Month: November 2018

Where Do You Turn for Capital When Rates Rise?

When rates rise, apartment building lenders are really concerned with two things: (1) Will rising rates depress the future value of the subject collateral? (2) How do I take advantage of higher future rates to increase my return on the loans I make?

As interest rates rise, property cap rates should rise with them. All things being equal, this will cause the value of an apartment building to go down. In an effort to mitigate the risk of a property’s value declining and ending up over-leveraged if NOI does not increase, many lenders are dialing back how much loan dollars they will give on any investment. If they were willing to give out 75 percent loan-to-value on acquisitions when rates were stable, now maybe they have moved down to 70 percent loan to value. Ultimately what this means for an investor is coming to the table with more upfront dollars and a lower return on the dollars invested. Coming in with an extra 5–10 percent may not be the end of the world, but for many properties that were being sold for top dollars and tight margins, that could make a big difference in whether or not the investment makes sense.

Shorter Terms Prevail

Many apartment building lenders are also looking at rising rates as an opportunity for them to capture more yield on their loans. This can be a difficult task, however, since most investors are going to demand a fixed rate. If a lender can offer a swap, it can be an attractive way for them to see upside as rates rise. But many borrowers do not qualify for them and some that do push back on doing swaps. What many lenders do instead is simply hold off on offering long-term fixed rates and instead offer short-term fixed rates in an effort to see short- to medium-term rate adjustments on their loans. What this means for investors is that they are going to find many more short-term fixed-rate options in the market as opposed to long-term, 10-year fixed products.

The lenders most likely to get conservative in a rising-rate environment are going to be banks and other depositories. They are heavily regulated and often need to be ahead of the curve in risk management or they can end up explaining themselves to the FDIC later down the road. Investors should be aware of this when looking for loans today and be certain to explore non-bank lending options, especially through government agencies. Investors with small property loans under $1 million may not have many loan options with these types of non-bank lenders, but investors with loan amounts over $1 million per property will be able to take advantage of much more competitive options.

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Savvy Strategies for Security Deposits

Within the residential leasing business, the security deposit has long been a vital tool that has allowed landlords to ensure their properties and rent rolls are protected. Figuring out what to charge and whether to return deposits after alterations have been made to the apartment, however, can be quite tricky. As a longtime specialist in landlord representation, these topics are ones to which I have given much thought.

Typically, tenants are required to pay a deposit that is equal to one month’s rent. For recent college graduates or those who have been at their job for less than six months, I will typically request a deposit equal to two month’s rent. I will make an exception if someone can prove that they’ve been previously employed in a similar industry for a significant period of time. If I’m dealing with someone who has no credit, often because they’re from a foreign country, I will likely require that a deposit somewhere from three to six month’s rent be paid upfront. Guarantors, whether individuals or companies, may certainly help to reduce the amount of security deposit that’s required, on a case-by-case basis.

Credit Counts

Many younger people in particular don’t have the credit score required to put down only one month’s rent for a security deposit. Due to faulty advice they’ve received, many recent college graduates have only one or two credit cards, which doesn’t bode well for their credit when it comes time to rent. I always advise young people to open as many lines of credit as possible and either pay them off in full every month or to not use them at all. The more cards one has open and paid off and the more available lines of credit that one has but doesn’t use, the better their credit looks to a landlord who is considering what amount of security deposit to retain. Other ways by which a potential tenant may establish credit include securing a mortgage or car loan.

When it comes to the traditional rule that a potential tenant’s salary must be 40 times the rent, I am definitely not religious about this requirement, and I would advise other landlords to not focus as much on salary. After all, the creditworthiness of a potential tenant is a much better indicator of how they pay their bills. In general, I find myself requiring a larger deposit for those with poor credit as opposed to those with lower incomes.

Damages Subtracted

In terms of returning security deposits to renters, the laws often favor tenants in this regard. In the state of New York, landlords have 30 days to return deposits. If they’re keeping part of the deposit, they must send a letter by certified mail within 30 days that includes an itemized list of damage done and the cost for each item of damage. If certain damages aren’t on the list, landlords must refund the non-itemized balance. If a tenant wishes to dispute charges, they may sue in court and the statutory maximum which they can be awarded can be as high as three times the initial deposit. A landlord can likewise be sued for triple damages if they fail to return the tenant’s security deposit within 30 days.

