This post is probably going to raise an eyebrow or two about apartment investments, but oh well…as long as someone benefits from it. This isn’t by any means an offer or solicitation but rather an inquisitive look into a creatively crafted transaction that allows one party to retire from managing their apartment buildings while still keeping their passive income and another party to make a decent amount of profit managing the building with an opportunity to purchase it without a bank loan. Please feel free to point out any flaws or suggest an improvement. I’d love to try this one day.
In markets like ours here in Glendale, CA, long-time apartment owners very rarely decide to sell their buildings and even if they do, they really stick to their price. That’s another indicator of how desirable apartments are in the non-rent control environment of Glendale. From my experience as a broker specializing in this area, a lot of the property owners WOULD list their property but they just don’t think it’s worth the hassle of dealing with a sale, especially because the values aren’t quite as high as they’d like. Apartment investments in Glendale are constantly growing streams of passive income to their investors…who would want to give that up? Especially if it’s paid off!
Well, any commercial real estate broker that’s worked this area long enough will tell you that a lot of these buildings actually are debt-free and owned by elderly investors who have owned the properties for decades. Most of them rely on the income for a living while others simply pass down the benefits to their trust. (Some would call this an impenetrable market because property owners really have very little reason to sell; they’d have to be in some kind of distress or they’d be price motivated, asking unreasonable amounts for their building.)
Either way, there’s one thing a lot of these older owners have in common: they’re all tired of dealing with the things that come along with owning an apartment building. Decades of dealing with “my toilet broke” calls at 2am or having to rent out empty units can get a bit annoying when you’re trying to enjoy retirement. This is why a lot of my sellers end up trading into a NNN investment where they have no management issues whatsoever. In fact, that’s basically what this post is all about; turning an apartment building into a NNN leased investment with a small lease-to-own and seller-carry component.
How does it work?
Let’s assume I’m trying to do this on a 10 unit apartment building in Glendale at 336 Sample Street. The property owner, an 85 year old retired engineer, has had enough of managing the units but relies on the income. He’s too weary of the current market conditions to sell this investment, but he’s already tried getting his desired sales price for it and failed. I step in and underwrite the property, giving him an accurate view of what it’s worth in today’s market and where the opportunities are. While evaluating his building, we learn that he only gets $1,000 per month in rent from each of the 10 units, while the market rate for apartments like his are $1,200 a month. He’s already missing out on $2,000 every month. Also, his expenses are unnecessarily high (30%) because of the lack of upgrades in the units (low-flow toilets, energy-saving technology, etc.) thus bringing his annual Net Operating Income down to only $84,000. In today’s market, his building would be worth somewhere between $1,350,000-$1,500,000 depending on the location and condition.
Now, if the circumstances are right, I’ll suggest our magic transaction to the owner. We sign a Master Lease Agreement where the owner leases the entire property to me for 5 years on a triple-net basis, meaning I now collect the rents and reap the benefits of the property while also paying for the property tax, insurance and maintenance. I agree to pay him $7,000/month in rent for leasing the property to me. Now, this may seem like too little, but if you do the math correctly, it’s actually what he was actually netting after property expenses and property taxes. Also, every time the rents went down in the neighborhood, he probably made less there too. This $7,000 that he’s getting from me is purely passive profit that is unaffected by any market conditions. Whether or not the building is fully occupied, he’s getting his money!
How the hell could this be profitable for me? Well, I step in and take over management of the building now. I make rental adjustments by raising them to market rates, thus creating an extra $2,000-$2,500 of monthly income. Every time a unit turns over to a new tenant, I send my crew in to upgrade it and make it way more energy efficient. I reface/repaint the exterior of the building to bring it up to or above par with the neighborhood. I modify the expenses until it’s running as efficiently as possible. The lil’ old apartment house that the engineer so tirelessly tried to manage for years is now earning him a guaranteed sum of money ($84,000) every year without him even having to think about it. Meanwhile, I’m netting an extra $45,000-$50,000 a year just by managing a 10-unit apartment building and dumping a minimal amount of capital into it.
