JF2291: How a Passive Investor Vets an Apartment Deal Part 2 | Vetting The Market | Actively Passive Investing Show with Theo Hicks & Travis Watts

December 10, 2020 | Joe Fairless | 00:25:24

JF2291: How a Passive Investor Vets an Apartment Deal Part 2 | Vetting The Market | Actively Passive Investing Show with Theo Hicks & Travis Watts

Today Theo and Travis will be answering a common question about vetting the real estate market before entering a deal. Since this knowledge is shared from a limited partner perspective, the goal is to find a way to keep the market information up to date while spending less time researching it.

This episode is part 2 of the series “How a Passive Investor Vets an Apartment Deal”, focusing on the most commonly asked questions about real estate deals. The other parts will focus on vetting the team and the deal itself.

We also have a Syndication School series about the “How To’s” of apartment syndications, and be sure to download your FREE document by visiting SyndicationSchool.com. Thank you for listening, and I will talk to you tomorrow. 

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TRANSCRIPTION

Theo Hicks: Hello Best Ever listeners, and welcome back to another episode of the Actively Passive Investing Show. I’m Theo Hicks. As always, we are back with Travis Watts. Travis, how are you doing today?

Travis Watts: Theo, doing great. Happy to be here for episode two.

Theo Hicks: So, yes. As Travis said, this is part two of our first-ever actively passive investing show series on how to vet a syndication deal. And so these are the three categories of things that you want to look at before investing in a particular deal. Make sure you check out part one which was last week, or if you are listening to this in the future, seven episodes ago, and that was how to vet the team. And today we’re going to talk about how to vet the market that they are investing in.

One thing that I forgot to mention in the last episode is why these three things. And when we talk about specifically apartment syndications, the three major risk points from the perspective of all parties involved is going to be the team, the markets, and then the deal. So the syndicator should be doing things to minimize the risk of the deal failing, of the market failing, or of the team failing.

Last week we talked about questions to ask to not only evaluate and qualify the team, but also see what things are being put in place to reduce that risk point. So this next thing we’re going to want to qualify is going to be the market. So Travis, do you have anything else to say? Or do jump right into these points?

Travis Watts: I think we could jump right in. Well, one thing real quick is – I had said this on the last podcast, but I get asked these questions on nearly every podcast I’m a guest on, every investor so to speak that I speak with. It’s always something to the extent of how do you vet a team, a market, or a deal, or what pieces of criteria are you looking at, what’s most important to focus on… So that’s why we’re doing this series, just from a high level. I thought, “Hey, why haven’t we done this on our own show? We need to share this with people. It’s critically important.” So that’s all I have to say. Go ahead and kick it off.

Theo Hicks: Perfect. So the first point we’ll talk about is the role of the team for identifying the target market. So just kind of like an overall before getting into specific actual metrics, but you want to have a basic understanding of their market evaluation process. So what does this entail? Are they just googling “top markets” and then going to some blog post that some random person wrote, and then picking that top market, and like “I’m investing here”? Obviously, there’s going to be more that goes into it than that. So, what specifically are they doing? What type of research are they doing online? What metrics are they looking at? Are they actually visiting these markets in person before investing? Or at least the submarket or the neighborhood. And then during this trip, what types of things are they doing? What type of things are they looking at?

And then also, is it just the GP that’s involved in this, or are other members of the team involved as well? The property management company for example. Are they signing off on the strengths of this market? And then lastly, is it a one-time thing where they said “Oh, this market is great, and it’s always going to be great for all time. I’m never going to analyze this market ever again”? Or are they doing things to consistently reevaluate and reconfirm that it’s a good market? Basically, what’s their process for this, right? Are they every quarter looking at the metrics again and tracking those? Are they visiting the markets? Are they consistently reading the news in that market? Best practices, setting up Google alerts for that market… This is something that passive investors can do as well actually – set up a google alert for the target market, and businesses, and unemployment, and jobs, multi-family apartments. So just high level, first of all, are they analyzing the market on a consistent basis, and what does that actually look like?