Situations in which landlords have the right to withhold part of the security deposit include a tenant leaving very dark paint on the walls or if a tenant uses faux paint or wallpaper. Holes in the wall and floor that require more than basic repairs such as plastering and sanding are also damages for which the tenant must pay. At times, I have noticed major damage of appliances beyond regular wear and tear. If a refrigerator door is falling off or a stove has stopped working due to being jammed, I will certainly add those damages to an itemized list. These scenarios can be even more frightening when dealing with furnished rentals where televisions, chairs and coffee tables are often destroyed. Water damage that either was the tenant’s fault or wasn’t the tenant’s fault but that they failed to report is also something for which I hold tenants accountable.

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Apartment Construction Begins to Slow Down

Apartment building developers may finally take a breather in their rush to build new units.

“Starts will begin to slow down soon, translating into more moderate development activity by late 2020,” says Jeanette I. Rice, Americas head of multifamily research for CBRE Research.

There are still hundreds of thousands of new apartments already under construction, scheduled to open over the next year or so. But rising interest rates, rising construction costs and already tough lending standards are making it more difficult for developers to keep building at the rate they have been. Developers took out fewer permits to build new properties in September compared to previous months.

“The shift is a mild pullback, rather than an abrupt move to lesser activity,” says Greg Willett, chief economist for RealPage, a provider of property management software and services.

Strong demand for apartments has kept developers and investors interested in starting new projects despite the growing number of vacancies in many markets. Rents are still rising, even if not as quickly as they had in recent past.

“Development, just like investment, is a lower return environment than in previous cycles. But the very strong appeal of the sector makes this acceptable to market participants,” says Rice.

Fewer permits and construction starts

Developers have been taking out fewer permits to build apartment buildings. Their seasonally-adjusted annual rate of permitting has been slowing down since March 2018—shrinking to 351,000 in September 2018. That’s well below the average rate of 417,000 permits per year for 2018 so far, according to data from the U.S. Census.

“One can expect the decline in permits to translate into a decline in starts in the coming months,” says Rice.

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Nearly 1.5 Million Vacant U.S. Homes in Q3 2018 Represent 1.52 Percent of All Single Family Homes and Condos

IRVINE, Calif. – Oct. 30, 2018 — ATTOM Data Solutions, curator of the nation’s premier property database, today released its 2018 Vacant Property and Zombie Foreclosure Report, which shows that nearly 1.5 million (1,447,906) U.S. single family homes and condos were vacant at the end of Q3 2018, representing 1.52 percent of all homes nationwide — down from 1.58 percent in 2017.

The report also found that there were 10,291 vacant “zombie” foreclosures homes nationwide at the end of Q3 2018, representing 3.38 percent of all homes actively in the foreclosure process. The number of zombie foreclosure homes was down from 14,312 a year ago, and the zombie foreclosure rate was down from 4.18 percent a year ago.

“The number of vacant foreclosures is now less than one-fourth of the more than 44,000 in 2013 when we first began tracking these zombie homes,” said Daren Blomquist, senior vice president at ATTOM Data Solutions. “Policy solutions such as land banks designed to mitigate the ripple effects of vacant properties on neighborhoods and cities have had a substantial impact, and a booming housing market in many areas of the country is lifting all boats. There are still high concentrations of zombie homes and other vacant homes in some local markets and submarkets, but those high concentrations are becoming fewer and farther between.”

Markets with highest vacant home rates

States with the highest share of vacant homes were Tennessee (2.65 percent), Kansas (2.50 percent), Oklahoma (2.49 percent), Mississippi (2.47 percent), and Indiana (2.45 percent).

Among 153 metropolitan statistical areas analyzed in the report, those with the highest share of vacant homes were Flint, Michigan (6.99 percent); Youngstown, Ohio (3.80 percent); Beaumont-Port Arthur, Texas (3.71 percent); Myrtle Beach, South Carolina (3.70 percent); and Mobile, Alabama (3.69 percent).

Among 405 U.S. counties analyzed in the report, those with the highest share of vacant homes were Baltimore City, Maryland (7.83 percent); Genesee County (Flint), Michigan (6.99 percent); Saint Louis City, Missouri (5.93 percent); Bibb County (Macon), Georgia (5.73 percent); and Wayne County (Detroit), Michigan (5.60 percent).

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Watch Real Estate for First Signs That Passive Has Grown Too Big

(Bloomberg) –The future of passive investing is facing one of its biggest tests yet. And surprisingly the challenge is coming from a handful of relatively obscure real-estate companies.

Funds that track indexes are coming increasingly close to owning a majority of shares in eight property owners and managers, according to a report from Bloomberg Intelligence. Real estate stands out in a wider market where just 16 percent of stocks are held by passive investors. That makes these companies potential bellwethers for the impact of benchmark tracking as the funds grow.

“For firms with high passive ownership, you have lower reaction to company-specific news,” said Itzhak Ben-David, a finance professor at Ohio State University who’s studied the topic. “When everybody pulls money out of the market or gets into the market, the tide lifts all boats.”

