Apartment-Multifamily Real Estate Syndication

Apartment syndication is a great way to invest your money, but doing so requires a lot of work and maybe even some expert guidance. If you are new to investing, you probably have a lot of questions about real estate syndication. How do you get a project off the ground? How do you find the right people with whom to do business? What is the difference between active and passive investing, and which option is best for you? Over the years, I have helped curious investors like yourself navigate the world of apartment syndication, and have done so successfully. That’s why I am confident I have the resources you need to thrive, and, as my clients have learned, since I left the world of advertising and immersed myself in real estate, my goal is to help you “do more good.” That means freeing up your time so you can use it as you wish. Today, I am happy to share some of my real estate syndication insights with you for free through my comprehensive blog. Below, you will find many posts that can help you get started with apartment syndication, including where to find great apartment real estate, what it takes to stand apart from other syndicators, and how to close the deal on your first deal. After reading these posts, you may want to schedule a planning session, which can teach you how to buy apartments and how to bring in investors; additionally, you can learn how to start investing with me, which would lead to plenty of passive investment opportunities, provided you are an accredited investor.

Apartment Amenities and Coronavirus: 6 New Trends

Due to the onset of the coronavirus, the types of amenities and services in demand by residents of apartment communities have shifted. 

Whether this shift is permanent or temporary remains an uncertainty. It depends on how long the pandemic lasts and, maybe even more importantly, how long resident’s memories will be.

Nonetheless, it is helpful to know what residents are demanding. Armed with this information, you can adjust your current investments, as well as intelligently analyze prospective investments.

Here six amenities and services currently in demand by apartment residents as a result of COVID.

1. Virtual Everything

Residents still want to socialize with other residents. Therefore, social-distanced and virtual events are desired. Simple examples are virtual happy hours, virtual craft events and contests, and food truck events.

Another service that has become popular during COVID are virtual fitness classes. This can be as simple as providing residents with fitness videos on YouTube. You can also partner with a local fitness instructor. They can record videos for residents or do live fitness events over video, as well as be available to answer resident questions. 

At Class A apartment communities, consider an interesting service called TF Living, which is a technology-enabled amenities company providing wellness and lifestyle services to apartment communities across the US. 

Depending on the local COVID restrictions, you can offer outdoor fitness classes.

Something else that is currently in demand and will likely remain so even after the pandemic has subsided are virtual tours. Residents should be able to obtain enough information on the available units to rent sight unseen. Examples include video recordings of units, 3D walk throughs, and live video tours.

2. Outdoor Spaces

Residents who are stuck at home still want to experience the great outdoors. Therefore, access to outdoor spaces, both common and private, are desired.

Residents want access to the outdoors in their own private units, which means patios and balconies are in demand.

The demand for public outdoor amenities isn’t new. Pools, BBQ grilling areas, and pet parks remain in demand. 

An outdoor space more recently in demand are walking and biking paths, ideally ones that connect to existing local parks and paths.

3. Working Spaces

Remote working may be temporary. However, many employers will likely continue to allow their employees to work from home for the foreseeable future. Therefore, onsite public and private workspaces are in demand.

The type of workspace you can offer your residents is limited by the existing footprint of the community. However, here are a few unique tips on maximizing the current space:

 

  • Add seating in outdoor areas
  • Add seating and dividers in indoor areas
  • Tweak the furnishings in the model unit to include a workspace (ideally near a window)
  • Add console/desk combination under the living room table (like what you find in hotels) to select units for a premium
  • Offer In-unit fold down desks for rent

 

Arguably the most important shift is the quality of internet. In unit and shared Wi-Fi must have the bandwidth to support video conferencing. 

4. Kitchen Space

With the closure of restaurants and limited seating, more people are forced to eat at home. Therefore, residents are demanding new kitchen features. The bar eating area dividing the living room and the kitchen is a great way to maximize space since residents won’t require a kitchen/dining room table. 

Since people are cooking at home more, larger pantries to store more food, especially nonperishable item, and more cabinets to store new cooking tools are desired.

5. Package delivery capabilities

More people are purchasing home goods over the internet. Therefore, your apartment must have the ability to securely deliver packages to residents. Ideally, the apartment community have package lockers or package rooms that can be accessed with a code 24/7.

6. No-Touch Technology

The demand for sanitation likely won’t go away anytime soon. Therefore, residents prefer no-touch technologies, both in unit and in common areas.

For example, no-touch entry. For units, this means door handles that can be unlocked/opened with a phone app, hand way, elbow-open, or voice activation. Also, touchless soap dispensers and faucets in unit and common bathrooms. Adding touchless hand sanitizer stations in common areas is also a smart move.

 

Whenever an unforeseen event, like coronavirus, occurs that impacts the economy, the winners are always those who know how to identify new opportunities and then pivot accordingly. 

In multifamily, offering the right amenities is always a must. Using the information in this blog post, you can pivot from your existing amenities offered to increase the demand for your units, maintain (or even increase) revenue, and become a winner during the pandemic.

 

 

 

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Investing in Apartments as a Limited Partner

Why Apartments Are “The Asset of Choice” 

Large multifamily properties have historically been owned by institutional investors such as mutual funds, REITs, insurance companies, and pension plans because of the stability and yield that apartments offer. 


Being a Limited Partner investor allows an accredited investor and in some cases, a sophisticated investor an opportunity to buy a passive ownership stake and participate in these same large real estate acquisitions; a 400-unit apartment building, as an example. The Limited Partners (individual passive investors) can experience the same buying power, leverage, and potential tax benefits, just as institutional investors do. 

 

The individual passive investor has the benefit of owning a percentage of an apartment community without the day-to-day management obligations. Additional benefits may include monthly or quarterly cash flow distributions, potential income sheltering through depreciation and tax benefits, debt leverage, principal pay-down, and potential appreciation in value.

Predictable Income


An apartment building’s revenue is derived from rents paid by the residents for leased units and other income-generating items such as covered parking spaces, fenced-in yards, coin laundry facilities, on-site storage facilities, to name a few. A strong property management team will focus on attracting qualified residents to the property and carefully have lease agreements executed, often with contracts lasting 12 months or longer. These practices in turn, generate long-term, consistent cash flow for the Limited Partner investors. 

 

Forced Appreciation


By making improvements to an existing property (known as a value-add business plan), the property’s value can increase through this repositioning process. By increasing rents and occupancy, higher levels of revenue are generated. Since multifamily apartments are primarily valued based on the income they produce, a value-add business model can in-a-sense, “force” the property to appreciate in value rather than relying on market conditions or annual inflation. When the property is refinanced or sold, the proceeds can be returned to the Limited Partners or in some cases, can be rolled into another “like-kind” investment property using a 1031-exchange to defer the taxes.

 

Steady Cash Flow


One of the greatest advantages of real estate investing is the steady, and often tax-sheltered, monthly cash flow. Few investments can be bought with the same kind of steady cash flow return combined with the appreciation potential.

 

Tax Benefits


Distributions made to the Limited Partners are treated more favorably than most other types of investments because a significant portion of the distributions are often not considered income according to the tax code. This is due to the flow-through of expenses and depreciation. Additionally, the capital appreciation is deferred from taxation until the assets are sold and may be further deferred from taxation if a 1031-exchange is implemented. 

 

Total Returns


An apartment’s combination of stable cash flow (primarily derived from rents), capital gains (resulting from increased property value upon sale), principal paydown (from residents paying down the loan balance over time) and tax savings (due to the current IRS rules and the additional benefits from the Tax Cuts and Jobs Act passed in 2017) provide returns that can be quite impressive given the current state of the stock market and the lack of yield offered by banks, money markets, CDs, and bonds. 

 

A Hedge Against Inflation
Historically speaking, rents, property values, and the replacement cost of real estate improvements rise with inflation. This makes real estate a particularly effective hedge against inflation, and might be an asset class to help you balance your investment portfolio, especially in the low yield environment we are in today. 

 

Ownership of Real Estate
Passive investors desiring steady income with a balance between risk and reward, may consider multifamily apartment investing as a Limited Partner to provide a solid foundation for building lasting wealth. Additionally, the ability to use a “hands-off” investing approach can be useful in building passive income streams that, in turn, free up time to spend on what matters most to the individual investor. 

 

To Your Success

Travis Watts 

 

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People Are Fleeing Urban Centers for the Suburbs – What This Means for Apartment Investors

One of the main metrics I look at when analyzing a prospective market to invest in is the population growth. 

The thought process behind this is simple: if the population is increasing, the demand for real estate is increasing, and vice versa. 

Of course, there are other relevant factors like the supply side of the equation. However, there are some investors I’ve met who ONLY select markets based on the net migration. If more people are moving out of the market than are moving in, it is automatically disqualified.  

U-Haul is actually a top source for migration data, which they release annually. you can view their migration reports here.

When you understand where people are moving to and moving from, you can adjust your apartment business plan accordingly. If you are in a market with a positive net migration, you are sitting pretty. However, if you are in a market with a negative net migration, there may be trouble on the horizon.

One of the biggest migration trends resulting in part due to the coronavirus pandemic is the urban-to-suburban pipeline

Not only are more people interested in leaving urban markets, but in some states, such as New York, the exodus has already begun.

The Hill, in their article “Americans leave large cities for suburban areas and rural towns”, says that approximately 250,000 residents plan on moving out of New York City while another two million consider moving out of the state altogether. Also, more than 16,000 New Yorkers already moved to suburban Connecticut. 

And this trend isn’t unique to New York. 

“A record 27.4% of Redfin.com users looked to move to another metro area in the second quarter of 2020,” reads a Redfin analysis performed in July 2020

The most popular destinations are Phoenix, Sacramento, Las Vegas, Austin, and Atlanta. Here is a breakdown of the top 10 metros by net inflow of Redfin users and their top origin.

 

The locations with the large outflows were New York City, San Francisco, Los Angeles, Washington DC, and Chicago. Here is a breakdown of the top 10 metros by net inflow of Redfin users and their top origins.

 

Are any of your investment markets on either one of these lists?

There is also an increase in demand for rural markets. For example, according to US News, 57% of realtors who responded to their survey said they’ve seen an increase in interest in rural Montana. The main reasons were because of its low coronavirus infection rate, as well as because they grew up and had family there. The same The Hill article cited above said real estate sales in Montana were 10% higher year-over-year, and that rural Colorado, Oregon, and Maine experienced similar increases in sales.

So why are people leaving the urban centers? 

Another telling article was written in NASDAQ entitled “The Urban-to-Suburban Exodus May Be The Biggest in 50 Years.” This article provided more data on the reasons why New Yorkers were fleeing urban centers. The top 5 reasons were cost of living, crime, looking for a non-urban lifestyle, concern over the spread of the coronavirus and the ability to work from home.

One of the major COVID-related changes that is driving more people out of urban centers is working from home

According to MARKINBLOG, 88% of companies are encouraging or requiring employees to work from home due to COVID and 99% of people prefer to work remotely. Compare this to just 3.4% of the US population working remotely pre-COVID, this has the possibility to massively disrupt real estate, especially the type of real estate that will be demanded.

Since employees aren’t required to go to the office, they are choosing to live in areas that are more affordable, closer to family, and closer to local amenities while still having direct access to a downtown. Hence, they are leaving urban areas for the suburbs. 

However, they are also choosing to head to the suburbs due to the type of homes that are offered. For example, people are looking for more outdoor spaces (whether that is a private yard or nearby greenspaces and parks) and homes with an extra room to convert into a home office. Greenspace is universally nonexistent in a lot of urban areas, and the cost of an extra bedroom in urban areas is also financially unrealistic for many would be buyers and renters. Therefore, if they want to see real green grass and trees, as well as have a home office, the suburbs or rural areas are their only options.

What this means for you?

As a multifamily real estate investor, you need to understand the population and migration trends in your investment market.

If you are heavily invested in major urban centers, it may be time to consider a pivot and diversify into suburban areas.

This is great news for those already invested in suburban areas, as you should benefit from both an increase in rents as well as an increase in value due to falling cap rates.

Newer investors can take advantage of the low barrier of entry since real estate is generally more affordable in suburban and rural markets.

No one knows for certain what the future holds for real estate post-COVID. However, due to other factors leading up to the pandemic (which I outline in my article about why I am confident in multifamily) combined with the migration trend outlined in this article, I believe multifamily real estate in suburban areas will thrive in the years to come.

