The Capital Stack
Multifamily Investments Must Have…
#1- Good Location
#2- In Place Upside
#3- The Right Price
Location
Evaluating an area’s median household income and average home price helps us determine if we should purchase real estate in that location. We look for the median income to be $60k+ and the average home value to be $250k+.
The higher income locations where we own properties like Plymouth ($90k) and Royal Oak ($90k) have achieved top rents while maintaining the highest collections. Regarding collections, we require tenants to make 3x the monthly rent to be approved for an apartment. In markets like Royal Oak and Plymouth where our rent are $1200-$2000, we usually find residents living well below their means, making median income of $7,500 per month and our most expensive unit being $1800 is less than 25% of their monthly income.
When it comes to areas with less affluent population, we end up declining many applicants because they don’t have the income to support the rent. Let’s say we move someone in who is making $3,000/month. Now let’s say that same person has car trouble this month. They need their car to get to work. According to AAA, the average car trouble incident costs the owner~$500. Now they are only making $2,500 this month. Rent is $950. Utilities, car insurance, car payments, and groceries quickly eat up the remaining $1,550 of that months’ income. Historically, rent is one of the last payments made as people know they can simply incur the late fee and attempt to make a payment thereafter. The vicious cycle begins, trying to collect rent from a resident who can’t afford to pay us yet. We run into this scenario a lot in lower income areas as residents are on average one car issue away from not being able to make their rent payment. Properties in higher income areas are more predictable and maintain higher collections.
Upside
purchasing a property with upside in place is simply buying a property with rents that are below market rate, where we can add physical value/operational value. Finding properties with below market rent allows us to underwrite to market rate and see great returns.
Example A, Suburban 36 (South Lyon, MI)
The average rent on this 36-unit portfolio when we closed in July was $1,015. We believed with very strong conviction we could achieve $1,300-$1,500. We recently had a resident move out and in just over a week have a new approved tenant willing to pay $1,500 + pet fees. The new resident found the property through Facebook marketplace as the full marketing package is not yet completed. This unit only needed new flooring on the main level and a new paint job to increase income by 53%. This unit turn validated our pricing projection, and we will continue to push rents across all 36-units as current leases expire.
Example B, Hollyvillage (Holly, MI)
When we purchased this property in November of 2021 the rents were just $645 a month. The last lease that the seller solicited before we purchased the property was $750. He had 111 applications and 12 approved applicants. This scenario shows us that demand is high and his rent prices were too low. The seller didn’t understand the market and was just happy to keep the building occupied. We had our first unit come open just a month or two after closing and we leased it without spending any money, didn’t even paint, and it rented for $925 plus $50 utilities charge. We achieved a 51% increase on the income for this unit, simply by knowing the market and responding to demand better than the previous owner.
Example C, Royal Oakland (Royal Oak, MI)
We can further drive upside through renovations. The units at Royal Oakland were previously renting for an average of $950. We spent $25k renovating each unit and our new rent is $1,800. We had an in-place upside to market rate as the unit should have been renting for ~$1,200 without renovations, we choose to renovate the units and push rents even higher which significantly increases the property’s value. We are all into Royal Oakland for just under $2m and completed a cash out refinance in February of this year at a value of $4,150,000. During this 18-month period we more than tripled the price we paid for the property ($1.3m), and more than double our cost with renovations and purchase price (~$2m) just on the new refinance.
Price
We must be able to purchase a property at a price that the property can justify. Let’s say we want to buy a 20-unit property where the average rent is $1,000, we are willing to pay $100k per door knowing that it will cost another $25k/unit in renovations and closing costs to fully optimize the income of the property. Hypothetically we are expecting to achieve $1,500/unit in monthly rent. We would be all in for $2m purchase plus $500k renovation for a total of $2.5m. We think the value of the property will be $3,420,000 when it’s completed. This scenario allows us to increase value by 37% which is a worthwhile investment. However, the seller says they want $150k/door. Making us all in at $175k/unit which puts our total cost at $3.5m and the end rent number is still $1500/unit so the end value is still $3,420,000. In this scenario our total cost is higher than the end value. Obviously, this is not a worthwhile investment, and we would have to pass.
Major Market News
The Suburbs
According to an article by Crain’s home buyers are flocking to the suburbs of Detroit. The article mentions several developments in Lyon Township as well as a planned development for Erwin’s Orchard. The article quotes a real estate broker with RE/MAX and says “People’s general feeling is they’d rather be out a little ways and have a little room to breathe”. This is great news for several of our properties located in the suburbs of Detroit.
Article: https://www.crainsdetroit.com/real-estate/detroits-exurbs-still-see-new-home-construction
Tips and Tricks
Tip
Always be willing to let a deal die. Be a disciplined buyer. This means sticking to what you know works. We have found success through the three tips we shared in this newsletter. Sometimes it can get easy to really want a property and find some way to justify what you know in your heart isn’t true about location, price, or rent growth.