Travis Watts: That’s a great plan. I want to pick up on one thing that you pointed out, I think it’s really important, and that’s the bias that a lot of folks have. Just because maybe they were born and raised in a particular market, and they’ve never moved, they’re just always going to invest in that market. And on the pro side of that, yeah, they probably know that market really well; on the con side of that it may not be the best market to be investing in at this particular time. And I see that all the time with different operators. So be aware of that and ask those questions. Great point.

And here’s the other thing – I tell every other limited partner, you do not have to be an expert in everything. That is the beauty of being a limited partner. So the way I approach this is I do the macro-level research. I look at just the big picture – how is the economy doing, the unemployment rate, the interest rates from the fed, whatever is going on from a high-level migration trends, where people are moving… That’s kind of my research. Quite honestly, you can do the macro-level research on any particular market in a matter of hours if you’re efficient, or let’s call it a matter of days if you want to take your time through it. And then you could be done potentially for six months on that particular market; you could really understand the fundamentals and what’s happening. Market’s don’t change that rapidly.

Now to that point, obviously, you need to focus on the micro-level. Now, this is what I personally defer to the sponsors; they should be the experts on the ground, so to speak, they need to know everything about this particular property, this three-mile radius, the incomes in this area, the school system ratings, the employment hubs, they need to know it all. Well, I can’t be an expert in all of that, on top of the macro. You could, but it would take all your time. And then what’s the point of being a passive investor if all you do is research non-stop? You might as well be active in the space. So that’s kind of how I approach it – focus on the macro, let the GP’s do the micro. That’s really all I have to add to that category.

Theo Hicks: That’s a great point. So on that point, we’re going to go over some of the metrics that the GP, as Travis mentioned, will know in extreme detail. And from the passive investor’s perspective, you don’t necessarily need to go every single day to the census website to look up these numbers; the point here is you have an understanding of the types of things that will impact the investment. And a lot of what you’ll see is kind of like common sense, it’s kind of obvious. And then when you’re reading through these investment summaries, you can see what is the main highlight of this market. And then you can see if there’s anything that’s left out that you might want to look up, to see if it’s left out for a specific reason because it makes the market not look as good. And so the first thing we’re going to talk about is going to be the demographics of the market.

So the first thing that we mean here is what percentage of the market are renters? As opposed to owner-occupied. Because at the end of the day – again, it’s common sense, but it’s just a supply and demand formula. So all these metrics are going to indicate whether there is a high demand for multi-family rentals in that market. And specifically, the type of multi-family rental that’s being offered, whether it be luxurious A-class, or C-class for working-class folks.

First is how many people are actually renting there? If everyone there owns homes, well there’s not going to be a large supply of renters for them to choose from, whereas opposed you want to see a renter population in that is fairly high compared to the average. I also mentioned, you want to know the actual demographics from a perspective of age. So the different generations demand different things. Millennials and Gen Z want an entirely different type of units and experience than that baby boomers want. So if it’s a heavy baby boomer area, you’re going to have a different type of product to offer.

And then I mentioned, you also want to understand the employment type. I think we might talk about this a little bit later actually, but what types of jobs are people working there, and then how much money are they making; that will indicate the type of property to offer, and the rent. So I think Travis, you might have talked about this before, or maybe it was someone else, but you don’t want to see an apartment that’s got rents that are two times the median income. This means that half their income is going to that rental. You want to see something around 35% max, ideally, 25% to 30% is a little bit better. And there’s obviously a lot of other demographic metrics you want to look at. And Travis if you could talk about the other one, which I know is important, which is going to be the population growing or not.

