How to REALLY Find Apartment Deals
By Charles Dobens, Esq

Let’s say you just graduated from a three-day bootcamp on multifamily investing or finished reading a home study course from the latest and greatest real estate guru and are ready to take the world by storm. Maybe you bought all the other courses that they tried to sell you at the end of every full day session or maybe you were convinced that if you just signed up for the coaching program, you will get a seat at the table with the experts and all your warts and shortcomings will be hidden and you will be the next great multifamily millionaire.

When you got home, you took what they taught you and started to look for properties in all the places they described in the class. You live in Virginia but the guru does all his deals in Texas because according to him it is the next great emerging market. So you follow suit. In today’s world you can search for deals anywhere and anytime. So you jump on the internet, pull out your manual and start looking in the usual areas; Loopnet, Costar, CIMLS, Marcus & Millichap, and the list goes on.

What’s the problem with this? Very simply, the other three hundred Bootcamp attendees and the previous twelve graduating classes of four hundred investors apiece are all doing the exact same thing. What’s the difference between you and the previous graduates? They have been looking for years now and have never found a deal that works for them. These are the people that I hear complaining all the time “this business is so hard. I can never find a deal that works”. For crying out loud people, understand the math.

A commercial broker told me his statistics regarding listing property on LoopNet. After he lists, he typically receives, on average, over 1700 requests for additional information from investors all over the country. From that 1700, he will get approximately fifty follow up requests for additional information; questions on the rent roll or income and expense report. This is then whittled down to approximately 10-15 more in depth phone conversations with potential buyers. When all is said and done, he will have received between three and five legitimate offers that he takes to the seller who then chooses the lucky winner and the ultimate offer is accepted.

Can you imagine showing up at a foreclosure auction with 1700 other bidders? What do you honestly think your chances of buying that property are going to be? Now add on top of that, the fact that you don’t have a sponsor and this is the first deal you have ever done. Do you think the broker is going to give your offer a lot of credence and recommend your offer to his client? If you don’t perform, the broker’s credibility with his client is shot. He’s probably not going to take that chance.

If this is where you are looking for deals, along with all the other places that you were taught in the training courses, then you better have another outlet. Remember what Einstein said about the definition of insanity; doing the same thing over and over again and expecting different results. If you are frustrated because you are not achieving the results that you were expecting and you have tried everything that they told you to do, don’t despair. There is an alternative. It is one that very, very few people are using but one that can provide the solutions you are looking for.

CASE STUDY: John the Investor

In 2005, John Investor took a buyout package from his employer, cashed in his stock options and went home, strategizing over what the next half of his life would entail. After much consideration, John decided that investing in apartment buildings was the way to go, so, like everything John has ever done, he immersed himself in the subject; buying every book and home study course and attending every seminar on the subject. After earning what he thought was the equivalent of a masters degree in the subject, John set about acquiring his first property.

Looking in the emerging market of the Dallas-Fort Worth Metroplex, John settled on a 120-unit property with a purchase price of $5.25MM. He searched the debt marketplace and found a lender willing to provide funding with the following competitive terms: 15% down, interest only, and a 7-year term.

In order to make the deal happen, John needed to raise $787,500 for the down payment and an additional $262,500 for liquidity and closing costs. Not having these funds available personally, John began contacting his friends and family and in short order, had put together an investment group made up of his three brothers and his college roommate. In addition, John successfully negotiated a no-interest second mortgage with the seller totaling 5% of the purchases price that runs concurrently with the first mortgage. The second mortgage is to be paid off upon maturity of the first mortgage.

Fast forward seven years. The notes are coming due. The property has had its ups and downs but all in all has proven to be a solid asset in a solid submarket. It makes money every month, pays its bills, but the property has not met all investor expectations. The exit strategy was to either refinance or sell the property outright. Regardless, the investors are expecting a payday soon. Remember, his investors are friends and family – relationships are starting to be affected.

John contacted the mortgage broker who put together the financing seven years ago to start the discussion about refinancing his property. Since 2005, when John was last in this game, the terms and underwriting guidelines have changed considerably. Fifteen percent down loans no longer exist — now maximum LTV is 75%. In order to successfully refinance this deal, John needs to conform to these new underwriting guidelines in order to keep his property.

Over the last seven years, the NOI of the property has ebbed and flowed. Some months the property lost money and some months the property was able to get caught up on all its bills. As a result of the weakening economy and increased fuel costs, NOI has increased only slightly from its 2005 numbers. When John purchased this property, the cap rate was at a solid 7%. During the last several years, cap rates have increased and then started to decline again but not yet to historic lows. For John’s asset, the current cap rate is approximately 8.25%. This rate will likely change over the next year or so until John needs to refinance, but for sake of this example, we will assume that he needs to pull the trigger on the transaction today.

Knowing the seller second is coming due John reaches out to try to renegotiate the terms with no luck. The two parties did not leave the closing table as friends, and now the prior owner just wants his 5% and is threatening to foreclose on the property to get it. Based upon the above factors, the change in the numbers on John’s deal are as follows:

2005 2011
NOI $367,500 $380,000
Cap Rate 7.0 % 8.25%
Valuation $5,250,000 $4,600,000
Loan Balance $4,462,500 $4,462,500
LTV 85% 97%
Cash needed to reach 75% LTV $0 $1,012,500
Cash needed to pay 2nd Mortgage $0 $262,500
TOTAL CAPITAL SHORTFALL $0 $1,275,000

In order to secure new financing, John needs an additional $1.275MM. This problem has occurred entirely because the economy went down, cap rates increased and underwriting guidelines tightened. This problem was not of John’s making. Because the apartment business is so highly leveraged, it is constantly shaped and reshaped by the external forces of the capital markets; John’s deal is no exception.

Where does John get the money he needs? How does he solve his problem? Are his existing investors going to step up and put in that additional funding to keep their investment? This is where an opportunity presents itself for you.

After reviewing information provided either be Pierce-Eislin or Trepp, you find John’s property is a quality prospect. His property profile is exactly what you are looking for; size, location, steady performance, over leveraged and currently in the pre-distress stage. You gather your Level I data and then up pick up the phone and call John to introduce yourself and begin the dialogue about his property.

It may take several calls for the relationship building process with John to bear fruit. Your goal is to get to the point where conversation is collaborative and transparent, where John willingly provides enough Level II information about his property and the ownership structure for you to determine (1) deal potential or (2) if you want or need John to remain in the deal. Keep in mind that John needs you more than you need him. With multiple billions of dollars of loans to be resized, there are many “Johns” who can use a problem solver like you. This is the position you want to be in when negotiating any deal.

Your job is to present a solution to John and his partners that makes sense for you, them and the existing lender. While you continue to strategize with John, you are gathering Level I and Level II data points on as many potential deals that you find meet your investment criteria. The great thing about this strategy is that you don’t wait for a broker to bring you a deal; you go out there and find them on your own.