To make this deal even sweeter, you could try working out a deal with the owner to have your lease amount go towards your down payment, in case he decides to sell it to you later on down the line. Or he can agree to seller financing if you already have enough to pay as a down payment.
Please share your thoughts about this one…I’d love to hear if anyone’s done anything like this.
Before I get into this, I want to encourage you to throw in your two cents. Obviously, if you’ve found this blog, you’re involved in the commercial real estate industry in some way and have the ability to form your own intelligent opinion. Don’t be afraid to speak your mind and/or ask a question. None of this is really news, but rather an obvious concept that most passive investors don’t really look into.
All over the internet, you can find articles and blogs discussing technical data, showing graphs/charts and “forecasting” where the markets are heading. Some of the industry’s leading researchers and advisors – like Hessam Nadji of Marcus & Millichap in his blog “StreetSmart” (found here) – talk about the multifamily sector as a whole and how the general outlook is positive for the time being.
If you’re like most of my clients, you don’t have the time nor the brainpower to sit there analyzing these things yourself. You have a direct question and expect a direct answer.
When a large number of homeowners are in foreclosure and the housing market is going down the drain again, every apartment investor wants to know one thing:
How will my apartment investment be impacted by the decline of the housing market?
–Larger Tenant Pool.
- Older and more affordable buildings experience an increase in occupancy while newer construction buildings have to compete with the demand for more affordable housing by possibly reducing rents. People who are losing their home need a new place to live, even if it’s a major downgrade from the house they couldn’t afford anymore. Also, some are finding it more logical to rent until home prices bottom out so they can purchase a new home. In Glendale, for example, a family who is struggling to make the $5000/month payment on their large house in the hills wouldn’t mind short selling and moving in to a 3 bedroom apartment for $2,800 if it means saving their credit and financial strength.
– What Credit Report?
- Landlords are faced with an influx of rental applications from non-creditworthy tenants with foreclosures and bankruptcies on their credit report. Some clients I’ve spoken to recently even mentioned that they no longer give credit reports too much attention. As long as the tenants are employed and seem trustworthy, they feel comfortable. One owner said he has received 20 applications for the same unit, all of which were from prospects who are coming out of a BK or foreclosure.
– More Demand = More Dollars
- Major rent growth! In some cases, I’ve seen landlords go from having 50% of their building vacant to being 100% occupied and at full income potential within one month. Recently, we sold a building that was completely vacant. Within just a few days, we had the entire project rented out and cash-flowing nicely. This is mainly because of the high demand for affordable housing stemming from people losing their homes and/or downgrading in order to survive financially.
– Ready. Set. Sell.
- Everyone loves a stable performing asset. Apartment owners who have been sitting on the sidelines waiting for their property to appreciate will finally have the chance to entertain reasonable offers on their investments with the help of brokers like myself. Although the “vultures” are out looking for distressed deals, most investors turning to multifamily from the stock market or commodities markets are actively seeking out stabilized assets that are cash-flowing from day one and don’t require much management/maintenance.
– Refi Time!
- Better fundamentals and occupancy generally translate to easier financing conditions. Property owners who have loans maturing or have bad interest rates will have the chance to refinance their mortgage and yield a higher return on their investment.
So, with all this being said, you can kind of see how this all works. Homeowners become prospective tenants for apartment buildings due to foreclosure and/or financial weakness. Apartment investors leverage the increase in demand by collecting higher rents. Because of this, their property values go up substantially and they have a chance to make some very lucrative moves in the market. Those owners who aren’t over-leveraged have the opportunity to sell their building and reinvest the equity into something more profitable.
I’ll even be so bold as to say that if you own an apartment building in the Los Angeles area today and haven’t at least checked with your broker to see what your building is worth, you’re doing yourself a huge disservice. While most investors are still in the “wait-and-see” mode, there is serious money to be made in today’s market.