Travis Watts: Exactly. And one thing I’ll pick up on what you said which just flashed back in my memory – I wrote a blog, I forget how long ago it was, on BiggerPockets about rent versus own. And I got in a little debate with someone, a happy, friendly debate of course… And it was funny because they were advocating that you always, always, always should be a homeowner and never rent. It was a very black and white perspective. And by the way, they were from Indiana. The average home price is like 150k and the average rent is like $1,500. Yeah, okay. I’m pretty much with you on that. But I said “Hey, what about in San Francisco, where you’ve got a million-dollar average home price and maybe an average rent of two thousand a month or something?” I forget what the stats were. But in other words, could it perhaps make more sense to rent in that particular market? Maybe. That’s a lot bigger gap, like you said, with the average home price; so something to think about.

Back to this topic here, here’s the bottom line – is the population on that particular market growing, declining, or stagnant? Census.gov, lots of public info, look at up. Again, macro level is what I advocate, and just understand what the trend is, look back for the last five, ten years, look at historics, look at the recession. That’s one thing that’s helped me a lot, is each recession and depression and whatnot, they’re not the same, but they’re similar. So I like to look at what this particular market did in 2008, 2009, and 2010, how much it declined… And things changed. For example, Houston has come a very long way at being job diversified and industry diversified and industry diversified. It used to be, it was just pretty much oil and gas. So if oil and gas goes in the tank, that whole market is in the tank. It’s not so much the case anymore. Again markets move slowly; that’s taken decades and decades and decades to change. So again, once you do some macro-level fundamentals, you’re probably good for at least six months, maybe even twelve months. So that’s all I have to say on that.

Theo Hicks: And I think it’s a perfect transition to this next part, which is looking at the employers and then the industries in the market. So as Travis mentioned, Houston for example used to be predominantly oil and gas. So I’m not sure what the exact number was, but if half the employee population is working for oil and gas, then that’s great for real estate when oil and gas is doing really well. But then when oil and gas is not doing very well, then that’s not good for real estate, because the people don’t have jobs, if they don’t have jobs they can’t pay for real estate.

Similarly, you can look back at the most recent recession, not including the one that we’re technically in right now, Michigan would be an example, right? A lot of the population was employed in the auto industry, the auto industry tanked, therefore real estate tanked. Right now with the pandemic, the areas that are the hardest hit are the ones that have a large percent of the population in the service industries, because those are what closed down. So you want to take a look at what the population breakdown is for each industry, and ideally no industry is employing more than 25% of the population. That way, if that industry was completely wiped out 100% then you still have a large portion of the population still working, still making money, and still paying rent.

And then similarly, you often to look at the actual companies themselves, the top employers, because you also want to see the situation where a large amount of the population is working for one specific company… Because if that company were to take a hit — again, maybe it seems like Walmart is never going to go away ever, but people don’t think GM or Chrysler was ever going away either, I’m sure. So again the whole point here is to minimize risk. So to minimize the risk you don’t want to see one single company or one single industry dominating the employment population percentage.

Travis Watts: Exactly. And just took quickly recap all of that, two things; it comes down to companies relocating to a market or currently in a market, and it comes down to people currently in a market or moving into a market. That’s really all it is, it’s jobs and people. That is multi-family housing. You’ve got to have people to rent and they got to have jobs that can afford your rent, it’s really that simple. As we said before, it’s not rocket science, it’s common sense, at least to me, mostly common sense.

So what you look for are, again macro-level, look for “Oh, hey did you know that Amazon is building a brand new headquarters distribution center in Dallas Forth Worth? They’re going to bring on 2000 new jobs in this particular 10-mile radius.” It’s important to recognize that stuff.

And to your point to have diversity. It’s not just Amazon and then there is no other employment for 50 miles in either direction; you want a little health care, maybe oil and gas, and tech, and financial, all that good stuff. So check out — U-Haul stats are great. You can just get them right off their website uhaul.com, I guess that’s what it is. But they’ll show you where people are renting a truck and where they’re dropping it off, a.k.a. that’s people moving. So just check out what’s going on, macro level. And then let the GP’s fill you in on specifically what’s happening right now and that little sub-market.