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Residential Lenders Tighten Their Lending Standards – Why This Is Good News for Multifamily Investors

A little more than a year before the onset of the coronavirus pandemic, I wrote a blog post entitled “Why I Am Confident Multifamily Will Thrive During and After the Next Economic Correction” (which you can read here).

The economy was experiencing a record long expansion and showed no signs of stopping. However, like most economic expansions, various economic and real estate experts were warning about an impending recession.

“The stock market is inflated” and “real estate prices and rents will not increase forever” they said. 

However, whether the economy continued chugging along or experienced a minor or massive correction, I was confident is multifamily real estate’s ability to continue to perform. 

My confidence was not emotionally driven or biased because I am a multifamily investor. It was based on my analysis of the facts. The most telling fact was the change in renter population

Historically, more people rent during recessions (which is one of the reasons why I was attracted to multifamily in the first place) and more people buy during economic expansions. The former held true for the 2008 recession as more people began to rent. However, during the post-2008 economic expansion, the portion of renters continued to increase (more US households were renting in 2016 than at any point in 50 years). 

Therefore, I predicted that the portion of renters would increase or, at minimum, remain the same during and after the next correction. 

Then, coronavirus hit and induced an economic correction (or a temporary slowdown, depending on who you ask).

But, sure enough, a study published on June 17th, 2020 projected a decline in homeownership and concluded that  “the demand for rental housing will increase somewhere between 33% and 49%” between 2020 and 2025.

In both my January 2019 article and the June 2020 study, one of the reasons why more people are renting is due to tightened lending standards (other reasons were student loan debt, inability to make a down payment, poor credit, and people starting families later).

A metric that is used to measure lending standards is the Mortgage Credit Availability Index (MCAI). The MCAI is based on a benchmark of 100 set in March of 2012 and is the only standardized quantitative index that solely focuses on mortgage credit. A decline in the MCAI indicates that lending standards are tightening while an increase in the index are indicative of loosening credit.

Between December 2012 and November 2019, the MCAI was steadily trending in the positive direction, increasing from the high-80s to the high-180s.

  

However, starting in December 2019, the MCAI began to decline. The three largest drops were in March 2020 (decline of 16.1% to 152.1), April 2020 (decline of 12.2% to 133.5), and August 2020 (decline of 4.7% to 120.9, the lowest since March 2014).

Joel Kan, Mortgage Bankers Association’s Associate Vice President of Economic and Industry Forecasting said in the August 2020 report, “credit continues to tighten because of uncertainty still looming around the health of the job market, even as other data on loan applications and home sales shows a sharp rebound. A further reduction in loan programs with low credit scores, high LTVs, and reduced documentation requirements also continued to drive the overall decline in credit availability.”

People will always need a place to live. Their only two options are to rent or to own. As indicated by the massive MCAI declines since the end of 2019, less and less people will be able to qualify for residential mortgages. The programs available to people with low credit or who cannot afford a high down payment have disappeared. 

Therefore, by default, more people will be forced to rent.

One last interesting thing to point out is how the MCAI during the current economic predicament compares to the 2008 recession. 

Here is an expanded MCAI graph that shows credit availability back to 2004. The pre-2011 data was generated biannually, making it less accurate than the post-2011 monthly generated data. However, the graph still highlights an important point. At least as it relates to the availability of credit at the time of this blog post, the current economic recession is nowhere near as severe as the 2008 recession.

To receive the monthly MCAI report, click here.

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The CDC Eviction Moratorium – What You NEED To Know

You may have seen recent headlines referring to an “eviction crisis”: 

The COVID-19 Eviction Crisis: an Estimated 30-40 Million People in America Are at Risk – The Aspen Institute 

 

Experts fear the end of eviction moratoriums could plunge thousands of people into homelessness – CNBC

President Trump signed an eviction moratorium order that effectively bans evictions nationwide through the end of the year. According to the Centers for Disease Control and Prevention (“CDC”), the moratorium order has been issued to provide housing stability and to prevent the further spread of COVID-19. However, it is important to note that rent is NOT cancelled through the end of the year. Let’s dive into how this order effects landlords and owners of real estate…

 

According to the moratorium, there are stipulations in order to receive this “eviction protection.”

Those who are eligible must meet additional criteria before presenting their landlords with a declaration, which will be made available on the CDC website. This criteria includes: 

  1. The resident has sought all available government rental assistance
  2. The resident will earn no more than $99,000 in 2020 (or $198,000, if filing jointly)
  3. The resident can’t pay their rent in full due to a substantial loss of income 
  4. The resident is trying to make timely partial payments, to the extent they can afford to do so
  5. The resident would, if evicted, likely end up homeless or forced to live in a shared living situation

What to do if you (the landlord) receives a CDC Declaration from a tenant?

 

According to Colton Addy from Snell & Wilmer Law, if a landlord receives a CDC Declaration from a tenant, the landlord should respond in writing to the tenant to encourage the tenant to make partial payments of rent (and similar housing-related payments) to the extent the tenant is able, in accordance with the CDC Declaration. Additionally, the landlord’s written correspondence should remind tenants that the rental amounts are not forgiven and will ultimately need to be paid. 

 

Additionally, many tenants may not be aware of the government assistance programs that are available to tenants to help tenants pay their rent during the COVID-19 Pandemic. Landlords should include a list of available resources that tenants can use to pay their rent. The Department of Housing and Urban Development (HUD) has stated that nonprofits that received Emergency Solutions Grants (ESG) or Community Development Block Grant (CDBG) funds under the CARES Act may use these funds to provide temporary rental assistance to tenants. 

 

The following websites provide information on federal assistance that is available:

 

www.hudexchange.info/programsupport

https://www.hud.gov/coronavirus

https://home.treasury.gov/policyissues/cares/state-and-local-governments 

 

Additionally, landlords should include other programs that may be applicable in their jurisdiction. Landlords may also consider filing an eviction proceeding for one of the reasons permitted by the CDC Order, but landlords should use caution in pursuing such actions as eviction proceedings in the current climate are likely to draw additional judicial scrutiny.

 

Penalties:

 

The penalties for individuals who violate the Order are severe, including:

 

 

  • A fine of up to $100,000 and up to one year in jail, if the violation does not result in a death; or
  • A fine of up to $250,000 and up to one year in jail, if the violation results in a death.

 

The penalties for an organization violating the Order are even more severe.

In summary, the moratorium order provides temporary relief to those residential tenants facing eviction who submit the required declaration, through the end of the year.  The order, however, does not absolve a tenant from paying rent or restrict a landlord from applying penalties, interest, or late fees on the tenant’s account for non-payment of rent.  Additionally, the order does not relieve landlords of their debt service obligations if a tenant seeks relief under the order. 

 

Disclaimer: The materials contained in this blog post are for educational and informational purposes only. Nothing in this blog post is to be considered as the rendering of legal advice. Readers are advised to obtain legal advice from their own legal counsel. Additionally, please note that the orders and laws related to the COVID-19 Pandemic are changing on a daily basis and your jurisdiction may have stricter rules related to evictions in place. Please verify the rules currently affecting your property at any given time.

 

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How to Underwrite an Apartment Deal with Incomplete Financials

A frequently asked apartment syndication question is “how do I underwrite an apartment deal when the seller doesn’t effectively track financials?” 

The two important items needed from a seller to underwrite a deal is a rent roll and a T-12. The rent roll provides information on the current rental income. The T-12 provides information about the historical income and expenses.

The typical underwriting process at a high level is as follows: Armed with the rent roll and T-12, the apartment syndicator populates a cash flow calculator with the current rents, T-12 income and expenses, and their assumptions for how they will operating the asset after acquisition. Once debt terms and other acquisition terms (i.e., general partner fees, renovations costs, limited partner compensation, etc.) are added, the apartment operation can determine an offer price based on the cash flow. 

Therefore, without the financials, it is very difficult to calculate a fair offer price.

Does this mean you should only underwrite deals that come with a detailed rent roll and a T-12? 

Of course not. Often, these can be some of the best deals. You will also have minimal to no competition. 

Before you can benefit from these types of deals, you need to understand how to successful underwrite deals without financials, which is the purpose of this blog post.

Types of Deals With Missing Financials

Most on-market deals listed by a broker will have a rent roll and a T-12. A broker usually won’t bring a deal to market without obtaining clear financials from the seller. The broker knows that it is difficult to sell a deal with missing or incomplete financial for the aforementioned reasons.

Therefore, deals with missing or incomplete financials are generated through off-market lead generation strategies. More specifically, financials are lacking on off-market deals owned by mom-and-pop owners who self-manage.

This does not mean that the all deals with missing or uncomplete financials are off-market, mom-and-pop, self-managed apartments. Nor does it mean that financials are only lacking on these types of deals. It is always important to request a rent roll and T-12 on all deals, on-market or off-market.

If you request the rent roll and the T-12 and either one or both are missing, the process that follows is how to best underwrite the deal, which was inspired by an interview we did with Chris Roberts of Sterling Rhino Capital.

What is the Secret Short Cut?

The first thing to realize is that there is not a shortcut to underwriting a deal without financials. Essentially, the overall underwriting and due diligence process is the same. The major difference is that you will need to create the missing or uncomplete financials from scratch.

However, creating the financials from scratch is time intensive and must include the efforts of the seller. Therefore, this creation process usually will not start until the deal is under contract.

Submitting an Offer

The actual offer price is less important when the financials are missing or incomplete. For example, the final sales price on Chris Robert’s deal was approximately 20% below the original contract price after negotiations were completed. Therefore, determine what the price at which the owner wants to sell. Assuming this is at least in the ballpark of recent sales comparable, do not worry about an intensive back and forth negotiation.

The most important part of the offer are the terms. The earnest deposit needs to be 100% refundable or deposited after the financials are created. The official due diligence process, which starts with an inspection, shouldn’t begin until after the T-12 and rent roll are created. There need to be adequate contingencies in place, like an inspection contingency and a financing contingency.

When you create the proper offer terms, worst case scenario is the loss of time without the loss of money.

Work with the Seller Directly

Once the deal is under contract, the next step is to create the financials. This is best accomplished by working with the seller directly. Therefore, if a broker is involved in the deal., the first step after placing the deal under contract is to bypass the broker to work directly with the seller. 

Even if they broker is against you working directly with the seller at first, it is likely that the deal will reach a stand still where the only way forward is directly connecting you with the seller or canceling the contract. 

This is what happened on Chris Robert’s deal. He attempted to work through the broker to get the seller to create the financials to no avail. Eventually, because the deal was stalling, the broker caved and let Chris speak directly with the seller. 

When speaking with the seller, Chris discovered the point of contention. The seller was under the impression that is was Chris’s responsibility to create the financials by himself, which is impossible. He told Chris, “why am I doing your work for you?” 

Chris replied, “Look, we are in this together. You are not going to sell your apartment unless you have financials, because neither I nor anyone else is going to be confident in investing a deal without historical numbers. I am willing to work with you to create these financials so that we can both get what we want.”

By showing the seller that it was in his best interest, Chris was able to convince the seller to take the required steps to create the financials.

How to Create the Financials from Scratch

Working directly with the seller, the next step is to create the rent roll and T-12 from scratch. 

The first step is having the seller connect with their CPA. The CPA can use the seller’s bank statements and tax returns to generate the profit and loss statement. Additionally, on Chris’s deal, he sent the seller a T-12 template and asked the seller to update the template each month.

To build a rent roll from scratch, your property management team will need a copy of each lease. Your management team should be local to the market, which means they can travel to the property to create the rent roll. 

Re-negotiating the Price

Once you have the rent roll and T-12, you can officially underwrite the deal and renegotiate the price accordingly. 

At this point, you can follow the standard due diligence process. Whenever you come across a step where a financial document is unavailable, you and the seller will need to work together to create it from scratch.

 

The total time between receiving the lead and closing will depend on the cooperation of the seller and the level of missing documentation. For Chris’s deal, it took nine months. In general, I wouldn’t expect to close in the traditional 60 to 90-day time frame.

The main different between a traditional deal and a deal with incomplete financials is the time required to work with the seller to create the financials from scratch. It may be a lengthy process but it is a great way to acquire a deal below market, especially in a competitive market.