Identifying the potential dangers within passive investing vehicles — particularly exchange-traded funds — has been a Wall Street parlor game for years, not least among displaced stock pickers. Variously described by active managers as being akin to Marxism or financial weapons of mass destruction, indexed funds are poised for another year of inflows as actively managed products hemorrhage cash, data compiled by Bloomberg show.

Tipping Point?

But with the number of U.S. indexes far outstripping stocks, anxiety is mounting over whether passive funds — which buy the stocks in their benchmarks regardless of news, earnings or other fundamentals — artificially inflate share prices, fueling bubbles.

Societe Generale SA last month argued small caps, dividend shares and gold miners were particularly at risk of market selloffs due to their outsized ownership by passive investors. Goldman Sachs Group Inc., meanwhile, suggested in a report last year that stocks with a larger exposure to passive funds could trade more on cross-asset flows and macro views than their own fundamentals.

Tanger Factory Outlet Centers Inc., which owns and operates out-of-town retail parks, could be the first stock to test passive’s tipping point. Indexed funds own 46.9 percent of the real estate investment trust, which has a market capitalization of $2 billion, the data show.

Based in Greensboro, North Carolina, Tanger may seem like a strange yardstick for the future of investing, but its diverse appeal has made it a stock to watch. It’s owned by dividend strategies, funds that buy mid-cap or small-cap companies, and investors in real estate or REITs.

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Investing Through the Buy and Hold Strategy

Real estate has long been considered a viable and reliable area for investment. Unlike the stock market, which can fluctuate based on the whims of the market, real estate is relatively cyclical in terms of time and is extremely local in nature. This means that a slow market in Los Angeles, California does not necessarily mean a slow market in Miami, Florida. In addition to this, the asset in a stock market is just a number on a computer screen – it’s not tangible, or something you can touch and feel. Let’s compare this to real estate, where you can actually see (and live in!) the asset you buy. You can add paint to improve it cosmetically, do more extended maintenance to improve it structurally, and generally control what you do with the asset.

Passive real estate investing through the “buy-and-hold” strategy entails buying a property for the long haul. This is opposed to wholesalers and flippers, who buy properties in the hopes of making a quick return. Buy-and-hold investors purchase a property, typically using bank financing, and rent it out for long-term passive income. The term “passive” means that you are not actively working for the money you earn. After the initial investment into a turnkey residential property or an income-producing commercial property, investors typically hand the property over to a property manager who takes care of the tasks related to hosting a tenant. These investors then receive a check from the property manager each month with a portion of the earnings.

The buy-and-hold strategy is ideal for retirees who don’t want to actively manage an investment and just want to receive a steady flow of money throughout their retirement. It’s also quite ideal for young investors who have a longer investment horizon, or time consideration, for their investments. They can purchase income-producing properties whenever they are financially viable, even at the start of their careers! Now they can collect a paycheck from their employer and a check from their rental property. Most employed adults have a 401-k plan through their employers, and typically have a pension plan as well. Real estate investing is a steady and relatively safe way to build a retirement portfolio and diversify your investments even further.

One important concept related to passive real estate investing using the buy-and-hold strategy is the benefit of using bank financing instead of buying a property with cash. It’s true that you can often negotiate a much lower purchase price when you have cash to pay with – it’s enough of an incentive for the seller to forego the pains of dealing with a buyer who must get approved for a mortgage and ultimately fund the loan at the closing table. The seller gets cash in their bank account, and the buyer walks away with a new property – everybody wins, right? Not exactly, and that’s due to a concept called return on investment, or ROI.

Return on investment is a metric that many investors use to determine how successful their investments are. It’s expressed as a percentage and is calculated with a simple math problem: (total money earned) divided by (total money spent). It is typically calculated on an annual basis, so the ROI for your first year owning the property will be calculated as follows: (total rent money earned in year one) divided by (total amount of money spent purchasing the property, including the purchase price, closing costs, and any money spent on initial repairs and improvements). This calculation gives the investor a general idea of how much “bang for the buck” the property has.

When an investor buys an investment property using all cash, the portion of the equation related to the total amount of money spent is extremely high. This, in turn, drives the ROI metric down and essentially tells the investor that he or she is getting a low return on the property for year one. On the other hand, when an investor buys a property with bank financing, the bank typically requires a 20-25% down payment. Though this may sound high, it’s a lot less money than paying 100% in cash. This lower initial investment will drive the ROI up when compared to a cash transaction. Keep in mind that ROI should increase as the years go on, because the total money spent is generally the highest at the time when the property is initially purchased. ROI is just one of many metrics that investors use to gauge their success, but it can be a quick and helpful signal.

