You’ve heard it said many times that location is key in real estate. It is, but perhaps for different reasons than you though. In this article I will explain to you where to buy investment real estate, and why.
WHAT DRIVES VALUE in REAL ESTATE
To me – the investor and manager of a portfolio of real property, there are several value centers in every transaction; several elements that I care about. These value centers can be more or less prominent relative to one another and my particular objectives, but there are a few foundational principals that remain intact. In order to really understand why the location is so key and in order to begin developing a sense of where to buy investment real estate, we must first discuss the 3 key value centers, specifically as they relate to syndication of income-producing assets.
WHAT DO I AND MY INVESTORS WANT IN A DEAL?
What we want in any deal is a good return on our investment – of course. My investors are putting money in, while I am investing a ton of time, and all of us want a good return on our investment. As I see it, and I am never wrong about these things :), out ROI is a function of 3 elements which represent the 3 main value centers:
1. Safety – we would like to own asset which will keep our invested capital safe.
2. Growth – we would like to own an asset that will more likely than not increase in value over time.
3. Ease of Liquidation – we would like to own an asset which, when we are ready, will be easy to sell for a profit.
With the above value centers in mind, the real question we need to ask is:
What attributes of a building/investment opportunity will contribute to us being able to achieve the stated goals?
Safety in a Syndicated transaction, or any other for that matter, as it relates to Multi-Family space is represented in Stable Cash Flow. We are buying this apartment building in part because we like the idea of getting paid a dividend every month, which in this case is represented by the Cash Flow. We like this, because we feel it’s less speculative in comparison to investments which require us to put money in, but not see any returns until we “hopefully” cash out some time later. Think of it this way:
We put $1,000,000 on the table by way of the down-payment and other out of pocket costs, and every year we take out 10% ($100,000). This means that each year, the amount of our original invested capital remaining in the deal comes down, and with it so does the risk…
Less Dough On the Table = Less Dough that Can Be Lost = Less Risk
OK – so we’ve established that we want to see Cash Flow in the deal throughout the life of the deal. Now it is appropriate to establish the basic condition of Stable Cash Flow:
Question: What does it take to achieve Stable Cash Flow?
Answer: Tenants paying consistently and on time…
Question: What does it take to get tenants paying consistently and on time?
Answer: Your building, where it is and what it is must attract the right kind of tenant.
Question: Who is the “right kind of tenant?”
Answer: Tenant whose socio-economic circumstance affords him/her options, but who chooses to live in your building in lieu of another.
Question: What kind of building can attract the right kind of tenant?
Answer: Not the building – stupid. The location!!! We can change attributes of a building, but we can’t do anything to change the character of the location.
With this in mind, the basic premise should be apparent that safety in real estate resides first and foremost in the ability of the location to attract the right kind of tenants! Ask yourself – where in my town are the locations that attract people who have the capacity to be choosy?
Once we achieve the first objective of safety, the second element on our investment wish-list is naturally to make a profit on the sale, which is a function of growing value of our asset.
Understand – in the income-producing sector, of which multi-family is one example, the main driver of value is income; we buy apartments for the income stream they represent, and the more the income, the higher the value. Relative to this, the strategy of achieving growth of value is to increase the income – read this article to get the big picture of exactly how we do this!
But, with this we circle back to the question of what kind of building will lend itself to growing income. And having pondered this for 30 seconds we arrive at the same basic reality:
It’s not the building – stupid. It’s the location!!! We can certainly do things to the building and the units to spice them up and make them more attractive to residents. However, no matter what we do, if the building is in the wrong location then the right kind of tenants (those tenants with options and capacity to pay higher rent) will not choose to stay in your building…
Thus, just as safety is ultimately function of location, so is growth! Do I need to spell out the question you must ask yourself…?
EASE OF LIQUIDATION
Having taken profits along the way in terms of Cash Flow, we also want to make substantial Capital Gains at the end when the asset is sold or traded – this is a big part of our IRR (Internal Rate of Return – I will address this metric in an upcoming article). In other words, having increased the income and with it the valuation of the asset, we now want to sell it for more than what we paid for it:
Question – What does it take to sell well?
Answer – The building must be very attractive to potential buyers.
Question – What does it take for the building to be attractive to the potential buyers?
Answer – It must be SAFE and must generate good returns relative to Cash Flow and future gains.
Question – What kind of building represents both of the above?
Answer – The kind that attracts good tenants! Question – What does it take to attract good tenants?
Answer – LOCATION – stupid!
That’s right friends – the success of a indicated income-producing investment in the multi-family space, or any other for that matter, comes down to the asset’s capacity to attract the right kind of tenants, and 90% of this formula is indeed LOCATION! It could be said that where to buy investment real estate is of much more importance then what to buy…
CONVERSATION WITH A BROKER
I bet over the past 2 weeks I must have looked at 100 Proformas and have spoken to a lot of brokers. Commercial brokers are widely perceived as the most educated sales agents out there. As such, my expectations of their knowledge base, capacity to assess investment opportunities, and ethics are always high – so far, I’ve been very disappointed…
A lot of the listings that interest me happen to be with CCIM designated brokers. I wrote about these guys in my recent article on the BiggerPockets blog – check it out; some amazing stuff there. But this particular conversation happened with a broker who is not a CCIM.
So – I call this guy last week; he has a listing I’d like more info on. I am honest with him and tell him right away that while I know a lot about income-producing real estate, I am indeed a first-time syndicator and as such I represent a bit of a wild card. I also tell him that I am a licensee in the State, but that I have no intention of using my license in this transaction.
We talk for about 15 minutes; long enough for me to explain to him my criteria. The following day I receive a Proforma from him, which lists the building as a B- Class (I will address A, B, and C classifications in later article).
The building does look to be well taken care of indeed; however, the mere age of the building disqualifies a B Class designation and rather puts it into C Class. But more than that, I happen to be familiar with the location, and there is no chance in hell that is a B location – period. But, to cross-reference myself I make a few phone calls to investors I know in the area, and they unanimously confirm a C Class location – and that’s on a good day…
What happens next is amazing, because when I approach this broker about the classification on the Proforma, his words are:
“I disagree with you…the building was very well taken care of!”
WOW – I proceed to explain to him that in a town where 2-bedroom units rent in the range of $400 and $1,200 per month, a location that can only command rent of $575 simply does not qualify as a B Class; it just doesn’t. Tenants who have options will not choose to live in this location no matter how nice or well taken care of the units are. People who can pay more and pay on time will go some place else. And because of this, managing this building during time of ownership, growing value in this building, and finding a willing and able buyer to sell to when I am ready are all highly problematic. The argument that “the building has been very well taken care of” does not even enter into the equation as it is superseded by the limitations of the location…
Naturally, I don’t have time to educate the brokers I work with, and as such we are very unlikely to work together…
SO – WHERE to BUY INVESTMENT REAL ESTATE
Whether considering a syndicated acquisition or simply your first 4-plex, we have very distinct objectives. These can be different from investor to investor and asset to asset, but the notions of safety, growth, and return on investment are always present. All are first and foremost a function of LOCATION!
And having established that location is the key to success, we must attempt to quantify the unquantifiable, and the best way to do that is from the stand point of desirability to tenants. Bottom line – if people want what you have, then there will be options and techniques that you can use to achieve the stated objective; the opposite is also true…
Does this provide you with perspective on where to buy investment real estate?