 

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Debunking a Common Myth About Apartment Insurance Rates

A common practice when underwriting multifamily apartment deals is to assume a stabilized insurance expense equal to the T-12 insurance operating expense. In other words, the assumption is that the insurance premium paid by the current owner will remain the same after acquisition.

This practice was indeed correct for the past five to ten years. However, according to commercial insurance expert Bryan Shimeall, who was interviewed on the Best Real Estate Investing Ever podcast, this is no longer a safe assumption.

Due in part to the onset of coronavirus, as well as to the increase in the number of people entering the commercial real estate investment realm, insurance rates are rising fast.

Towards the end of 2019, the insurance market transitioned from a soft market to a hard market. 

In a soft market, insurers are competing for apartment investors, resulting in more competitive rates. Therefore, when underwriting deals, apartment operators were assuming the T-12 insurance rate would remain the same after acquisition, or even potentially decrease. 

However, in a hard market, the opposite is true and apartment investors are competing for insurers. As a result, insurance rates are rising. 

The magnitude of the increase is geographically driven. According to Bryan, an apartment investor should expect between a mid-single-digit and up to a 20% increase in the insurance rate when underwriting deals.

He also said that insurance companies are pickier about the types of apartments they will insure, as well as offering non-renewing insurance policies. If an apartment qualifies for insurance, there is no guarantee that it will continue to receive the same rate, the same coverage, or any coverage at all once the initial contract has expired.

Now that you know about these recent changes to insurance rates, what changes should you make when underwriting apartment deals?

The most important thing you need to do is have a conversation with your real estate insurer. If you do not have one, you need to find an insurance company or broker that specializes in real estate.

Ask the insurer about the insurance rate increases in the market you invest in.

Another important factor besides geography that is driving the rate increases are the history of losses. Bryan says it is more important than ever to provide your insurer with the history of losses as soon as possible.

Once you know you are serious about a deal, email the listing broker (if on-market) or the owner (if off-market) and request a copy of the history of losses for the apartment. 

Your insurer will need accurate and complete information about the history of losses at the property to provide an accurate insurance quote. Without the history of losses, the insure will generate a quote based on a clean history.

If your insurer obtains the history of losses report that isn’t clean, the insurance rate will be higher. Depending on the type of losses, the insurer may decide to not provide insurance at all. 

The worst-case scenario is your insurer receives the history of losses and won’t provide insurance on the apartment after you’ve invested tens of thousands of dollars into due diligence. Another bad scenario is the new insurance quote is significantly higher than your original projections and you need to back out of the deal or renegotiate a new purchase price.

Therefore, to avoid canceling contracts and wasting thousands of dollars, do not assume an insurance rate that is the same as the current insurance rate. Instead, have a conversation with your insurer prior to submitting a contract to understand the projected rate increase in the market. Then, obtain a history of losses as soon as possible so that your insurer can provide you with the most accurate quote before you have progressed further into the due diligence period.

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High Net Worth Frugality – How To Save Like The Wealthy

Frugality has played a major role in my life, starting in childhood and being brought up by two very frugal parents. I have tremendous gratitude looking back on the lessons learned and seeing the impact that saving money has had. In this post, I want to share with you some interesting data I recently came across and a unique perspective on frugality.

Americans spend the majority of their money on three expenses: Housing, Transportation and Food, according to the U.S. Bureau of Labor StatisticsYou probably already knew that, so I want to dive a bit deeper in a direction I think we could all benefit from. I want to share with you how High Net Worth Individuals save and spend their money compared to everyone else in these three primary categories. Obviously, there is no official handbook or methodology that all wealthy individuals follow; so I compiled some data and research so we can take a peek behind the scenes. 

#1 Housing 

You might be familiar with the fact that Warren Buffett paid $31,500 for his home in Omaha nearly 50 years ago and he has not increased his spending in this category ever since. This is an extreme example, but how much do you think the average American spends on housing as a percentage of household income? To my surprise, the data shows nearly 30% of household income is spent on housing costs according to the U.S. Bureau of Labor Statistics

 

Now let’s take a look at another High Net Worth example; we’ll use Tim Cook (the CEO of Apple). Tim Cook has an estimated net worth of 650 million dollars and he bought his California residence for 1.9 million dollars. This home purchase represents less than 3% of his net worth (if he paid cash) or a mortgage payment of approximately $7,500 a month if he financed the home with a traditional loan and 20% down payment. If the house is mortgaged, that means Cook spends approximately .072% of his annual income on housing costs based on the 125 million in compensation he received from Apple in 2019. It’s interesting that Buffett and Cook have the ability to buy nearly any home they desire, but they chose to embrace a reasonable frugality in this category. There are, of course, hundreds of other High Net Worth examples like these, but it is fascinating to consider this mindset when the majority of American homeowners max out their debt leverage to buy the most expensive house they can afford.  

 

#2 Transportation

According to a study done by researchers at Experian Automotive (and published on Forbes), 61% of wealthy individuals (defined as earning $250,000 or more in income per year) drive Hondas and Toyotas and Fords. You may also be familiar with the fact that many billionaires drive inexpensive vehicles as well, many of which are valued under $30,000. A few examples include:

 

  • Steve Ballmer (Billionaire) Ford Fusion Hybrid MSRP $30,000
  • Mark Zuckerberg (Billionaire) Acura TSX MSRP $30,000
  • Jeff Bezos (Billionaire) Honda Accord MSRP $20,000
  • Ingvar Kamprad (Billionaire) Volvo 240 MSRP $25,000

 

According to AAA research agency, the average American spends $9,282 a year on their vehicle, which equates to $773.50 a month. The median household income (for 2018) was $61,937 according to Current Population Survey and American Community Survey, which are surveys conducted by the U.S. Bureau of Labor Statistics and the U.S. Census Bureau. Americans dedicate nearly 15% of household income to a vehicle. 

 

#3 Food

This is one of my favorite topics when it comes to personal finances. In this post, I will keep it brief, but you can check out some of my other blogs and articles that dive deeper into the topic. According to The National Study of Millionaires, which is a 71-page nationwide study conducted on 10,000 U.S. millionaires and their spending habits, it was found that 36% of millionaires spend less than $300 each month on groceries and 64% spend less than $450, and only 19% spend more than $600 a month on groceries. The punchline; non-millionaires spend about 57% more on groceries compared to millionaires. But that’s just groceries, so what about restaurants and dining out? I’ll get right to the point on this one… 

 

To turn a profit, many restaurants charge around a 300 percent markup on the items they serve. When you go out to eat, you are paying for service, convenience and atmosphere. There is certainly a time and place for restaurants, but if you are eating out frequently, consider that you could make a $15 meal in a restaurant for $5 at home. The statistics are also interesting. According to a study from the JPMorgan Chase Institute that focused on fifteen specific metropolitan areas, studying credit and debit card purchases from more than fifteen billion anonymous transactions and characterizing them by quintiles of income, the poorest 20% spent 16.6% of their income at restaurants, trailing the wealthiest income quintile at 17.8%.

 

Takeaways

Perhaps it’s time to remove “The Joneses” from our life and start keeping up with ourselves instead. 

 

There are two sides of the money coin. One side is about making money and the other side is about saving money. Long-term financial success requires a commitment to both. We can’t forget about mentors like Mike Tyson, who amassed over 300 million dollars in a career and filed for personal bankruptcy in 2003 after going completely broke. Or perhaps the more recent example of Johnny Depp “losing” his 650 million-dollar fortune due to wild spending habits like $30,000 a month on wine and renting 12 storage facilities to store his “memorabilia”. We all know of athletes and celebrities who unfortunately were not taught about frugality, or simply chose not to pay attention. The goal for you and I may not be to join the Billionaires Club, but perhaps it’s a worthwhile pursuit to find a balance between having enough and living life on your own terms. 

 

To Your Success

Travis Watts 

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9 Things to Consider When Converting Apartments to Condominiums

Besides the traditional three apartment investment strategies (turnkey, distressed, and value-add), condo conversions is another less common business plan that can be very lucrative.

The condo conversion investment strategy involves purchasing an apartment community, converting it from individual rental units to individual condos, and reselling the individual condos for a profit.

This post isn’t going to discuss which investment strategy is the best, because like most things in real estate, it depends on what you are interested in and what your goals are. However, if you do decide to pursue the condo conversion investment strategy, here are the 9 things you need to consider:

 

  • Speak to an attorney: First and foremost, speak with a real estate attorney that specializes in condo conversion projections. You need to know the state and local laws on condo conversions and the step-by-step process you must follow.
  • Vacating the property: The largest potential challenge is the process for vacating the apartment building. An attorney will tell you the laws that protect the rights of the existing residents. In some markets, the residents must be given a specific time frame of the notice to vacate. You may even be required to cover their relocation costs and give them a chance to purchase a completed condo. The longer it takes and the more expensive it is to vacate the property, the greater the holding costs.
  • Hidden fees: There are a lot of hidden fees involved in condo conversions, which the attorney can help you uncover. There are application fees with the city, surveying fees, attorney fees, and fees related to code compliance. Once the conversion is completed, the city will inspect the condominium for code violations, which you will be required to address. Therefore, another fee is associated with hiring a private condo pre-inspection specialist to inspect the property to give you an opinion on potential code violations and the costs of the repairs. Another hidden fee is the increase in insurance costs. Insurance on condominiums is generally higher than apartment insurance, so make sure you obtain a quote for the new insurance premium. Last are the upfront and backend fees you charge for putting together and managing the project.
  • Financing: You will need to speak with a mortgage broker who specializes in condo conversion projects to securing financing. This conversion needs to begin prior to placing the deal under contract so that you can estimate the debt service and other important loan terms, like I/O periods, loan term, interest rates, prepayment penalties, financing fees, and closing costs.
  • Timing: To determine the holding costs and hold period, you need to know the estimated timelines for each step in the condo conversion process. First, how long will it take to vacate the building? Once vacated, how long will the renovations take? How long will it take to list the condo units for sale after the renovations are completed (i.e., post-conversion requirements like setting up the HOA, inspections, etc.)? Lastly, what is the average days on market and closing timeline? Add these all together and you have the hold period and can calculate the holding costs.
  • Holding costs: The holding costs are the ongoing expenses paid during the hold period. These include insurance, taxes, utilities, and debt service. Since you will be generating no cash flow (or some cash flow in the beginning while vacating the property), these expenses must be covered by initial equity.
  • Renovation costs: There are four aspects of the renovation costs to consider. One is the cost to convert the apartment units into individual condos. Two is the investment amount is required for the common areas. Three is the cost to address deferred maintenance. Last is the size of the contingency budget.
  • Sales process: The first thing you need to know is the projected after-repair value of the condominium units, which requires a sales comparable analysis. You also need to consider the costs associated with marketing and selling (i.e., the broker’s commission) the condo units.
  • Limited partner compensation: Lastly, you need to determine the compensation structure offered to the limited partners who invest. What type of return will you offer (i.e., preferred return, profit split, or both) and when are they paid (i.e., after each condo is sold or when all condos are sold)?

 

To address all the above, you will need to work with at minimum an attorney, a mortgage broker, and listing broker, and a contractor – all who specialize in condo conversions.

Purchasing an apartment community and converting the rental units into individual condo units is an alternative to the traditional apartment investment strategies. However, you need to understand the laws surrounding condo conversions, the added costs, and the required team members to properly underwrite the deal, successfully complete the conversion and conserve and grow the investors capital investment.

 

 

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President Trump Signs Coronavirus Relief Executive Orders

President Donald Trump signed an executive order on Saturday night after negotiations reached a deadlock in the House over another coronavirus relief package.

Click here to read the full memorandum.

Here is everything you need to know about the executive orders:

Unemployment Benefits

Unemployment benefits include an additional $400 per week, retroactively starting August 1st. The federal government would contribute $300 and the states would contribute $100.

White House economic advisor Larry Kudlow said Sunday that people could expect checks in a couple of weeks.

Eviction Moratorium and Renter Assistance

The executive order did not provide specifics on a renewed eviction moratorium or renter assistance. Instead, it defers to other governmental agencies to make that determination.

The decision to ban evictions will be decided by the Health and Human Services Secretary and Centers of Disease Control and Prevention Director.

The decision to provide financial assistance to renters will be decided by the Treasury Secretary and Housing and Urban Development Secretary.