Theo Hicks: Actually, go to joefairless.com and then search “U-Haul migration trends,” because we have a blog post on the most recent data.

Travis Watts: Perfect, I didn’t know that. Thanks.

Theo Hicks: Alright, so the next metric you would want to look at would be more of the supply side, but also an indicator of demand, which should be new construction and absorption rates. So new construction can indicate demand for multi-family. But not always, right? Because there could be hyper supply; but if these large massive commercial real estate companies are building a lot of property, similar to if a massive fortune 500 company is moving to the area, they likely know what they are doing. Again, not a guarantee, but it’s an indicator that there’s a demand.

A better metric that’s an actual number would be an absorption rate, so you can look up the number of new constructions on the Census website, they kind of track that every single year. And then if you could just type in “new construction”, I think there’s something that’s actually tabulated quarterly or monthly too somewhere else. But the absorption rate is also a really good indicator of demand. The absorption rate is a ratio of the number of units that have been rented to the number of available units over a certain period of time. So the higher the absorption, that means that there is less supply to keep up with demand. And a really low absorption means there’s a lot of supply. So this kind of lets you know that obviously if there’s more demand, that pushes rents up and then that’s good for investors. And so take a look at that absorption rate as well.

And as I mentioned before about hyper supply – IRR releases a yearly report that talks about the phase that all the major markets are in; they break them down to is there an expansion, and hyper supply recession or recovery. So obviously recession, hyper supply, maybe avoid those markets; expansion is good, but it might be ending soon, and the recovery phase is a good place to get in to maximize growth. Something else too,  on the flip side – if they’re not building a lot, that could also be a good thing, because that means that there’s a constraint on supply. So just because they aren’t building anything might mean that it’s hard to build in the area, which also a good thing for investors. So a lot of new construction could be good, but it also can be bad, and then no construction can also be good, but can also be bad. So I guess it kind of depends.

Travis Watts: Exactly. And there’s so much data, you guys listening, that we’re going through… Please get a book; again, I already talked about obviously your book, Theo, and Joe’s book, The Best Ever Apartment Syndication Book, a great resource. But there’s a lot of books that can go through all of this in much more detail… Because I know me back when, when I was trying to figure all those stuff out – it was overwhelming, really was overwhelming. So the best thing to do… We’re only giving you the high-level stuff to think about, so make a little bullet point to study up, and then go find a resource, or a mentor, or a program, something to help fill in the blanks for you.

The last thing I would say to that category is the unemployment rate. The national average right now give or take 7%-8% national unemployment. So when I’m looking at markets, again, macro-level as a limited partner, I’m just looking for a market that is outperforming the national average, quite frankly. So I’d love to be in a market where unemployment is 3%, 4%, or 5%, or something, not 7% or 8% as the national average.

To your point earlier, I know you mentioned Michigan being reliant on the auto industry back in the last recession, and still kind of is… Their unemployment went up, if I remember right, over or about 17% in that market during the great recession. Well, that’s a huge number. So again, that’s why job diversity is so important; industry diversity… 17% unemployment… Usually, by the way, I’m not a conspiracy theory guy, but usually it’s a little higher than what’s actually reported, so just a note, that’s a really bad thing for multi-family. So I’d like to do more study actually on what multi-family did in Detroit during those years, but… Tat’s all I’ve got to say on that topic.

Theo Hicks: Yeah, and one quick follow-up to kind of what you’re saying at the end there… Something else you might want to consider looking at – you don’t have to, but it’s just something that’s interesting is actually to look at the labor participation rate as well, because that’s what they’re basing the unemployment rate on. It’s who is actually looking for a job.

