Our top real estate buying criteria

We hope you are doing well and staying safe. This month we’ll share one of our most important buying criteria and how it protects us against many unfortunate scenarios. But first, we’d like to share some exciting news!

We’re selling Haven on Peoria fka Ridgepoint

After nearly 20 months of ownership, we are under contract to sell Haven on Peoria. We have owned 5 properties in Phoenix, 577 units in total. This will be our second exit in the past 12 months.

We like to look at each property as a long-term flip with cashflow. We renovate units and increase the cashflow with each completed renovation. As we get closer to renovating all the units, we either sell the property or refinance to boost the cashflow. Below are some details regarding the sale:

Name: Haven on Peoria
Size: 164 units
Investor IRR: 24%
Investor Multiple: 1.5x (Example: $100k invested will return $150k)

We are always looking to buy our next apartment building in the Phoenix market. If you would like to have a first-look at our future investment opportunities, please fill out this short survey.

Buying in the Delta

As you know from our previous newsletters, the Phoenix market continues to be very competitive. As we continue buying in a rising market, we always think of how we can be conservative investors. We have several ways that we protect ourselves from changes in the market. One of those ways is by buying in the delta. But what does buying in the delta mean?

Delta is the difference between two things. For us, the delta is the difference between in current net operating income (NOI) and our projected NOI.  Our strategy is to buy value-add properties where we can significantly increase rents by renovating each unit with Class-A finishes. We usually aim for an increase of at least $300 per unit per month. As you can imagine, it is very difficult for us to find properties that meet this requirement. 

Why is buying in the delta so important?

This is a big advantage of passively investing in real estate syndications. Investors can get all the tax benefits of real estate without having to answer late night phone calls or fix leaky toilets.

As a passive investor, you own a percentage of the LLC that owns the property. Based on your ownership percentage, the tax benefits are passed on to you. During tax season, our accountants will divide the tax benefits and issue a K-1 form to all investors.

This should not be confused with investing in REITs. REITs are a public security and do not offer tax benefits such as passive losses via depreciation.

1) What if we can’t increase rents as much as anticipated?

If we find that we cannot push rents as high as projected, we can cut back on our renovation scope. Everything is a cost-benefit analysis. We spend north of $12k per unit for top-of-the-line renovations. We can always cut back on our renovation scope to balance the decrease in rent.

2) What if rents in the market decrease?

There are two ways we protect ourselves in this scenario. First, our renovation scope is unparalleled with our in-house construction team. If you compare our properties to nearby properties, we have nicer cabinets, flooring, countertops, etc. If two properties have similar rents and amenities, you would pick the property with nicer finishes.

Second, if rents drop by $100 in the entire Phoenix market, we can still push rents by $200 (instead of $300). Wth $200 rent increases, we still are able to provide strong returns. We would not be able to do this if our strategy depended on increasing rents $100-$200 per unit.

3) What if the cap rates expand more than our underwriting, thus lowering our exit?

We already account for expanding cap rates in our underwriting. If cap rates expand even more than that, it doesn’t affect us as much. Cap rate equals the NOI divided by the purchase price. 

If we were buying properties with a $100 NOI increase per unit, our assumed returns would be impacted more by cap rate increases. Since we are increasing the NOI by $300 or more per unit, changes to the cap rate don’t affect us as much.

With each investment, we run multiple stress tests. We usually stress test three scenarios: $100 rent decreases, 1% additional cap rate increase, and 1% increased interest rate for a refinance. Then we combine all three scenarios for a hail mary stress test. Often times, we end up with high single-digit returns for our hail mary stress test.

Summary

As property prices continue to increase, it becomes even more important to buy true value-add deals. This gives us multiple exit strategies and allows us to adjust as the market changes.

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