily acquisition to better fit your goals and situation. For example, if you don’t have your own construction and renovation capability – or have a really good partner – the 15% below market target may be too aggressive.
Related Link: What Are Class A, Class B, and Class C Property
1. Searching for deals
Start out looking for properties with rents 15% or more below market in a given MSA, zip code, or submarket. Use Yardi, Costar, LoopNet, Zillow, MRI, and/or other sources for searches and data.
Set a radius and look for all the properties within that area. Calculate the average rent and scoop up all the properties whose rents are below that average by whatever margin you set for yourself. Those are the target properties. Verify ownership on the county website to make sure that the ownership that’s stated in the database is legitimate and the contact information is correct.
2. Reaching out to prospects
This is a good time to put yourself in the shoes of the people you hope to talk to. You want to have a friendly conversation, not get a curt, “Not interested. Good-bye.” What are their intentions? Maybe they just haven’t gotten around to listing the property. Maybe they feel they need to make some improvements before they put it on the market. Don’t be pushy. If they are not interested, set a reminder to contact them again in a year.
If there is an email address, send an email first. Introduce yourself and say that you want to make an offer on the property, that you have financing, and that you’d love to arrange a meeting. If you don’t hear back within 3-4 days, call the contact number. If you can’t get a hold of them by phone, follow up by email. Invite them for a cup of coffee. Don’t be deterred by rejections. Keep on emailing and keep on calling.
3. Analyzing Income statements
If the party does show an interest in selling, send them a non-disclosure agreement (NDA) to assure them that none of their information will be divulged. Ask them for the property’s most current rent roll, trailing 12-month (T12) income statement, and most recent full-year income statement.
When looking at the rent roll you’ll want to verify the current occupancy rate, unit mix and square footage, and average rent for each unit type. Based on that information, calculate the average price per square foot as is.
Now pull in the comparable rent data from the properties in the submarket to estimate how much you can potentially raise the rents. This will help validate to investors that the desired rents you project are achievable.
Examining the T12 numbers is a great way to project future expenses off of historical performance. Focus on property management, utilities, administrative, insurance, and other operating expense line items to identify possible areas of mismanagement that you can capitalize on to lower expenses and increase profits.
4. Calculating the cap rate
Even if you can’t immediately identify any opportunities to lower expenses, you at least have accurate numbers to enter into your underwriting model. Add in a cost of vacancy factor, typically calculated at around 7% of income. Income minus Operating Expenses = Net Operating Income, or NOI.
Now you want to calculate the capitalization rate or cap rate. This is the ratio of a property’s net operating income to its purchase price. It’s an essential number for gauging a property’s rental income potential and quickly comparing the profitability of different properties.
So, if you’ve calculated your NOI to be $800,000 and you’re thinking of paying $10 million for the property, that calculates to a cap rate of 8.0%. That is the expected annual return on your investment before accounting for debt. The higher the cap rate, the better for the buyer. Higher cap rates generally correlate with lower-rated properties, which are regarded as riskier investments.
To estimate your debt service payment, you need to project the interest rate that you might get from your bank. Look up the 30-day LIBOR rate plus 300 basis points (3 percentage points). The LIBOR is the most common of benchmark interest rate indexes used to make adjustments to adjustable-rate mortgages.
Next, you want to calculate your expected Net Cash Flow. This tells you what profit you can make on the asset after debt service. NOI minus Debt Service = Net Cash Flow. When we analyze potential multifamily acquisitions at Smartland, we project five years of these cash flows because our goal is to exit properties at the end of five years.
Cap Rate Calculator
Knowing your Cap Rate is critical. Simply ﬁll in your Annual Rental Income, Operating Expenses and Purchase Price and this will automatically calculate your Cap Rate.
5. Setting your selling price
Wait – you’re not finished. You need to determine what you want to sell this property for at the end of five years. Use sales data for the past three years from your market or submarket to more accurately determine the exit cap rate and exit price per door you can expect to realize. With that number, you can calculate your targeted internal rate of return or IRR.
In finance terms, the internal rate of return is the discount rate at which the net present value of future cash flows of an investment is equal to zero. In simpler terms, the IRR is the rate at which the value of a real estate investment grows. Viewed another way, IRR represents the percentage rate earned on each dollar invested over the entire period that you hold the property.
For example, if an investment property was purchased to be rented out for five years, interest on the rental income received during the first year is earned for the remaining four years. For the second year, interest is earned for the next three years; consequently, each year adds more earned interest. The sum of the interest earned over the five-year period is used to calculate the internal rate of return. Here are three ways to calculate the IRR in Excel.
At Smartland, we assume that as long as we can hit at least 17% IRR, we can meet our investors’ goals for the asset. Our offer price will be based on what we can pay for the property that will allow us to reach our investment goals.
And now you have everything you need to write your letter of intent and work on closing your off-market acquisition for a multifamily property!
Complimentary underwriting assistance from Smartland
Have a multifamily property you are underwriting and want our expertise to assist? We’d be happy to do a complimentary evaluation and provide our expertise. Email with property address, rent roll, income statement, and any pertinent information to email@example.com
Partner on buying a multifamily property with Smartland
Have a property that you are interested in partnering upon? Have a deal off-market or under contract? Reach out to firstname.lastname@example.org
Sell your real estate with zero headaches and a quick turnaround to Smartland
Have a multifamily property that you’d like to sell? Reach out — we’d love to review and make an offer and reduce your headaches with selling a property. Email with property address, rent roll, income statement, and any pertinent information to email@example.com