The Ridgeview Report
What Makes a Good Deal? Part II
In last week's newsletter, I share the importance of evaluating the market conditions, debt situation, and projected performance of a property. In this week's article, let's further discuss a few more key factors that contribute to a favorable deal.
The Structure
When evaluating the buildings themselves I consider several factors. This includes the property's age, condition, quality of the construction, and layout of the units. I target properties built in the 1980s or newer, although exceptions can be made for well-maintained older properties. The importance of proper maintenance cannot be understated, as neglect can lead to costly surprises that may not be easily accounted for during the underwriting process. Additionally, the quality of construction is a significant consideration. Foundation issues can prove to be extremely costly. It is also advisable to steer clear of common issues like Stab-Lok breakers, aluminum wiring, and galvanized water lines. While flat roofs are acceptable, sloped shingle roofs are preferred due to their cost-effectiveness when replacing
In addition, apartment layouts hold substantial influence, as a well-thought-out design can significantly impact rental appeal. For example, an 800 sq ft 2-bedroom apartment with a functional floor plan may be easier to rent than a 1000 sq ft 2-bedroom with a less desirable layout. Features such as open kitchens, abundant windows, ample closets, and ceiling heights of 8 feet or higher are sought after to enhance the overall tenant experience. Taking these factors into account ensures I can achieve my targeted rent premium once renovations are completed.
Upside
I seek to purchase properties rented below the market rate that can benefit from both physical and operational improvements. Some of the best deals are properties that are dated inside and have not undergone significant updates. Properties that can benefit from physical value-add are easy to recognize as the units often feature obsolete paint colors, old cabinets, poor lighting, and dated tile. These features can hinder rental potential. By making necessary upgrades, the property's appeal can be enhanced, leading to increased rents. Furthermore, the addition of amenities such as dishwashers and in-unit laundry facilities can result in substantial rent increases, as they are highly desired by tenants.
I have found operational value-add can be generated by implementing various strategies. One approach is to introduce additional revenue streams such as Ratio Utility Billing System (RUBS) and pet fees, which can significantly boost income generation. Another tactic that I implemented at the property I own in Champlin is to adopt a water usage reduction program. By installing water-saving fixtures in all the renovated units and adjusting the frequency of the lawn sprinklers I can optimize my operating costs and save the property approximately $2,000 a year.
Increasing the property's occupancy rate can also be achieved by leveraging modern marketing channels. In the case of the Champlin portfolio, I acquired it from an owner who relied solely on yard signs for property marketing. After taking ownership, I implemented a comprehensive marketing package and established a strong online presence for the property. This allowed me to reach a wider audience, attracting more tenants and maximizing occupancy rates.
Mitigated Risk
While there are natural risks associated with any real estate purchase, I make sure to always implement specific precautions to minimize those risks.
Thorough Due Diligence: Conducting comprehensive due diligence is crucial in reducing risk. This involves conducting thorough property inspections to uncover any potential hidden issues, reviewing financial documents in detail, and conducting extensive market research. By carefully examining all relevant aspects, potential problems can be identified and informed decisions can be made prior to finalizing a purchase.
Insurance coverage: Securing appropriate insurance coverage, such as property insurance, liability insurance, and landlord insurance, is essential for protecting against unforeseen events and mitigating potential risks. Now more than ever, it's important to understand the insurance market in the area you are investing in. Insurance in some markets is increasing by 300% per year, and in other areas, insurance companies are pulling out altogether. An unsuspecting buyer could find their investment no longer cash flows due to rapidly increasing insurance costs. (See Florida example below)
Cash Flow: Choosing a real estate deal that generates positive cash flow from rental income helps mitigate risk. Positive cash flow ensures that the property generates sufficient income to more than cover operating expenses, including mortgage payments, property taxes, insurance, maintenance costs, and property management fees. This steady income stream serves as a protective measure, creating a cushion to handle unexpected expenses as well as periods of vacancy.
Market News
Florida Insurance Rates
According to an article by TheRealDeal (March 8, 2023), commercial property owners in Florida are bracing for 45%-50% insurance rate hikes this year. The report suggests that the state's insurance market is facing significant challenges due to a combination of factors, including rising reinsurance costs, insurance fraud, and increased claims related to natural disasters. Insurers are expected to pass on these increased costs to property owners, particularly those located in high-risk areas prone to hurricanes and other weather-related events. This anticipated surge in insurance rates poses a considerable financial burden for investors, potentially impacting their profitability and overall cost of operations.
Source: TheRealDeal. (2023, March 8). Florida commercial property is in for big insurance hikes this year. https://therealdeal.com/miami/2023/03/08/florida-commercial-property-in-for-big-insurance-hikes-this-year/
Tips and Tricks
Terms:
Ratio Utility Billing System (RUBS)- The Ratio Utility Billing System (RUBS) is a method used to allocate and distribute utility costs among tenants. Instead of individually metering each unit, RUBS calculates each tenant's share of the utilities based on predetermined ratios, such as square footage or number of occupants. This system allows landlords or property managers to fairly distribute the costs of shared utilities without the need for separate meters for each unit.
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