The Fastest Way To Build A Six Or Even… Seven Figure Real Estate EMPIRE!
Our net operating income was stagnant, we were running into vacancy issues due to COVID, and if that wasn’t enough, we were being sued!
Here’s the deal. We purchased this 164 unit property for $9.2M in August 2019, with a projected valuation of $14.2M after increasing the rents and completing some minor interior upgrades over a two year period.
The problem was, due to COVID, our net operating income stayed flat, we couldn’t get into the units to renovate them, and some of the medical students didn’t return to class at the university nearby.
And on top of that, the local school board sued us when they found out that the property had been sold so that the real estate taxes would be reassessed. We were looking at a $200k increase in real estate taxes, per year!
Thankfully, we were able to get a lot of these issues sorted out and even had a few things work in our favor. It definitely was a bit of a rollercoaster ride, but in today’s episode, you’ll hear how we overcame some of these major challenges.
Key Takeaways: 164 Heights Case Study
- How COVID forced our hand and altered our projections.
- Our net free cash flow nearly doubled thanks to the drop in interest rates.
- How we negotiated a deal with the school board with a one-time payment for the real estate taxes increase.
- Having a good asset manager and business partner paid off in dealing with so many issues during the pandemic like leasing, evictions, and general COVID concerns. Shout out to Jack for everything he did. He was phenomenal.
- The property manager matters! We were so lucky to have someone that the residents trusted during the past year. That was another huge bonus that we were able to keep someone like her.
- How our lender and broker were a tremendous help to getting these appraisals completed and navigating through the refinance process.
- Forging great relationships with private investors and being transparent with them builds trust which is a huge asset to making deals in the future.
- How purchasing a Class-A property in a Class-A neighborhood helped overcome the challenges that we faced during COVID.
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Josh Cantwell: Hey there. Welcome back to Accelerated Real Estate Investor with Josh Cantwell. I’m your host and I’m excited to be back with you. Let me jump in pretty quick to another one of our live case studies. We call this 164 Heights. This is a 164-unit property that we bought back in August of 2019, right before COVID. And I’m really excited about the results of this, especially considering some of the challenges that we had with COVID and with all of our buildings and just with the whole economy and the whole world.
And so, the Heights portfolio is 164 units. It’s eight buildings in the Cleveland Heights and Shaker Heights suburbs of Cleveland. This is a really solid A-class location of Northeast Ohio. It’s right around the corner from the Cleveland Clinic, which is one of the world’s best hospitals, definitely one of the top four hospitals in the United States. It’s right around the corner from (UH) university hospitals and right around the corner from Case Western Reserve University, which is one of the great medical schools in the country.
When we bought it, it was already 95% occupied and it was owned by the same guy for 27 years who used to show up on-site every day and work. He basically was an owner-operator. These are three-story and four-story garden-style apartment buildings with a lot of medical and professional tenants. What we loved about the building when we bought it was that it had in-house leasing. The previous owner’s daughter was going to stay and continue to manage the building. It had a 24-hour in-house maintenance. There were two guys, the previous owner again treated these guys really nice, maintenance guys, left them behind. It had onsite laundry, covered parking. You could walk to shops, restaurants, and other businesses, and was literally a five to ten-minute drive to the Cleveland Clinic, to university hospitals, and to Case.
We were able to get this deal off-market. It never hit the market. Nobody knew about it. It was brought to us by a commercial broker and it was run really well, actually, 95% occupied. It was always leased, 90%, 95%. I mean, these are buildings. The masonry and the brick structures are in just absolutely phenomenal condition. Literally, it’s a nuclear bomb shelter. I mean, the signs are up in the garage, that kind of thing. And when we originally bought it, we bought it for $9.2 million. It was about $56,000 a door. The renovation budget was only $410,000. The renovation budget was basically cosmetic improvements. We were going to take half of the units, roughly 80 units, and we were going to put about $5,000 a unit roughly into those 80 units, okay, $400,000, plus closing costs and holding costs, we’re going to be all-in for about $9.8 million.