Student Loan Payment Deferrals

Student loan debt interest would be waived through the end of the year. This only applies to loans held by the Department of Education, so it does not apply to privately held student loans.

Payroll Tax Cut

The federal tax withholding for the payroll tax would be deferred (not forgiven) starting September 1st and through the end of the year for people earning less than $100,000 a year.

The Treasury Secretary may also exercise his authority to defer the withholding, deposit, and payment of the tax, meaning it may be forgiven. He could also extend the program for a full year.

 

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Why Multi-Family? Why Now?

Why Real Estate? 

Most people who are career focused and have money to invest or people who are coming to the end of a professional career, often look to real estate as a viable investment option either for building equity or for income generation. Unfortunately, real estate investing is typically thought to be a sole ownership strategy. Very few people are aware of the passive investing opportunities in multi-family private placements or “apartment syndications”. 

Why Multi-Family?

Syndications and/or private placement offerings are all about “pooling” your money together with other investors to purchase large assets that may otherwise be unattainable as a sole ownership purchase (for example, a 300-unit apartment building). If you have 10 million dollars to use as a down payment, you might have the means of purchasing an asset like this individually; however, if you prefer to only invest $100,000, that’s where a syndication structure can be a huge benefit and allow you to participate in a deal of this size. 

Why Value-Add?

I tend to invest in value-add projects. In this business model, the General Partner or Managing Partners and their teams often add value to the apartment community in a number of ways. Common value-add strategies include renovating the units, updating to modern appliances, countertops, in-wall USB ports, smart thermostats, on-site storage lockers, improve the landscaping, renovate the clubhouse, gym, pool, parking lots etc. Every property is unique and the business plan will be different for each; the overall goal is to update the property and match the current market demand while increasing below market rents along the way.

The value (price) of an apartment complex is primarily derived from the NOI (net operating income), which is comprised of the total collected rents and income minus expenses to operate the property. When the net operating income increases, the value of the complex increases. For example, let’s say the annual net operating income on a property increases by $100,000 a year. A $100,000 a year rent increase could potentially bump the purchase price up by nearly one million dollars (for example/educational purposes only). 

Why Invest? 

Multi-family real estate investing has a lot to do with diversification of an investment portfolio. There are two common reasons why people invest in real estate. Most people either invest and wait for the property to increase in value or “force” the appreciation (equity investing) or they rent it out and collect the cash flow (income investing). Why not do both? Value-add business plans are often designed to capture both of these strategies. 

Multi-family real estate is a diversified asset in itself. This is largely due to the fact that when you buy an apartment building, you are investing in many units. With single-family homes, you have (1) unit and (1) tenant. If your tenant moves out or doesn’t pay rent, you are 100% vacant and 100% unprofitable. With a 300-unit property, it is not uncommon to have the ability to lose 70-90 tenants at any given time, and still be profitable. The diversification does not stop there. Many people invest passively in syndications because they can spread out their risk geographically among several properties and Sponsors.  

Why I Decided to Invest in Multi-Family

In 2015, after a complete burnout of trying to expand my single-family portfolio, I decided to return to the drawing board in search of a more sustainable and scalable approach to investing in real estate. I was desperate to become a hands-off investor after realizing how active this business can be. In 2015, after reading 52 books, listening to podcasts, networking in real estate groups and seeking mentors, I ultimately decided that multi-family real estate was my solution. More specifically, investing passively in apartment communities via private placement offerings (syndications). 

These Were a Few of My Reasons:

  • I needed a hands-off approach to invest in real estate 
  • I wanted tax advantages equal to or exceeding single-family 
  • I wanted geographic and asset type diversification 
  • I was seeking a recession-resistant asset class
  • There was (and still is) a nationwide demand for affordable housing 
  • I wanted to leverage other people’s expertise, track record and deal flow

Whether you decide to be active or passive in the multi-family space, I wish you success in your journey. This asset class has truly been a blessing for my family and I. I have a passion for helping educate others in real estate. If you have any questions, please reach out anytime. I would be happy to connect on a call or email to help in any way I can.  

 

To Your Success

Travis Watts 

 

 

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“You Shouldn’t Use the Radio to Generate Leads” Myth Debunked

“Don’t waste your money or time advertising on the radio.”

“The radio is prehistoric.”

“No one listens to the radio anymore.”

I am certain you’ve heard one or a version of the above in your real estate career. Consequently, most real estate investors believe they should not use the radio to generate leads.

However, the statistics on radio usage may surprise you. Radio is still one of the most powerful mediums in the United States with a weekly reach of around 90% among adults. Since adults are listening to the radio and adults own real estate, the radio can be a great way to generate leads.

But the myth isn’t quite debunked just yet… Enter Chris Arnold.

We interviewed Chris on the Best Real Estate Investing Advice Ever Show. He has closed on over 2,500 real estate deals. And guess what? Every single deal came from a lead generated using the radio!

Now, the myth is officially debunked.

One of the main reasons why Chris has had so much success using the radio is because most people believe the myth this blog post is attempting to debunk. How many real estate investors do you personally know who use the radio to generate leads? For most of you, I bet the answer is a big fat zero.

Many people are listening to the radio yet very few real estate investors utilize it to generate leads. Therefore, there is a massive supply-and-demand imbalance from which Chris is benefiting, and so can you.

How can you replicate Chris’s success on the radio? Here’s his simple four-step process:

Define Target Audience: First, you need to define your target audience. Chris’s target demographic are people over the age of 50, because this is the demographic that is likely motivated to sell a home due to things like retirement, inheritance, tired of being a landlord, etc. Since defining a target audience isn’t the purpose of this blog post, click here and here to learn more about this topic.

Create the Advertisement: Once you’ve defined your target demographic, the next step is to create your advertisement. Like any advertisement, it needs to touch on the pain points of your target demographic, as well as include how you will alleviate that pain point and a call-to-action. Chris says you can either record the ad audio at home or, if you don’t have the proper equipment, you can use the local radio station’s studio.

Find a Radio Station: After you’ve created your advertisement, you need to find the right radio station on which to air your advertisement. Selecting the right radio station is easy. You’ve already defined your target audience, so all you need to do is determine the type of music they prefer. Since Chris targets the 50+ demographic, he airs ads on classic or old school rock stations. If your target demographic is rural, he says country music radio stations are best. Or R&B stations if your target demographic is urban.   

Negotiating the Costs: The last step is negotiating the costs of the advertising spot. Chris says the average person calls into a local radio station, asks for their media packet, and pays that price. However, Chris pulls reports on the value of the radio station prior to calling. Based on the reports, he calculates how much the advertising spot is actually worth. Then, once he calls the radio station, he tells them how much he is willing to pay based on his research rather than asking how much do pay. As a result, Chris is able to pay $1,500 for 100 sixty second ad spots per month.

 

One of the major benefits of using Chris’s method is that it is a set-it-and-forget-it strategy. Record the ad, send it to the radio station, and wait for the phone to ring. This is contrasted with other, more active marketing strategies like cold calling, direct mail, or driving for dollars.

And, as I mentioned previously, the number 1 benefit of using the radio to generate leads is that no one else is doing it. 

Chris’s episode is scheduled to air July 22, 2020. Be sure to mark your calendars so that you can listen to his episode to learn even more about this powerful lead generation strategy. 

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How to Navigate 2020 – 5 Tips for Real Estate Investors

What a crazy year this has been! It has certainly been a rollercoaster to say the least, but the good news is that there are ways you can not only survive, but thrive in 2020 as a real estate investor. 

Here Are 5 Tips That Can Help:

#1 Educate, educate, educate. Working from home? Can’t travel? Attend some online events, webinars, read a few books, listen to podcasts, watch “how-to” videos, get on BiggerPockets and read blogs. 

“An investment in knowledge pays the best interest” – Benjamin Franklin 

#2 Re-define your goals and investing criteria. What are your long-term goals? What do you REALLY want to gain from investing in real estate? It’s not all dollars and cents and it’s not all about cashflow vs equity. Take a couple hours this summer to write down what it is you really want to achieve in life. Money can only be exchanged for experiences or “things” – what are you after? 

“You should set goals beyond your reach so you always have something to live for” – Ted Turner

#3 Volunteer your time – seek mentors. Learn from other’s successes and failures. Mentorship can come in many forms, but the most effective is usually in the form of having a personal coach or mentor. This has made the biggest impact in my life over the past decade. Have money to spare? Consider hiring a coach or mentor. Don’t have money to spare? Consider volunteering your time to add value to others in exchange for mentorship.  

“The richest people in the world look for and build networks. Everyone else looks for a job” – Robert Kiyosaki 

#4 Get your personal finances in order. What can you do to reduce overhead or save additional cash? Could you start a side business for some additional income? Stay focused and disciplined on your long-term objectives. Any time you spend money on things you don’t need, you move further from your goals.

“Personal finance is only 20% head knowledge and 80% behavior” – Dave Ramsey 

#5 Learn from mistakes. You will make mistakes and you will likely lose money based on inexperience; I know I have. Reading biographies, seeking mentors, asking people about their “lessons learned” can help you cut the learning curve. 

“It’s good to learn from your mistakes. It’s better to learn from other people’s mistakes” – Warren Buffet 

I hope you find these helpful. Even if you only implement ONE of these, you will be 90% ahead of most. This year, more than ever, is a time to grow, expand and thrive. 

To Your Success

Travis Watts 

 

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Senate Announces HEALS Act Stimulus Package: Here’s What You Need to Know

On Monday afternoon, the Senate Republicans unveiled the Health, Economic, Assistance, Liability Protection and Schools (HEALS) Act, the second stimulus package meant to offset the economic impacts of the coronavirus pandemic.  

Here’s what we know so far about the potential terms of the second stimulus package based on the HEALS Act:

Second round of stimulus checks: Like the CARES Act, the HEALS Act should send payments to qualifying individuals and families. The payment amount was up to $1,200 per person in the CARES Act, and the HEALS Act will likely follow the same payment model. What is undecided are the eligibility guidelines. However, it seems like the negotiation is between keeping the eligibility guidelines the same or allowing more people to receive the payment. Therefore, people who were eligible for the CARES Act stimulus checks will likely be eligible to receive a second payment. The goal is for people to receive checks in the beginning of August.

Unemployment benefits: People who applied for unemployment for the first time due to COVID or were already collecting unemployment will receive a weekly payment on top of the ordinary unemployment benefits. People who were unemployed received $600 a week from the CARES Act. However, the HEALS Act would reduce the extra payment to $200 a week and over time increasing to $500 a week.

Payroll Protection Program (PPP): The PPP program provides forgivable loans to small business to cover payroll (and other costs) as an incentive to keep employees on the payroll. The HEALS Act is expected to target the hardest-hit small businesses with PPP loans. 

Employee retention tax credit: This tax credit program was introduced in the CARES Act. Companies receive tax credits for wages paid to their employees during the pandemic as another incentive to keep employees on the payroll. The HEALS Act proposes to include additional tax relief for companies who hire and rehire workers. 

Return-to-work bonus: If an unemployed person gets a new job and begins working at a previous job again, they will receive a bonus of up to $450 a week on top of their wages.

Renter assistance: The renter assistance programs proposed would help tenants pay their rent, help landlords pay expenses and put another hold on evictions for up to a year.

The next step is for the House to negotiate the terms of the act to finalize the bill. Hopefully, Congress comes to an agreement by next Friday, August 7th, which is the last Senate session before a month-long recess. 

We will keep you posted on any developments regarding the next stimulus package.

 

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How to Go From Solopreneur to a Business That Can Run Without You

Want to go from working 20, 30, 40 or more hour per week while doing one deal a month to working an hour per day while doing over 100 deals per year?

Mike Simmons, a wholesaler and fix-and-flip investor who Theo interviewed on the podcast, was able to go from a solopreneur to operating a business that runs without him by following one simple trick.

For nearly five years, Mike worked 7:30am to 4:30pm in a W2 job. After work, on weekends, and sometimes even during his lunch breaks, he would work in his fix-and-flip business. Since it was just him, he did it all. He found the deals. He negotiated the contracts. He attended closings. He managed the contractors. Overall, he spent 20 to 30 hours on his business each week, resulting in one deal per month. 

Flashing forward to present day, Mike almost never sees the houses that he buys. He doesn’t attend closings. He doesn’t find deals or buyers. Yet, he completes over 100 deals per year.