So if you look at markets… The last time I looked I’m pretty sure the labor participation rate was in the 60% range; so it’s 60% of the population that’s looking for a job or is employed, and what percentage of them are unemployed. So if you go to a market and it might have like a 1% unemployment, like “Oh, it’s the best market ever.” When you look at it and only half the population that’s there is considered part of the labor force, that’s what Travis means that the unemployment rate might not be exactly what the unemployment rate says on the census. It might be higher, because… It means there are more people  unemployed in that market than just 8%, or whatever.

Another metric, just a really quick one, is occupancy and rental rate trends. So again, pretty straight forward, but you’re going to want to see a market that has a stabilized average occupancy rate, so at least 95%, but then you’re also going to want to see it trending in the positive direction, right? You don’t want to see a market that has a year to year decline in the occupancy rate. And then similarly for the rents, you’ll want a see a rental rate that’s increasing.

On the same note, you can also find different multi-family institutions that will project out what they expect the rents to be in the future, and usually, the syndicators will include any rent forecasts in their presentation to you. But overall, you want to know the historic trends over say the past five years or past ten years for occupancy and rental rates. And then you want to see what some of these people are saying for the forecast. And they also forecast population as well, something else that you can find forecasts on. So you want to see what’s going on in the past, and then what do they think is going to happen in the future.

Travis Watts: Yup, a hundred percent. The last thing I’m going to add here, and then we’ll wrap it up, is check out the landlord-tenant laws in a particular state you’re looking to invest in; they’re not created equal. What you’re looking for, again macro-level, as a limited partner, is that the tax laws generally speaking are in favor of the landlord, which is you, it’s the owners of the real estate. Obviously, we need laws to protect both sides a hundred percent for that, right? However, there are some states… I always like to pick on California – it’s like, you can’t evict a tenant if it’s raining outside or if there’s a cloud that covers the sun. Obviously, I’m making that up. It gets so ridiculous that you’re like “Really?” You can’t even do business in the state. So pay attention to that stuff.

And additionally, I prefer investing in tax-free states, or at least tax-friendly states in general. Again, here’s a practical way to think about it from a limited partner perspective. Let’s say I invest in a syndication deal, five years later it sells, I’m looking at paying tax, long-term capital gain and state tax on a hundred thousand dollar gain, just to use simple numbers. Well, if that deal happens to be in California, I’m looking at paying them at least $13,000 in state tax upon the sale, whereas if that same deal were in Texas, and sold, I would owe nothing to the state. So there’s a direct $13,000 savings, just because I chose a state upfront that was tax-friendly. So something to think about. I mean obviously, if your preference or your bias is California, New York, New Jersey, fine. But just know that that’s going to be a factor one day down the road.

So with that, I think we covered some awesome stuff on markets. It goes much deeper, but again, everyone listening, these are just bullet points; take some notes, hopefully, open your mind a little bit and go dig a little bit deeper into it and get the facts for yourself. And that’s all, yeah.

Theo Hicks: And the last thing I would say is that we have a blog post on the website, so just go to joefairless.com, you can just type in “target market,” or if you just google “ultimate guide to evaluating a target market,” we have a very detailed blog post that goes into all the metrics we talked about today. I don’t think we talked about the landlord-tenant laws in the tax-friendly state in that blog post, but I do think we have a separate blog post about landlord-tenant laws. But everything else we’ve talked about, we go into a lot of detail on where to find this data and then what good metrics are and what bad metrics are in that blog post. So if you want to go learn more details check that out, or I’m sure there’s lots of books out there as well.

So yeah, that concludes part two on how to vet a syndication deal. We talked about the team last time in part one, the market today, and then in part three we’re going to go into detail on how to evaluate an actual live deal that is presented to you. So until then, make sure you listen to part one on the team. And Travis, again, thank you for joining us today, we really appreciate it. Best Ever listeners, thank you for joining us as well. Have a Best Ever day and we’ll talk to you tomorrow.

Travis Watts: Thanks, Theo. Thanks, everybody.

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