Fortunately, I provide free property valuations and get a thrill out of helping investors strategize their investments. Feel free to get in touch with me if you want to know what your building is worth in today’s market and how much more money you could be making.
We recently listed an eleven unit apartment building in North Hollywood at 6606 Vineland. The property generates an excellent stream of income and has very low expenses with very little maintenance required.
An experienced apartment investor can quickly add value by applying some cosmetic upgrades and perhaps revamping the structure a bit.
The reason why this deal is relatively a great value-add opportunity is because of the ongoing changes occuring up and down the Vineland Ave corridor. More and more buildings are being renovated, including a new construction on a vacant 60,000 lot just south of the subject property.
For more information about this investment opportunity and others, feel free to give me a call any time. (818) 400-7557
Also, check the LoopNet page!
Just a quick update for those who were following this transaction:
Our Del Taco listing in Norco (2552 Hamner Ave) sold for $1,150,000 after an aggressive 90-day marketing campaign on August 10th, 2011. Dozens of offers were generated by calling surrounding and like-kind property owners, reaching out to investors who were in an exchange and looking for an upleg, reaching out to active brokers also specializing in NNN deals, and simply creating a buzz around the NNN investment and Del Taco franchise communities.
Despite all of the roadblocks and obstacles this deal faced, we were able to successfully close the transaction with an all-cash buyer with minimal contingencies.
To talk about the details of this deal and how we can help you successfully list and sell your commercial property, feel free to give me a call any time. (818) 400-7557
Most of the cold calling I do is to apartment and office building owners. Almost 90% of the owners I get to talk to aren’t really interested in selling. In fact they’re usually pretty rude about it hehe. But if they were, they’d either only sell at a really high price or just to be able to exchange into a property where they’d be able to enjoy the cash flow of their investment without any headaches. These are people who own and manage multiple properties and always have to deal with minor management chores like collecting rent, paying their upside-down mortgage, finding new tenants, fixing broken toilets, dealing with contractors and so on. So, naturally, you can imagine why a management-free investment would sound amazing to someone who absolutely hates the management aspect of owning real estate.
Over the last few months, I’ve confirmed a rising new popularity amongst my clients towards NNN investments. A NNN (triple-net) leased investment is where the tenant of the property not only pays the landlord rent, but also pays for the maintenance of the building, property insurance, and property taxes. This lets the investor or property owner simply sit back and collect the rent without having any management duties whatsoever. Most of the time you’ll see major fast-food chains or franchise stores on these types of leases; Burger King, Starbucks, Taco Bell, Carl’s Jr., Walgreens, etc. .
Since I listed a Del Taco property in Riverside County in May, I’ve had the pleasure of speaking with hundreds of different investors who really only play with these types of properties. I asked them how they got into it in the first place and 9 times out of 10 they’d say they sold property that they inherited or owned before (usually apartments) and traded into NNN deals because it was easy to manage. They’d say that although they could be making a little more money in another product type like apartment buildings, this was the safest bet for their retirement.
Why are NNN deals so “safe”? Well, for starters, if a corporate-backed franchisee of, oh, let’s say McDonald’s couldn’t pay their rent, there would have to be some pretty epic economic catastrophe to explain it, right? We as Americans love our fast food. We love our coffee. We love drive-thru. Doesn’t matter if you’re rich, poor, black, white, fat, skinny…at some point in time (some more than others) everyone goes to these restaurants. It’s probably one of the very few industries that make a huge profit in a good economy and an even bigger profit in a bad economy. So, you can be sure that as a landlord, you’re pretty much guaranteed income for as long as you own it. It’s sort of the “low risk, low reward” alternative to real estate investing. If you put your money in a bank, the most you could get is maybe 2% return on your money? If you bought an office building, depending on the kind of deal you made, you’re maybe getting somewhere from 7.5-10% on your money? With a NNN deal like the Del Taco I’m currently selling, you’re making between 6-7% return without having to worry about a single thing.