His secret? Every step in the flipping and wholesaling process is automated, and he has hired an employee who is responsible for overseeing each of these processes.

When to Hire?

The first step in going from solopreneur to a business that can run without you is knowing when to start delegating. In other words, when do you hire your first employee?

The answer depends on how quickly you scale your business. 

Here are three examples of when you should hire your first employee.

You identify a bottleneck. Mike’s first bottleneck was the process of ensuring a wholesale transaction is completed once a deal is under contract and an end buyer is identified. He spent more time on this part of the process and less time finding deals and finding buyers (among other things). So, his first hire was a transaction coordinator to oversee this step in the process.

Your business is generating enough income to pay the salary of an employee. Mike paid his first employee $12 per hour. So, he was generating at least that much income in his business

There is something you really dislike doing or are really bad at. Another reason why Mike’s first hire was a transaction coordinator was because he had poor attention to detail skills. He needed an employee who was detailed oriented.

Who to Hire and In What Order?

As I mentioned above, you hire your first employee when you’ve identified a bottleneck in your real estate process and/or when there is something you don’t like doing or are not good at. Also, when your busines generates enough income to pay an employee’s salary.

After you’ve first hire, who do you hire next?

The decision on who to hire next is similar to deciding who to hire first. Either there is something else you don’t like to do or are bad at, or a new bottleneck is created by the previously hired employee.

Mike’s second hire was a salesperson. Mike thought of himself as a decent salesperson. However, he didn’t like it. After hiring a salesperson, not only was he able to focus on aspects of the business that he enjoyed more but he was also able to complete more transactions due to the higher level skills of this new hire. 

Mike made his third hire based on a newly created bottleneck. The salesperson was responsible for answering the phone calls for income leads. This took time away from the salesperson getting in front of potential sellers and negotiating contracts. To remove this bottleneck, Mike hired a person to answer the phones. That way, the salesperson could spend more time negotiating contracts and less time on the phone qualifying leads.

Now that Mike had a dedicated person to answer the phones, he had the capability to handle more leads. Therefore, he hired a marketing person to generate more leads to keep the person who answers the phones busy.

Overall, the order in which you hire new employees usually starts with tasks you don’t like doing and eventually evolves into alleviating bottlenecks created by a previously hired employee.

Doer vs. Leader

When you are a solopreneur, you are wearing all the hats in your business. You are working in your business.

Once you start to hire employees, you slowly work less “in” your business and more “on” your business.

When you work in your business, you are a doer. When you work on your business, you are more of a leader.

The skills required to be a real estate doer are different than those needed to be a real estate leader.

One tip Mike provided about how to be a better leader to your employees is to document a process prior to hiring someone to oversee that process. A bad leader hires an employee for a role and says, “just get it done.” A good leader hires an employee for a role and says, “here is what you need to do in order to be successful.” But rather than telling them what they need to do, you can provide them with documentation with the step-by-step process for how to successful in their role.

 

To go from a solopreneur to operating a business that runs without you requires hiring employees. To ensure that the business runs successfully without you, make sure you are hiring employees for the right reasons and in the right order. And as you hire more and more employees, make sure you are improving your leadership skills.

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Everything You Need to Know About the GP Catch-Up

In apartment syndications, the General Partner (GP) catch-up is a distribution to the GP such that they have received their full portion of the profits.

The GP catch-up is relevant when the compensation structure of partnership between the GP and the Limited Partner (LP) includes a profit split.

For example, let’s say the LPs are offered a 7% preferred return and the profit split is 70% to the LPs and 30% to the GPs. At the conclusion of the partnership, 70% of the total project cash flow (ongoing cash flow and profits from sale) must have gone to the LPs and the remaining 30% must have gone to the GPs.

There are two main types of GP catch-ups. The most common is a GP catch-up at sale. The other, less common, is an ongoing GP catch-up.

The advantage of the ongoing GP catch-up is that the GPs can receive distributions immediately rather than waiting until sale.

Whichever GP catch-up you decide to pursue, make sure it is properly defined in your waterfall in the PPM.

To explain how each of these two GP catch-ups work, let’s use the following dataset as an example:

  • Preferred Return to LPs: 7%
  • Profit Split (LP/GP): 70/30
  • LP Equity Investment: $1,000,000
  • Year 1 to 5 Cash Flow
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
 ($1,000,000)   $71,000   $77,000   $84,000   $93,000   $130,000

 

  • Profit at Sale (After $1,000,000 in equity is returned): $1,500,000

GP Catch-Up At Sale

For a GP catch-up at sale, the LPs receive their preferred return first. Then, the profits above the preferred return are split 70/30. At sale, after the LP equity is returned and before the profits are split 70/30, a catch-up distribution goes to the GP until they have received 30% of the cumulative cash flow up to this point.

Here is a breakdown to the ongoing distributions to LPs and GPs:

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Total
Total  $(1,000,000)  $ 71,000  $ 77,000  $ 84,000  $ 93,000  $ 130,000  $ 455,000
LP  $ 70,700  $ 74,900  $ 79,800  $ 86,100  $ 112,000  $ 423,500
GP  $      300  $   2,100  $   4,200  $   6,900  $   18,000  $   31,500

 

Based on the “Total” column, the LPs have received 93.08% of the profits and the GPs have received 6.92% of the profits. Therefore, the first portion of the $1,500,000 profit at sales goes to the GP until they have received 30% of the total profits.

Here is how you calculate that amount:

X equals $150,000.

After the $150,000 distribution, the LP has received $423,500 and the GP has received $181,500, and the 70/30 split is achieved.

The remaining profits, $1,350,000, are split 70/30. This equates to $945,000 to the LP and $405,000 to the GP.

Here is the updated data table for cash flows to the LP and GP:

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Total
Total  $(1,000,000)  $ 71,000  $ 77,000  $ 84,000  $ 93,000  $ 1,630,000  $ 1,955,000
LP  $ 70,700  $ 74,900  $ 79,800  $ 86,100  $ 1,057,000  $ 1,368,500
GP  $      300  $   2,100  $   4,200  $   6,900  $    573,000  $    586,500

 

The total distribution is $1,955,000. $1,368,500, or 70%, went to the LP. $586,500, or 30%, went to the GP.

 

Ongoing GP Catch-Up

With an ongoing GP-catch up, the LPs still receive their preferred return first. However, before the remaining profits are split 70/30, the GP receives a catch-up distribution. This distribution is equivalent to a 70/30 split.

Here is how that amount is calculated:

X equals 3.

Therefore, the GP receives a 3% return based on the total LP equity investment. Any unpaid GP catch-up is accrued and paid out when possible. Once both the LP and GP have been paid, the remaining profits are split 70/30.

Since our sample equity investment is $1,000,000, the LP receives $70,000 annually and the GP receives $30,000 annually.

Year 1 Cash Flow is $71,000, which means the LP receives $70,000, the GP receives $1,000, and $29,000 is owed to the GP.

Year 2 Cash Flow is $77,000, which means the LP receives $70,000, the GP receives $7,000, and an additional $23,000 is owed to the GP. Total amount owed to the GP is $52,000.

Year 3 Cash Flow is $84,000, which means the LP receives $70,000, the GP receives $14,000, and an additional $16,000 is owed to the GP. Total amount owed to the GP is $68,000.

Year 4 Cash Flow is $93,000, which means the LP receives $70,000, the GP receives $23,000, and an additional $7,000 is owed to the GP. Total amount owned to the GP is $75,000.

Year 5 Cash Flow is $130,000, which means the LP receives $70,000 and the GP receives $30,000. The remaining $30,000 also goes to the GP to pay down the accrued amount. Total amount owed to the GP is now $45,000.

At sale, after the LP equity is returned, the accrued amount owed to the GP, $45,000, is distributed. Then the remaining profit, $1,455,000, is split 70/30. The LP receives $1,018,500 and the GP receives $436,500.

Here is the data table for cash flow to LP and GP:

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Total
Total  $(1,000,000)  $ 71,000  $ 77,000  $ 84,000  $ 93,000  $ 1,630,000  $ 1,955,000
LP  $ 70,000  $ 70,000  $ 70,000  $ 70,000  $ 1,088,500  $ 1,368,500
GP  $   1,000  $   7,000  $ 14,000  $ 23,000  $    541,500  $    586,500

 

As you can see, the “Total” 5-year distributions to the LPs and the GPs are the same for each catch-up types. However, for the ongoing GP catch-up, the GPs receive more money sooner, which – in turn – means that the LPs receive money later. As a result, the LP internal rate of return (IRR) is lower with the GP catch-up

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 IRR
At Sale  $(1,000,000)  $ 70,700  $ 74,900  $ 79,800  $ 86,100  $ 1,057,000 7.390%
Ongoing  $(1,000,000)  $ 70,000  $ 70,000  $ 70,000  $ 70,000  $ 1,088,500 7.320%

 

Therefore, the GP catch-up at sale is more advantageous for the LPs and the ongoing GP catch-up is more advantageous for the GPs, even though both the LP and the GP receive the same total cash distributions in each scenario.

 

Disclaimer: The views and opinions expressed in this document are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.

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5 Tips for Raising Money from Family Offices to Buy Apartments

The typical progression for raising money for apartments goes like this:

  • For the first deal, you raise money from your family and/or closest friends
  • After the first deal, you continue to raise money from your family and/or closest friends. However, people who you are less familiar with begin to invest. Examples would be extended family, less close friends, work colleagues, and others who you’ve known for a few years or less
  • As you do more and more deals, you begin to raise money from investors who were referred from other investors. You also attract passive investors from your thought leadership platform
  • Eventually, you transition to raising money via 506(c), which allows you to advertise your deals to raise capital

The commonality between all steps in the above progression is that you are raising money from individual investors (or two investors who are a couple). 

Another, more advanced model for raising capital is to pursue private institutions. An example of a private institution from which you can raise money are family offices.

According to Investopedia, family offices are private wealth management advisory firms that serve ultra-high-net-worth investors. They are different from traditional wealth management shops in that they offer a total outsourced solution to managing the financial and investment side of an affluent individual or family. 

Family offices can be a great source of equity for advanced apartment syndicators. Seth Wilson, the founder and managing director of Clarity Equity Group, raises money from family offices for his real estate deals. 

We recently interviewed Seth on the Best Real Estate Investing Advice Ever Show. His episode is scheduled to be air on 9/16/20. In that interview, Seth provided his top five tips for raising money from family offices.

1. You Must Have Relevant Experience

The first step before you even consider raising money from a family office is that you must have experience. If you’ve never done a large apartment deal in the past, a family office isn’t going to take you seriously. If you’ve only been doing large apartment deals for a few years, a family office still isn’t going to take you serious.

It took Seth over 12 years and $65 million worth of real estate in order to raise money from family offices.

There is not a shortcut. If you want to raise money from family offices, the first step is to have years of experience successfully buying, managing, and selling apartment buildings.

2. You Must Be An Expert

It is likely that if you meet the “experience” requirement, you will meet the education requirement as well. 

The reasons why you need the relevant experience and need to be an expert on apartment investing are two-fold. First, family offices are entrusted by an individual or family to invest on their behalf and, more importantly, preserve their net worth. The individual or family did adequate due diligence on the family office prior to using their services. The family office did adequate due diligence before hiring their employees. Therefore, they are going to do adequate due diligence on you and your business.

Secondly, and because of reason number one, they are generally more sophisticated than your family, friends, and others you are used to raising money from. They are going to ask more complex, detailed questions about you and your business plan. When you are an expert, you can hold your ground when these questions are asked. They must be confident in your ability to conserve and grow their client’s investment.

3. Put Together the Look

Whether you like it or not, Seth says that a book is judged by its cover, especially in the higher echelons of investing. 

A family office is most likely not going to invest in your deals without seeing you in person. Therefore, you need to wear the proper attire. And there isn’t a one-sized-fits all approach. 

The acceptable attire when visiting a family office based out of Denver is a lot different than one in Manhattan. Seth says that the best way to learn the dress code is by asking. Call the receptionist, ask what the dress code is and dress one notch higher.

4. Speak to the Right Contact

When you are ready to raise capital from family offices, maximize your chances of success by speaking with the right contact.