Once you’ve decided whether to purchase using cash or financing, it’s important to have a general sense of what your profit will be. A licensed real estate agent will be able to help you get the relevant figures for the properties you are interested in. Profit is essentially the money you earn after all expenses are paid, and for a residential rental property it’s calculated as follows: (total rental income) minus (total property expenses). Pretty simple, right? Let’s expand a bit on what property expenses consist of. These include your monthly mortgage payment if you’re using bank financing and monthly HOA dues if the property resides in an area with a homeowner’s association. It’s also important to include escrows in your calculation of property expenses. Escrows are funds put away for later, and these include property tax payments, property insurance payments, and a reserve for maintenance and repairs. You should determine what profit threshold you are comfortable with so that you can easily spot the properties that fall within your requirements.

Here’s a simplified example of how to calculate your profit. Let’s say you found a single-family home with 2 bedrooms and 2 bathrooms. You’re putting down a total of $50,000 plus $5,000 closing costs. The homeowner’s association charges $150 per month. The yearly taxes on the property for the prior year were $3,000, and property insurance runs about $1,500 per year. The property needs a little bit of work, so you figure you’ll need $500 for paint and electrical panel replacements. After speaking with your mortgage broker, you find out your monthly mortgage payment will be $800 per month. Then, after speaking with your real estate agent, you find out that the average rent in the neighborhood is $1,600 per month for a 2-bedroom, 2-bathroom house. What’s your profit? How about ROI?

Profit = Total Rental Income – Total Property Expenses
Total Rental Income = $1,600 per month

Total Property Expenses = $800 monthly mortgage payment + $150 monthly HOA payment + $250 monthly tax escrow + $125 monthly property insurance escrow

Profit = ($1,600) – ($800 + $150 + $250 + $125) = $275 per month

Return on Investment = Total Money Earned / Total Money Spent
Total Money Earned = $275 monthly profit * 12 months

Total Money Spent = $50,000 down payment + $5,000 closing costs + $500 initial repairs

ROI = ($3,300) / ($55,500) = 5.9% annual ROI

Once you have these figures, you can make a more informed decision on whether the rental property in question is right for you. If you’re ready to get started with passive real estate investing through the buy-and-hold strategy, consult with your licensed real estate agent and mortgage broker.


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Charles Carillo is the founder and managing partner of Harborside Partners. He has extensive knowledge in renovating and repositioning multifamily and mixed-use commercial real estate. Prior to launching Harborside Partners, Charles founded an online payment processing company with partners and clients in 4 continents across the globe. Charles holds a BS from the Connecticut State University.

Identifying Lucrative Value-Add Multifamily Opportunities as the Cycle Lengthens

The appetite for value-add multifamily investments remains strong—and in light of this increasing competition, many investors are struggling to identify and secure assets that present high-reward opportunities.

While some investors have turned to extreme measures, including taking on projects that require extensive remediation and complete overhauls—or even repurposing entirely different product types for multifamily use—some of the greatest opportunities for growth and stability lie in strategically identifying and refreshing functional, yet under-managed vintage communities.

With a strong sourcing and repositioning plan in place, investors can still take advantage of opportunities to acquire ‘diamond-in-the-rough’ multifamily properties that present high potential for growth at this point in the cycle. We’ve included a few strategic approaches below:

Select submarkets with sustained growth and livability

Top-of-mind for many multifamily investors is the current point in the real estate cycle and impending market correction. The good news is that we’ve been in a slow growth economic cycle for several years, which has recently been bolstered by changes in policy and new employment opportunities.

Consequently, we anticipate continued upside for the next few years, and further, that many multifamily markets across the country will remain resilient even in the case of a downturn.

The key is selecting submarkets that are experiencing increasing population growth year-over-year, job growth that includes the influx of a diverse mix of employers and those that are located in regions that present a high quality of life—vibrant areas where today’s multifamily residents want to live.

For example, we recently added the eleventh apartment community to our Portland, Ore.-area portfolio in just over three years. The greater Portland market demonstrated strong fundamentals that brought it through the economic downturn of a decade ago relatively unscathed compared to many other markets, and we have been particularly bullish on Washington County submarkets, as in recent years the area has emerged as the tech hub of the Pacific Northwest, as well as expanded its presence as a sports apparel capital.

We expect well-positioned multifamily assets in continuously growing locations like Washington County to thrive, but as opportunities become scarce and competition high, it is also critical to keep an eye on newer emerging markets.

In the West, we are seeing that certain submarkets of Salt Lake City and Denver are demonstrating similar fundamentals that the Portland area has for the last several years.

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