I find it kind of funny that major fast food and pharmacy chains not only make the consumers’ lives “easier” and more “convenient”, but their landlords’ lives too. It’s like drive-thru cash flow!
That’s all the rambling I’ve got for now. I’ll have an update as soon as the deal is sold.
With this being the first actual post on this blog, I want to introduce myself briefly and give the readers some insight on a part of the commercial real estate investment world that many typical investors and brokers don’t really pay much attention to. Sorry for the length…I’ll keep them short from now on, I promise.
If you’re a savvy investor or broker and feel like this post might be useless to you, keep reading. If you’re an agent, read on and take notes! This may be interesting to anyone trying to get ahead in real estate.
So, in case you don’t know me or anything about me, I’m a commercial real estate agent in Los Angeles, CA with a strong focus on apartment, office, and distressed properties (yes, I’ll even do a residential short sale deal here and there). My business model is pretty much based around market research, cold calling and word of mouth referrals. That means I spend a ridiculously large portion of my day on the phone and computer…calling, texting, emailing, researching, skyping, facebooking, chatting and eventually meeting with clients or potential clients. The whole point of all of this is to constantly be in touch with owners/investors and share some newsworthy information, learn about new developments, and just generally have my finger on the pulse of the local market. That’s one of the things that help make brokers like me market experts.
In the real estate brokerage game, “information” is just as precious as “location”. You could hire your broker of 30 years to list your property for sale, but chances are it’s the young, energetic guys who keep in constant contact with the active owners in the marketplace that will really sell your deal. It’s simple…because they talk to more people (who are target buyers) and have information on everyone within the market, they can give you more exposure. Because they give you more exposure, they’re able to attract more interested buyers to your deal. More buyers means more demand. Demand means a bidding war. And as we in the eBay generation already know, bidding wars turn out nice for the person that’s selling.
Real estate agents aren’t as completely useless as they might seem. The right agent can really help you make extremely solid investments that will keep you wealthy for a lifetime and then some. However, not every agent can do the job as effectively. What’s the difference between agents who proactively get in front of owners and someone who just got their license in the “good old days” and hung it with their friend who was a broker? EVERYTHING.
First off, product specialization and focus play a huge role in the effectiveness of a real estate professional. You wouldn’t go to a cardiologist if you have a brain tumor for the same reason you wouldn’t list your medical office building with the nice lady who sold you your home. It just doesn’t make sense! I’ve met with sellers whose main objection to listing their property with me was, “Well, my brother has his license so I have to list my office building with him”. That’s great Mr. Seller…what type of real estate does your brother focus on? “Oh he’s not even really active in real estate he’s actually a dentist.” Nice. This particular client ended up never selling the property and in fact lost the property to the bank. His agent/brother had put the property on the market at a random price that he and the owner felt looked pretty on paper and the deal never got any attention because it was grossly overpriced.
Some of the most successful real estate investors I’ve met and worked with are the ones who treat everybody with respect and take the time to understand professionalism and make an impression on each and every single person they come in contact with. Have you ever wondered how some of these real estate guys came by these incredible deals where they made millions and all of a sudden dominate the market? It wasn’t done by hanging up on cold callers. These are individuals with top-notch social skills who welcome every opportunity to meet someone new and figure out how to make money with them. They probe around cleverly and use their smooth charisma to form working relationships with anybody who can possibly benefit them (which is pretty much anyone who is active in the market). The end result? Everybody wants to work with them. Everybody shows them deals. In effect, they get what they want which is the opportunity to make a ton of money.
So with that being said, some of you reading this probably get cold calls from me or my competitors…you know, those obnoxious guys who call you and as soon as they say anything like “property” or “real estate” you say, “NOT INTERESTED BYEEE!” and hang up on them…yea, those are actual real estate professionals that you can benefit from. Just because they’re fishing for listings it doesn’t mean you have to shut yourself out from talking to them completely. Get to know them. They know the tiny little details that will make you money. Plus, the success of your investment might be in their hands one day.
Oh, and if you’re still reading this, please feel free to throw in your two cents.