If you are reaching out to a family office who manages the wealth of a second-generation or later family (i.e., the wealth was created by the parents, grandparents, etc.), the best person to speak with is the Chief Investment Officer. Seth said that more established family offices will have an investment committee who sign off on all investments. The CIO typically sits on this committee. If you can win over the CIO, you’ll have your inside person on the investment committee to argue your case.

If you are reaching out to a family office who manages wealth for a first-generation family (i.e., the wealth was created by someone who is still alive), you want to speak to the patriarch or matriarch of the family. The person who made the wealth is likely heavily involved in investment decisions.

5. Take Massive Action

Like all things in real estate, raising money from family offices requires massive amounts of action. Seth recommends having one or two great phone calls with family offices each day. Use resources you already have to add value and take care of them.

Focus on building a business relationship and a personal relationship. For example, if you come across something that you think they would personally be interested in, text them. 

You also want to make sure you are physically meeting them in person. Seth has no problem flying out in the morning, having an hour or so meeting with a single family office in the afternoon, and fly home in the evening. 

Raising money from a family office is a great way to take your apartment syndication business to the next level. But it is a strategy that takes time to work up to. You must establish relevant experience and expertise before making the jump from “family and friends” to family offices.

Once you have a track record, make sure you dress the part, know who to speak with, and take massive action.

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Demand for Multifamily Rentals to Increase by Nearly 50% in Next Five Years

On January 18th, 2019, I published an article on my blog entitled “Why I Am Confident Multifamily Will Thrive During and After the Next Economic Recession.” 

In summary, historically, homeownership rates decrease during economic recessions and increase during economic expansions. 

During the post-2008 economic expansion, the Dow Jones tripled, unemployment was cut in half, and the GDP rose by nearly $5 trillion. At the same time, the renter population increased nearly every single year and grew by more than 25%. 

The reasons why more people decided to rent than own during the most recent economic expansion include high student debt, poor credit, tighter lending criteria, people starting families later, and inability to afford home payments. 

Since these reasons aren’t going away, I predicted that when the next economic recession occurs, the same percentage of people or more will rent. And when the economy begins to improve, the same percentage of people or more will rent.

Flash forward over one-and-a-half years and many experts believe we have entered the next economic recession, due in part to the coronavirus pandemic.

So what are people saying about the demand for multifamily rentals?

A study released by apartment properties acquisition and management company, Middleburg Communities, projects a drop in homeownership rates and a significant increase in demand for rental housing over the next five years.

Here is an excerpt from a GlobeSt.com article published on June 17, 2020 entitled “As Homeownership Declines, Demand for Rental Housing to Climb.”

“The June 11 report projects a decline in U.S. homeownership to 62.1%, the lowest rate in more than 20 years, before a partial recovery to 63.6% in 2025. Depending on the effects of the recession, the demand for rental housing will increase somewhere between 33% and 49% over that time period, the report concludes.

The analysis points to changing demographics playing a role in the changing demands. Married households are more likely to own homes, and their numbers are declining. The numbers of households with incomes of more than $120,000 is expected to drop while those with incomes of less than $30,000 are projected to increase.

“We do not claim to know the precise trajectory that household incomes will take over the next five years,” the report said. “However, with 19 million jobs lost as of this writing, the direction of household incomes in the near future is clearly negative.”

The number of non-white householders, who typically rent at a higher rate, is also growing.

But demographics alone are a “weak” explanation for homeownership shifts, according to the report. Student loan debt, inability to make a down payment, tightened lending standards, high rents and a shift in preferences play a role, too.

The report also zeroed in on three variables that offer a “reasonable” explanation for slumping homeownership: “lending standards, as measured by the average credit scores of mortgages, median net worth by age of householder, and the previous year’s deviation from the demographic-based projection, essentially inertia.”

The report notes that additional stimulus packages from the federal government could bolster homeownership rates.”

(Emphasis Added)

Like I said over one-and-a-half years ago, homeownership decreased during the economic expansion due to people starting families later, student loan debt, inability to make a down payment, and tighter lending standards.

Therefore, this study reinforces my thoughts on multifamily investing – there will be the same or increased demand for rentals during and after the current economic recession.

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1031 Exchange: The Rules

As the owner of investment properties large and small alike, there’s a vehicle available in which you can actually continuously invest into larger properties and delay the capital gains expenditure that is due to reveal itself at some point. This vehicle is called a 1031 Exchange.

 

According to the United States Internal Revenue Code (26 U.S.C. § 1031), a 1031 Exchange allows a taxpayer to defer the assessment of any capital gains tax and any related federal tax liability on the exchange of certain types of properties. In 1979, federal courts allowed this code to be expanded to not only sell real estate but also to continuously purchase within a specific timeframe with no liability assessed as that time.

 

In addition, these exchanges must be utilized for productive use in business or investment. Prior to 2018, properties listed under the code included stocks and bonds and other types of properties. However, as of today, the 1031 Exchange only includes real property which makes this excellent for investors.

 

1031 Exchange Rules Explained 

 

There are 7 primary 1031 Exchange rules which require a deeper study: 

 

  • Like-kind property 
  • Only for Investment or Business Intentions
  • Greater or Equal Value Replacement Property Rule
  • “Boot” is denied
  • Same taxpayer rule
  • 45 day identification window 
  • 180 day purchase window

 

1031 Exchange Rules Explained 

 

Like-Kind Property

 

According to the IRS, each property must be utilized in trade or business for investment purposes. Keep in mind that property used personally, like personal residences or second homes, will not qualify for the 1031 Exchange opportunity. 

 

However, real property, most commonly known as real estate, does include land and anything attached to the land or anything built upon it, or an exchange of such property held primarily for sale does not meet the requirements for the utilization of a like-kind exchange.

 

Only for Investment or Business Intentions

 

To meet the criteria for a 1031 Exchange, the real estate must be utilized for investment or business purposes only. The investment vehicle must be property that is not considered a primary residence but is used to generate income and profits through appreciation and that can take advantage of certain tax benefits.

 

For example, real property identified for investment purposes can be any property that is held for the production of income, whether it be a rental for leasing option, or if the value increases over time (capital appreciation). In order for it to meet the criteria for the tax deferral, the property must be held strictly for either investment or business use.

 

Greater or Equal Value Replacement Property Rule

 

The greater or equal value replacement property rule identifies a limitless amount of properties as long as their combined value does not exceed 200% of the originating, or previously sold property. In addition, this rule also includes the acquired properties to be valued in the neighborhood of 95% or higher of the property that is being exchanged for.

 

“Boot” is denied

 

The term boot is where money or the even exchange of items considered to be “other property.” If it is determined that a taxpayer does receive boot, that booted exchange or a portion of will become taxable.

 

Rules of Thumb for the Boot Offsetting Provisions:

if the seller receives replacement property of the same or higher value than the net sale price of the property previously sold, and in addition, the seller spans all of the proceeds from the acquisition on the property being replaced, then that exchange does meet the criteria to be totally tax deferral. If the seller follows these guidelines, then there is no consideration of this being considered “cash boot” received and either took on new mortgages in addition to the previously dissolved mortgage or the seller gave the “cash boot” to reconcile any received “mortgage boot.”

 

The Same Taxpayer Rule

 

It is mandatory under the same taxpayer rule that the seller who previously owned the property that was sold must be the exact same person, via tax identity, who takes over ownership of the property being replaced. The question is why? The answer is because if the taxpayer changed their identity, based on tax law, then there would be no continuous action of the tax. Therefore, the proceeds are subject to become taxable.

 

45 Day identification Rule

 

Under the 1031 exchange code, the taxpayer has a 45 day window from the date of the sale of the previously owned property to identify the replacement property. The 45 day window is commonly referred to as an identification period. This process must be done in writing with the authentic signature of the taxpayer.

 

When identifying the replacement property, remember the following suggestions:

  • Any real property as long as it is being considered for business or investment purposes may qualify. The property can be located anywhere in the continental United States. In addition, in 2005 there were certain temporary regulations that were allowed for rental real estate to be purchased in Guam, and the Northern Mariana Islands, and also in the US Virgin Islands.
  • The property must be clearly identified with a physical street address or legal property description, and in some cases, specific unit addresses are mandatory.
  • In the process of identification, the property may be changed or additional real estate can be added by 12 midnight on the first 45th day of your identification window. Keep in mind that there are two rules that must be remembered and they are the 3-Property Rule and 200% Rule. Sometimes, revoking your original identification may be required while you are in the process of making a new one.
  • If there is any property purchased within the window of the 45 day rule then there is no formal identification needed, however, keep in mind to take the identification of other properties in consideration.
  • Purchasing replacement properties from relatives should be given careful scrutiny.

 

180 Day Purchase Rule

 

When completing a 1031 exchange, the 180 Day-Purchase Rule mandates that the replacement transaction must be completed within 180 days or six months in total. Regardless, the rule always applies. This means that conveyance of title must be completed by this date. If you ever decide to participate in an apartment syndication, please adhere to this rule.

 

Executing a 1031 Exchange

 

Example 1: Assuming that a taxpayer has decided to invest into a multifamily unit and he has decided to sell it. To the taxpayer’s surprise, the property generated $300,000 in gains, and after closing, the net proceeds were $300,000. With the taxpayer staring at a capital gain tax liability of 200,000 in taxes (federal capital gain tax, depreciation recapture, state capital gain tax, and net investment income tax) after the property sells. Only $100,000 in net equity is available to be reinvested into another property.

 

Example 2: If the same investor chose to complete an exchange, the investor would have had to have identified the new replacement product being a multifamily unit within 45 days and invests the entire 300,000 into the purchase of the replacing property with no capital gains due.

 

For an investor, a 1031 exchange is an excellent opportunity. When you decide to invest in properties, it is natural to migrate to larger units, specifically multifamily properties.

 

As you continue development and growth in this area, you may even want to consider becoming an apartment syndication investor. This will allow you to pool resources from other sources that will facilitate the overall growth of your portfolio and investment profile. Understanding the 1031 Exchange can generate large revenue and save taxes.

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An Investor’s Secret to Doing Large Apartment Deals with No Experience

The more investors you speak with, the more you realize that a lot of the traditional real estate advice simply is not true. 

For example, “you need to have experience in order to do large apartment deals.” 

The main reason? We are told that sellers and brokers prefer to work with established apartment operators because their proven track record increases the probability of a close. Whereas a sale is more uncertain when working with a less experienced apartment investor, or one who has not taken a large deal full cycle in the past. 

Therefore, we are told to focus on smaller deals (single family rentals, duplexes, triplexes, quadplexes, etc.) to build a reputation of being a closer and someone who can successfully manage multifamily properties. 

However, I have spoken with countless real estate investors who have gotten into the large multifamily space without following the above advice. They didn’t slowly acquire larger and larger properties. Instead, they either made gigantic leaps or skipped the smaller properties and started off investing in large multifamily properties.

For example, I was able to go from single family rentals to a 150+ unit apartment community.

Another example is Hamza Ali, who Theo interviewed on my podcast, Best Real Estate Investing Advice Ever. He currently owns 1,000 doors in Houston, TX. 

Hamza Ali of Gray Spear Capital is an example of an investor who went straight to multifamily investing. He acquired a 24-unit apartment community from a broker without any previous multifamily experience. 

How was Hamza able to win over both the seller and the listing broker?  

He brought a large, local multifamily investor to broker meetings.

Once Hamza decided to pursue larger multifamily deals, he joined a local apartment meetup group. At the meetup, he met a local apartment operator who owned 1,000 units in the Houston, TX area. After establishing himself as someone who was serious about buying apartment communities, he invited this larger apartment operator to broker meetings.

One of the broker meetings was with an individual Hamza met at the meetup. This is the broker who sold Hamza his first deal – the 24-unit.

After putting the 24-unit under contract, the large apartment operator even walked the property with him.

Overall, Hamza was able to leverage someone else’s experience to close on his first apartment deal with no multifamily experience. 

The large apartment operator didn’t have an official role in the deal. He didn’t sign on the loan nor was he given a stake in the deal. However, by attending broker meetings, he was implying to the brokers that Hamza was a trustworthy individual who would be able to close.

If Hamza attended the meetings alone, chances are that we isn’t awarded the deal. But the presence of a well-known, big-time apartment player instantly increased his reputation in the eyes of the brokers.

 

Now, Hamza applied this strategy to winning over apartment brokers with no apartment experience. However, the concept can be applied elsewhere.

