A Conservative Strategy For Investment Opportunities, part 2


To be a genius in 5 years make smart multifamily real estate investments today. To minimize risk, consider only conservative investment opportunities:

  • Buying a multifamily investment with no debt, or very low Loan to Value debt.
  • If any debt is part of the deal make sure it is positive leverage! (Finance rate percentage is lower that Cap Rate.)
  • Buy in a city who’s in “Recovery Mode”.

Use Portland as an example of a Recovery Mode city:

  • Apartment prices per unit will be low
  • Absorption is high…no worries that rapid building will drop revenues
  • High barriers to entry (That’s PDX alright!)
  • Rents starting to rise (PDX!)
  • High occupancy rates (Portland is above 95%.)

When a conservative investor buys in the Recovery cycle they are buying in at the bottom of the market.  Buying in with little or no debt assures them that they can make much higher

I have chosen a boutique approach because I believe each investor deserves to have a strategy custom tailored for their needs.  If you would prefer individual attention rather than “shoehorning”…contact me at Rose City Commercial Real Estate: rick@rosecitycre.com or 503.577.1034.

returns than the bond market…and have their profits paid monthly from cash flow.  Because they have taken a very conservative acquisition strategy and used good timing, they are substantially sheltered from the pain of a further downturn. Even the combination of a reduction in occupancy and reduction revenues is not likely to impact them because of their superior Debt Service Coverage Ratio. Since they are buying in a Recovery market the inertia is for increased revenues and profits.

At the end of the year they will shelter their taxes with depreciation.  When they go to sell…their gains can be rolled over using a 1031 Exchange.  I know of an investor with several thousand multifamily units  that started out with a triplex in Eugene.  He made a nice return on the plex…but 36 years later the taxes still are deferred.  Now that’s a good deal…but I digress.

The Ultraconservative Approach: How to Invest

A truly conservative approach to multifamily investing would be an all cash purchase.  Let’s say you bought a 15 unit property that the listing agent said was a steal at a 7.5 Cap and $1,000,000.  For the right seller we might be able to offer $850,00 cash, conditioned only on books and records and physical inspection contingencies.  A 30 day close  has great value…particularly if the Seller is motivated.

Remember…this isn’t a sexy deal…as a conservative investor you’re more focused on:

  • Avoidance of equity loss.
  • Stability
  • Cash flow.
  • Preferential tax treatment on profits.

To achieve these you’re willing to give up some long term appreciation. (After all: you had your money in a bond that guaranteed a loss of buying power.)

The Cap rate is the ratio of the first year operational revenues- operational expenses compared to the sale price.  This allows us to see what kind of revenue generating machine we’re looking at without clouding the picture with capital expenses and financing costs.  In our example, after paying all of the operational expenses $75,000 (7.50% of the offering price, or 8.82% of the price paid) is left for profit, capital expenses and loan payments. We call this NOI or Net Operating Income.

Since we paid cash there is no loan to deal with.  The listing agent didn’t mention a capital reserve in his proforma…or he might have put in $150/unit per year in.  We don’t believe him.  As conservative investors we will set aside $350 per unit for a replacement reserve.  We will also pre-fund at closing an operating reserve to the tune of $10,000 and a replacement reserve at $15,000.  This will increase the original equity requirement to almost $900,000 due to closing costs, etc.

YIELD:   Our increased reserve fund payments took care of our capital expenses, but reduced NOI by to $5,025.  That left us a $69,750 year 1 return on a $900,000 investment or 7.75%. Please note that we can take depreciation based on a 27.5 year basis…so we have tax sheltered a significant portion of our profits.   Because we bought in at the lower end of the market we can expect an increase in cash flow over the next few years.    

Are you a conservative investor? Call Rose City Commercial Real Estate today at: 503.577.1034 oe e-mail me at: rick@rosecitycre.com.

 

 

 

 

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