Thursday, January 24, 2008

My First Investment In Multi-unit Properties

It's looking like I will be making my first foray into the world of multi-unit properties (aka apartments) this month. There is still a possibility other investors might fill up the available slots before I can get in, but I think I've got a decent chance right now.

Kenric alerted me to a deal that a local apartment investor was putting together for an apartment complex in Houston. I've met this investor a couple times, the first being at a get-together of people from the message boards in 2006, where he gave a presentation on the benefits of apartment investing. As I wrote back then, I saw the potential of apartment investing and have been looking to get into the field ever since. Of course, there are any number of differences between investing in single family homes and apartments, not the least of which is the amount of money needed to get into the game. So it was obvious I would need to partner with someone in order to get my feet wet and learn the ropes. And now it appears that opportunity has presented itself to me.

The Private Offering Memorandum for this deal is almost 100 pages long, so it will be tough to condense everything to a short entry here, but I'll try to hit the highlights.

The deal is for a 342 unit apartment complex in Houston, Texas. Investors get a 9% preferred return and anything over that is split 50/50 between the investors and the people offering the deal. The management team includes Steve, the guy I've meet. He's got over 9 years experience investing in apartments, has a current portfolio of properties worth over $29 million, and has bought and sold over $20 million worth of apartment communities. The rest of the team consists of a lawyer with extensive experience in real estate transactions, and a property management team that has been managing properties for more than 27 years. They specialize in improving the financial returns of apartment complexes and every property they have managed has increased in value.

The apartment complex itself is a B+ institutional grade property. It's about a full city block long, which means there is lots of drive-by traffic (which translates to free advertising for potential tenants). The complex has 2 pools, a fitness center, and gated access. The property, which was built in 1977, underwent a $2.9 million renovation about 4 years ago, so there is little deferred maintenance. The individual units have new appliances, two tone paint, crown molding, and some have wood floors. The complex is about 2/3 single bedroom units and 1/3 two bedroom units and has a 95% occupancy rate.

It is located in a nice district of Houston. In 2006, Forbes magazine rated Houston #1 in Texas and #3 in the entire U.S. as the "Best Place For Business And Careers." The area is seeing job growth across all sectors of the economy and there is a highly skilled, well educated labor pool there. The forecast is for continued job growth for many years.

The plan is to buy the property for $12.4 million (the property is already under contract) and invest about $100,000 in improvements. There is some maintenance to be done, such as repainting the carports, resurfacing the entry drive, and putting new carpet in some units. However, much of the improvement money will go to providing additional amenities, such as a nice water feature in the front (which helps attract potential tenants, as well as improves the overall look of the property) and a playground, to help attract tenants with children (who tend to be more stable renters).

Rents are currently at the low end of the market range and, as the improvements are made, they will be raised to the higher end of the market range, although not to the absolute top. Rent increases will be capped at $50 per month per year so as not to lose existing tenants.

As an added bonus, the recent Fed rate cut has helped. The financial analysis was done assuming a 6% loan and the managers are currently being quoted rates around 5.4%.

The investors receive a 9% preferred return, paid quarterly. What this means is profits are first distributed to investors until they receive their 9% ROI. After that, profits are split 50/50 with investors and the management team. After the second year, and each year thereafter, an analysis will be done to determine if it makes financial sense to sell the property. In the event of a sale or refinance, proceeds will be distributed as follows: all investors will be paid their 9% return, then the investors' original investment will be repaid, and then any remaining monies will be split 50/50 between investors and management. Investors purchase "units" of the investment. One unit costs $50,000 and there is a minimum of 55 units and a maximum of 60 units to be sold.

If you recall, I have said before I wasn't too interested in a 9% return because I felt could do better. I still believe that. I like this deal because it is really more about capital gains. Yes, I will get a 9% cashflow, but the real money will come from the improvements to the property and when the place is sold. At that point, the ROI should be in the 13% to 13.5% range. Additionally, I'll get some experience in seeing how investing in multi-unit properties works.

Correction: I was looking at the wrong set of numbers when I wrote the above. The annualized ROI after the sale of the property should be in the 30% - 35% range.

For future reference, I am labeling this project Multi #1.

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