Want to raise money from passive investors but lack experience? Bring a big-time player onto the General Partnership.

Having trouble finding this big-time player? Do what Hamza did, which is to start attending local meetup groups. Even better, start your own. The strategy at the meetup group is to establish yourself as a serious real estate professional. Show up to every meetup on-time. Ask educated questions. Offer valuable information to others. Maybe even offer to work for free for the big-time player from which you want assistance.

Thousands of investors have skipped the beginning or intermediate steps and jumped straight to large multifamily investing. Almost all of them did so by leveraging the experience and reputation of an established operator.

If you use Hamza’s strategy, you will be on your way to building a 1,000 or more unit apartment portfolio.

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Everything You Need to Know About Apartment Syndication Waterfalls

I’m not talking Niagara Falls but passive investor compensation.

In apartment syndications, a waterfall describes how, when, and to whom funds are paid in an apartment syndication deal. The type of waterfall will determine the returns to the Limited Partners and General Partners.

Ultimately, you as the General Partner decide which waterfall structure to have in place for your deals.

In this blog post, I will outline the waterfalls for the most common apartment syndication structures.

 

Waterfall #1: 8% Preferred Return Only

Compensation structure: Class A passive investors receive an annualized 8% preferred return only. Class B General Partners receive all profits.

Waterfall for cash flow

  • Cash flow is distributed to Class A until they receive an annualized return of 8% based on their initial capital contribution
  • Any remaining distributable cash flow is distributed to Class B  

Waterfall for capital transaction (i.e., a sale, supplemental, or refinance)

  • Repay the unreturned capital contributions of Class A investors (i.e., their initial equity investment amount)
  • Make up arrearages in Class A preferred returns (if applicable)
  • Any remaining distributable cash is distributed to Class B.

 

Waterfall #2: 8% Preferred Return + 70/30 Split

Compensation structure: Class A passive investors receive an annualized 8% preferred return and 70% of the profits. Class B General Partners receive 30% of the profits.

Waterfall for cash flow

  • Cash flow is distributed to Class A until they receive an annualized return of 8% based on their initial capital contribution
  • Any remaining cash flow is split 70/30, with 70% paid to Class A and 30% paid to Class B

Waterfall for capital transaction

  • Repay the unreturned capital contributions to Class A investors (the amount is either the initial equity investment or the reduced equity investment based on the capital returned from 70% profit splits)
  • Make up arrearages in Class A preferred returns (if applicable)
  • Cash is distributed to the General Partner until such time as the General Partner has received an amount equal to 30% of the cumulative amount distributed (i.e., total distributions from cash flow, including preferred return and profits)
  • Any remaining cash is split 70/30, with 70% paid to Class A and 30% to Class B

This is the waterfall structure that is currently set up on the Simplified Cash Flow Calculator, which you can download for free here. In the LP/GP Returns data table starting in cell B67, input the preferred return percentage to Limited Partners and the profit split to Limited Partners. The annual LP Return and GP Return is automatically calculated based on the preferred return, profit split, and flow of cash based on the waterfall structure outlined above.

At the sale, the unreturned capital contribution to the Limited Partners is their initial equity investment minus cash received, which you can see calculated on the IRR Calculation tab.

 

Waterfall #3: 8% Preferred Return + IRR Hurdle

Compensation structure: Class A passive investors receive an annualized 8% preferred return and 70% of the profits up to a 13% IRR. After a 13% IRR is achieved, Class A passive investors receive 50% of the profits. Class B General Partners receive 30% of the profits up to a 13% IRR to Class A. After a 13% IRR to Class A is achieved, Class B receives 50% of the profits.

Waterfall for cash flow

  • Cash flow is distributed to Class A until they receive an annualized return of 8% based on their initial capital contribution
  • Any remaining cash flow is split 70/30, with 70% paid to Class A and 30% paid to Class B 

Waterfall for capital transaction

  • Repay the unreturned capital contributions to Class A investors (the amount is either the initial equity investment or the reduced equity investment based on the capital returned from 70% profit splits)
  • Make up arrearages in Class A preferred returns (if applicable)
  • Cash is distributed to the General Partner until such time as the General Partner has received an amount equal to 30% of the cumulative amount distributed (i.e., total distributions from cash flow, including preferred return and profits)
  • Cash is split 70/30, with 70% paid to Class A and 30% to Class B up to a 13% internal rate of return
  • Remaining cash is split 50/50 between Class A and Class B

There can be more or more hurdles. For example, 70/30 up to 13% IRR, 60/40 up to a 15% IRR, and 50/50 thereafter.

 

Waterfall #4: Two Passive Investor Tiers

Compensation structure:  Class A passive investors receive an annualized 10% preferred return. Class B passive investors receive an annualized 7% preferred return and 70% of the profits. Class C General Partners receive 30% of the profits.

Waterfall for cash flow

  • Cash flow is distributed to Class A until they receive an annualized return of 10% based on their initial capital contribution
  • Cash flow is distributed to Class B until they receive an annualized return of 7% based on their initial capital contribution
  • Any remaining cash flow is split 70/30, with 70% paid to Class B and 30% paid to Class C 

Waterfall for capital transaction

  • Repay the unreturned capital contributions to Class A investors (since Class A isn’t receiving a profit split, their capital account isn’t reduced)
  • Repay the unreturned capital contributions to Class B investors (the amount is either the initial equity investment or the reduced equity investment based on the capital returned from 70% profit splits)
  • Make up arrearages in Class A preferred returns (if applicable)
  • Make up arrearages in Class B preferred returns (if applicable)
  • Cash is distributed to the General Partner until such time as the General Partner has received an amount equal to 30% of the cumulative amount distributed (i.e., total distributions from cash flow, including preferred return and profits)
  • Any remaining cash flow is split 70/30, with 70% paid to Class B and 30% paid to Class C

 

Waterfall #5: General Partner Catchup

This is a waterfall structure that you, the syndicator, can receive distributions starting from day 1.

Compensation structure: Class A passive investors receive an annualized 8% preferred return and 70% of the profits. Class B General Partners receive an annualized 3.43% preferred return and 30% of the profits.

Waterfall for cash flow

  • Cash flow is distributed to Class A until they receive an annualized return of 8% based on their initial capital contribution
  • Cash flow is distributed to Class B until they receive an annualized return of 3.43% based on the Class A initial capital contribution (3.43% is the equivalent to a 70/30 split between Class A and Class B – 70/30 = 8/x; 70x=240; x=3.43)
  • Any remaining cash flow is split 70/30, with 70% paid to Class A and 30% paid to Class B

Waterfall for capital transaction

  • Repay the unreturned capital contributions to Class A investors (the amount is either the initial equity investment or the reduced equity investment based on the capital returned from 70% profit splits)
  • Make up arrearages in Class A preferred returns (if applicable)
  • Make up arrearages in Class B preferred returns (if applicable)
  • Any remaining cash flow is split 70/30, with 70% paid to Class A and 30% paid to Class B

 

These are the waterfalls for the five most common passive investor compensation structures. 

Make sure you download the free simplified cash flow calculator (here), which has the waterfall #2. If you plan on using a different waterfall structure, you will need to update the formulas in this or other cash flow calculators accordingly.

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You Shouldn’t Do Deals During the Coronavirus Pandemic: Multifamily Myth Debunked

Let’s debunk another multifamily myth.

Click here to read my debunking of another common money-raising myth – that you need a strong track record in multifamily to raise money.

The myth I will debunk in this blog post is “I shouldn’t be doing any apartment deals until the coronavirus pandemic has passed.”

The key word is apartment deals. This blog post will focus on how you can continue to do apartment deals during the coronavirus pandemic.

My company recently renegotiated an apartment deal that we placed under contract before the coronavirus pandemic. My consulting clients are still actively looking at deals and putting them under contract. Active investors I have spoken to on my podcasts are still doing deals.

In fact, many active investors I have spoken with who raise money for their deals are saying that they are seeing an increase in demand. With the amount of uncertainty in the stock market, people are looking at passive real estate investing as an alternative.

What is allowing investors to continue to do apartment deals during the coronavirus pandemic? Because they understand what changes need to be made to the underwriting assumptions.

When analyzing apartment deals, you input your income and expense assumptions. Then, you determine the purchase price that will result in ROI projections that meet your passive investors’ financial goals. If you use pre-coronavirus underwriting assumptions, you are virtually guaranteed to overpay and fail to meet your projections.

Therefore, if you want to do deals during the coronavirus pandemic that conserve and grow your passive investors’ capital, here are the four changes you need to make to your underwriting process.

 

1. Year 1 Operations

It could be expected that there will be an increase in vacancy, bad debt, and concessions throughout 2020. Once things settle down a bit and the economy reopens, it is possible that some residents will no longer be able to afford living at the apartment any more.

Therefore, year 1 projections should assume some softening of the rent roll. That is, higher vacancy, bad debt, and concessions than the T-12 and typical market rates.

 

2. Rent growth

The rent growth for 2020 in the vast majority of markets is projected to suffer as unemployment rises. However, most of any rent lost in 2020 is expected to be recovered in 2021. Therefore, rent growth in years 1 and 2 should reflect the immediate area and demand in the market. This information will come from your experienced property management company.

 

3. Debt

As of right now, most private lenders are taking a “pause” from bridge lending. However, lenders that are still active are being extremely conservative with their loan proceeds and terms. The agencies are lending, yet they are also being conservative on their underwriting and requiring large upfront reserves for debt service payments. Therefore, more conservative proceeds should be underwritten and the underwriting needs to include these upfront reserves as it will impact the equity required to fund. Make sure you ask your lender or mortgage broker about the new LTV, upfront reserve requirements, and other terms prior to submitting an offer on a new deal.

 

4. Value-Add Deals

Depending on the deal, we have seen many owners pause their interior renovation programs until the markets re-stabilize. When underwriting a deal, it may be wise to assume that the value-add program does not start until the overall market stabilizes.

 

Overall, it is a myth that you shouldn’t be doing deals during the coronavirus pandemic. But you will need to make the correct updates to your underwriting assumptions:

  1. Underwriting higher vacancy, bad debt, and concessions during year 1,
  2. Underwriting a lower rent growth during year 1
  3. Include any upfront reserves that are required by your lender
  4. Expect to delay your interior renovations if you are a value-add investor.

If you make these four underwriting changes, you can continue to do apartment deals during the coronavirus pandemic.

 

Are you an accredited investor who is interested in learning more about passively investing in apartment communities? Click here for the only comprehensive resource for passive apartment investors.

 

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Will Apartments Be Stronger in the Post-Coronavirus World?

JP Morgan Chase, the largest lender by assets and fourth largest lender overall in the US, recently announced that they are raising borrowing standards for most new home loans to reduce their exposure during the coronavirus pandemic.

JPMorgan Chase’s chief marketing officer for the home lending business said “due to the economic uncertainty, we are making temporary changes that will allow us to more closely focus on serving our existing customers.”

What are these temporary changes? To qualify for a residential mortgage at Chase, a borrower must have a credit score of at least 700 and will be required to make a 20% down payment.

Additionally, Chase also announced that they are temporarily halting HELOC loan offerings.

JPMorgan is the first large lending institution to announce major changes to their lending criteria. I think a fair assumption is that other large lending institutions will follow suit in the coming weeks and months.

What does this mean for real estate investing and, more particular, apartments?

First, if less people qualify for residential financing, less people will be able to purchase their own homes. As a result, more people will be forced to rent. According to Experian, approximately 59% of Americans have a FICO Score of at least 700. And according to MBA, the average down payment across the housing market is around 10%. Therefore, the majority – and possibly the vast majority – of the population cannot qualify for Chase’s residential financing. Even if someone has a 700-credit score or higher, they may not be able to afford the 20% down payment due to the surge in home prices during the post-2009 economic expansion.

One benefit from buying a home during the post-2008 economic expansion was the increase in the value of the property from natural appreciation. According to Zillow, the average home value increased from $175,000 in March 2010 to $248,000 in March 2020. That is an overall increase of 47%, or 4.7% per year. This means that on average, the value of a home grew by nearly 5% each year. However, the Federal Reserve March consumer survey said home prices were expected to grow by only 1.32% this year, the lowest reading since the survey began in 2013. Therefore, one of the main financial benefits from owning a home has been eliminated, which may make renting more attractive.

16 million people are out of work due to the coronavirus. As a result, the number of borrowers who requested to delay mortgage payments rose by 1,900% in the second half of March. Currently, there has been a federal halt on foreclosures. So the question is, will foreclosures resume before or after these borrowers secure new employment? If it resumes before, many people will lose their homes and be forced to rent.

Overall, tighter lending criteria, the lowest projected home value increase since 2013, and the massive increase in the mortgage delay requests indicates that more people will be renting as opposed to buying in the near future. In fact, we are already seeing this happen. In March, the National Association of Realtors announced that they expect home sales to fall by around 10% compared to historical sales for this time of the year.

What do you think? Do you think more people will be renting or buying post-coronavirus?

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The S.O.S. Approach to Managing an Investment During Coronavirus

As I am sure you are aware, CDC is responding to an outbreak of respiratory disease caused by a novel (new) coronavirus that has first detected in China and which has now been detected in almost 70 locations internationally, including the United States. The virus has been named “SARS-CoV-2” and the disease it causes has been named “coronavirus disease 2019” (abbreviated “COVID-19”).

Consequently, the DOW Jones has dropped by nearly 10,000 points over the past 30 days.

Per the CDC, “the best way to prevent infection is to avoid being exposed to this virus.” Therefore, social distancing has been one of the main methods to combat the virus. As a result, many people are working from home and many others have been laid off or furloughed.

From a business perspective, when a crisis – like the coronavirus, hurricane, fire, earthquake, etc. –  occurs and you have an investment property, you need to have a process for approaching the situation, and even more so when you have passive investors. The procedure I use is the acronym S.O.S, which stands for Safety, Ongoing Communication, and Summary.

 

S – Safety

The first step when a crisis occurs is always and most importantly safety. That is, safety for both the people and the money.

So, you first want to ensure the safety of both your residents and your team members on the ground. We sent all of our residents safety notices outlining the CDC’s guidelines for preventing the spread of the disease, which includes:

  • Wash your hands often with soap and water for at least 20 seconds. If soap and water are not available, use an alcohol based hand sanitizer
  • Avoid touching your eyes, nose, and mouth with unwashed hands
  • Avoid close contact with people who are sick
  • Stay home when you are sick
  • Cover your cough or sneeze with a tissue, then throw the tissue in the trash
  • Clean and disinfect frequently touched objects and surfaces

We also provided URLs to the CDC webpages with more information on the coronavirus:

The money side of the safety equation is still up in the air. It is hard to tell how the coronavirus will impact multifamily real estate. The stock market is going down which means more money should flow into real estate. At the same time, many people are losing jobs, which means they will have difficulty paying rent. We will have to see how rent collections are impacted over the next few months.

One interesting strategy I’ve seen is to allow residents to use their security deposits to pay for rent over the next few months. For example, investor Julie Fagan will allow her residents with a $1000 per month rent payment and a $1000 security deposit to apply $500 to this month’s rent and $500 to next month’s rent, reducing their rents to $500 per month. In exchange, the residents sign a new 12 month lease and sign up for security deposit insurance. I like this strategy because it helps the resident as well as the bottom-line at the property.

Investors will need to start getting creative if the coronavirus does negatively impact multifamily collections.

 

O – Ongoing Communication

Once we have ensured the safety of the people, we sent an initial communication to our passive investors.

The communication we sent to our investors was similar to what we sent to our residents. The major difference is that it also included information on what we are doing to ensure the safety of both the people and the money.

In addition to the relevant CDC information, we mentioned that we are working closely with our property management partners to monitor the operations at the property and that we will have more information for them by the middle of next month. We also mentioned the coronavirus will not impact their distribution for the previous month.

So, we sent one email to let investors know that we are aware of and monitoring the situation and when they can expect another update. It is hard to tell how long the coronavirus pandemic will last, so the plan is to continue to provide monthly updates to our investors about the status of the rent collections at our properties.

Overall, I think it is better to only send emails when there is sustentive information to provide as opposed to hourly or daily updates.

 

S – Summary

Once things return to normal, we will send our investors a final email with a summary of how the coronavirus impacted the operations at our property and distributions, as well as any changes we will have moving forward to make up for lower cash flow and distributions, if applicable.

 

When a crisis occurs, like the coronavirus, the three step procedure is S.O.S. – safety of the people and the money, ongoing communication to provide your investors with status updates, and then providing a summary once things return to normal.

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Multifamily Money Raising Myth Debunked

A common refrain I hear and read about apartment syndications is “you need a strong track record in multifamily to raise money.”

The idea is that no one will entrust you with their capital if you haven’t completed at least one multifamily transaction already.

However, this is a myth. And it is fairly easy to debunk.

If you needed a strong track record in multifamily to raise money, the majority of apartment syndicators wouldn’t exist. Sure, some operators have previous experience with large apartment communities. Maybe they had the capital to do their own large deals and transitioned into raising money to scale. Or maybe they worked for a large institution that acquired apartment communities. However, many more apartment syndicators – myself included – were never involved with large apartment communities before doing raising money their first syndicated deal.

At some point in every syndicators’ career, they are sitting where you are sitting now. They wanted to purchase large apartment communities using other people’s money. The ones who didn’t have previous apartment experience didn’t let the myth of a strong multifamily track record stop them from buying their first, and many more, deals.

If you too want to raise money but don’t not have a track record in multifamily, here are the three things you need to do:

 

1. Change Your Mindset

First, you need to change your mindset. Not only is the need to have a strong track record in multifamily to raise money a myth but also a limiting belief. It is just a story you’ve convinced yourself to be true. It may be a powerful story, but it is fiction nonetheless.

It is like watching a horror film about the boogeyman and then checking under your bed every night before you go to bed to make sure he isn’t there!

The boogeyman isn’t real. And neither is this limited belief.

The main difference between an apartment syndicator with a billion portfolio and an aspiring syndicators who is hesitates is the belief in this boogeyman.

The boogeyman isn’t under your bed. You don’t need a strong track record in multifamily to raise money.

For more practical advice for how to get your mind right, check out some of my success habits blog post by clicking here.

 

2. Business Experience

I guess I should have said that “you need a strong track record in multifamily to raise money” is only partially false. The first part is actually true. You do need a strong track record. But it doesn’t need to be in multifamily.

One of the two areas that every single-first time apartment syndicator had a strong track record in was business.

Investing in real estate is a business. And apartment syndications even more so. When you are an apartment syndicator, you are creating and executing a business plan. Therefore, if you have a strong business background, you have a track record creating and/or executing a business plan.

A strong track record in business doesn’t mean you’ve just graduate college and were hired by a Fortune 500 company. It doesn’t mean that you had a lemonade stand as a kid (but, surprisingly, this could help you raise money! Click here to learn how).

It does mean that you started your own business in the past. It doesn’t matter how small the company was. What does matter is that it was successful (i.e., profitable). It can also mean that you worked for a large corporation and were promoted to the level of director or higher.

If you created a successful business and/or were promoted to a high level within a large corporation, you have the skill sets needed to successfully execute a business plan.

 

3. Real Estate Experience

If you do not have a strong track record in business, then you need to have a strong track record in real estate. Even if you have a strong track record in business, having a strong track record in real estate as well is a huge plus.

You have more flexibility with the real estate experience. It can mean that you were an investor (i.e., wholesaler, fix-and-flipper, single family rentals, small multifamily rentals, etc.). It can mean that you were a property manager. It can mean that you taught other people howto become investors. It can mean that you were a broker or a realtor.

When you have a strong track record in real estate, you understand how the transactional and management process works. All you need to do now is use that same knowledge on larger apartment communities.

 

Believing that you need to have a strong track record in multifamily before raising money is a myth. As long as you have a strong track record in business and/or real estate, your money raising foundation is almost completed.

The last step is to get educated on apartment syndications. A good place to start is by reading my apartment syndication blogs here or by listening to our Syndication School podcast series here.

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Texas and Florida Add The Most New Jobs in 2019

Each month, the US Bureau of Labor Statistics (BLS) releases a monthly Metropolitan Area Employment and Unemployment Report, which includes the current total number of civilian labor force and unemployment by state and metropolitan area (MSA), as well as the same metrics 12 months prior in order to determine the change in the labor force and unemployment over the past year.

The employment situation in a market is an indication of the demand for real estate. People need jobs to pay living expenses, which includes paying for rent. The more people with jobs in the market, the more potential “customers” for us as apartment investors.

BLS releases a lot of relevant economic data on a month basis, which can be found here. You can also view archived new releases for previous years here.

50 states, the District of Columbia, Puerto Rico, and 396 MSAs are included in the data.

Currently, we focus on the Texas and Florida markets for our deals. Here are some interest highlights from their December 2019 report about those two states:

  • 10 states added over 100,000 jobs
  • #1 was Texas (253,056 jobs) and #2 was Florida (178,978 jobs)
  • 31 states had a reduction in unemployment
  • 19 markets added over 25,000 jobs
  • The #2 market (Dallas-Fort Worth-Arlington) added more jobs than the total number of jobs added in 40 out of 50 states
  • The #10 market (Orlando-Kissimmee-Sanford) added more jobs than the total number of jobs added in 34 out of 50 states
  • The #19 market (Tampa-St. Petersburg-Clearwater) added more jobs than the total number of jobs added in 26 out of 50 states
  • 275 out of 396 markets had a reduction in unemployment

Here is the BLS data for our markets from December 2018 to December 2019

State of Texas

Visit Austin

  • New Jobs Added Ranking: #1 out of 50 states
  • Total Jobs 12/2018: 13,975,415
  • Total Jobs 12/2019: 14,228,471
  • Total Jobs Added: 253,056
  • Job Growth: 1.81%
  • Total Unemployment 12/2018: 501,787
  • Total Unemployment 12/2019: 470,429
  • Unemployment Rate 12/2018: 3.6%
  • Unemployment Rate 12/2019: 3.3%
  • Change in Unemployment: -0.3%

State of Florida

Florida Politics

  • New Jobs Added Ranking: #2 out of 50 states
  • Total Jobs 12/2018: 10,284,492
  • Total Jobs 12/2019: 10,463,470
  • Total Jobs Added: 178,978
  • Job Growth: 1.74%
  • Total Unemployment 12/2018: 338,922
  • Total Unemployment 12/2019: 265,350
  • Unemployment Rate 12/2018: 3.3%
  • Unemployment Rate 12/2019: 2.5%
  • Change in Unemployment: -0.8%

Dallas-Fort Worth-Arlington MSA

D Magazine

  • New Jobs Added Ranking: #2 out of 396 MSAs
  • Total Jobs 12/2018: 3,956,122
  • Total Jobs 12/2019: 4,054,399
  • Total Jobs Added: 98,277
  • Job Growth: 2.48%
  • Total Unemployment 12/2018: 128,944
  • Total Unemployment 12/2019: 117,547
  • Unemployment Rate 12/2018: 3.3%
  • Unemployment Rate 12/2019: 2.9%
  • Change in Unemployment: -0.4%

Orlando-Kissimmee-Sanford MSA

10best.com

  • New Jobs Added Ranking: #10 out of 396 MSAs
  • Total Jobs 12/2018: 1,348,435
  • Total Jobs 12/2019: 1,386,798
  • Total Jobs Added: 38,363
  • Job Growth: 2.85%
  • Total Unemployment 12/2018: 40,421
  • Total Unemployment 12/2019: 33,987
  • Unemployment Rate 12/2018: 3.0%
  • Unemployment Rate 12/2019: 2.5%
  • Change in Unemployment: -0.5%

Tampa-St. Petersburg-Clearwater

Parade

  • New Jobs Added Ranking: #19 out of 396 MSAs
  • Total Jobs 12/2018: 1,531,930
  • Total Jobs 12/2019: 1,558,569
  • Total Jobs Added: 26,639
  • Job Growth: 1.74%
  • Total Unemployment 12/2018: 49,086
  • Total Unemployment 12/2019: 41,111
  • Unemployment Rate 12/2018: 3.2%
  •  Unemployment Rate 12/2019: 2.6%
  • Change in Unemployment: -0.6%

You can view the full report for all US states and markets by clicking here.

Are you an accredited investor who is interested in learning more about passively investing in apartment communities? Click here for the only comprehensive resource for passive apartment investors.

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