We’ve got a bank loan for $7.65 million and we raised about $2.2 million of private investor equity. The current net operating income when we bought it was already $800,000. I don’t know why it was really strong, but the units were very much like 1990-ish. The building was kind of stuck in the late 90s, early 2000s. There were really nice original hardwood floors. The walls were plain white, but then all of the fixtures and finishes were gold. Bathrooms were kind of boring, and nothing was really done there. And we knew that if we made those improvements, we added backsplash, we had an LVP flooring in some of the units, or LVP in the bathrooms. We added tub surrounds, a new low-flow toilet, a new sink, a new backsplash in the bathroom, and upgraded some of those kind of things. We knew we could fetch a little bit higher rent. We didn’t need a huge rent bump.
The thing was, is that we really thought that we could push the NOI to about $925,000 and then a six and a half cap that would put the building value at $14.2 million. We bought it for $9.2 million. Our goal was, after roughly two years, to push the NOI to $924,000, refi the six and a half cap, get a valuation of $14.2 million, refi, and let’s say, 75% loan to value, put a new loan on it for roughly $10.6 million and be able to cash out half a million dollars or so of refi proceeds, cash flow the building roughly $217,000 a year and have remaining equity of about $3.5 million.
Now, here’s what actually happened. Alright, that was all of our projections. So, let me cover that again. Again, for those of you listening, original NOI $800,000, we’re going to push the NOI to $924,000 by bumping the rent’s, six and a half cap, $14.2 million stabilized value, refi at $10.6 million, put a new loan on it and return the investors equity, plus cash-out refi proceeds of about half a million bucks, stabilize cash flow at $217,000, remaining equity, $3.5 million. And as much as we work really hard to execute on that business plan, there’s always a bunch of levers, some work in our favor, some don’t that allow us to stabilize the building and kind of see how it washes out.
So, let me tell you about the projected, what I just covered, versus what actually happened. So, what actually happened is our net operating income essentially stayed flat for the last 21 months due to COVID. We had no ability to access the units, no ability to really get in them, turn them and raise the rents. And some of the medical students at Case Western Reserve University never returned. That kind of did not work in our favor. What did work in our favor is that the cap rate we originally projected at 6.5% went down to 6.1%. So, that worked in our favor. We wanted to get a projected value of $14.23 million, and the building actually appraised at $13.4 million. So, we bought it for $9.2 and appraised it for $13.4, we created almost $4 million of equity in less than two years. It’s still amazing, even though we didn’t hit the $14.2 million, we got an appraisal at $13.4, we were $800,000 short, still a win, especially in the middle of COVID.
Next thing, our original projected refi loan, as I just mentioned, we were hoping to get $10.6 million, the lender would only give us about 73% loan to value. So, the new loan that we put on, it was $9.9 million. So that, again, did not work in our favor, but still, we bought it for $9.2 with a significant increase of a $4.2 million valuation bump. Now, one of the things that did not work in our favor was the real estate taxes. We had not budgeted for a real estate tax reassessment because we did an entity drop. We bought the entity from the seller. We bought the business, and along with the business came the real estate. Now, what happened was the school board got smart. They hired a lawyer to comb through the records and they found that we had this new mortgage on the property of $7.6 million. So, they knew that it had transferred. So, they sued us. And instead of what they wanted to do was raise the real estate taxes by $200,000 a year, well, we agreed on was that they would raise the actual taxes $30,000 a year and we would have to make a one-time $250,000 payment to the school board. So, again, that did not work in our favor.
Now, one thing that did work in our favor was the interest rate. We originally projected that our interest rate on our long-term permanent financing would be 5.5%. Guess what it actually came in at? Any guesses? 3.65%. So, our net free cash flow nearly doubled. Instead of $217,000, our net free cash flow is projected to bump almost all the way up to $425,000 because of that interest rate drop. The interest rate almost dropped the full two points, which is amazing. Now, out of our cash flow, we’re going to have to spend some money on unit terms, still, we did about 100-unit turns. We’ve got about 60 left. So, we’re going to spend about $100,000 to $200,000 over the next two years finishing the unit turns. That will allow us to jack up the rent on those remaining units, about 200 bucks when we increase that income from those remaining 60-unit turns. We will be in a situation where that extra $200 per month times 60 units is about $144,000 a year at a 6 cap. That’s worth an additional $2.4 million of additional equity. So, even though we didn’t hit the $14.2 million valuation today, we got a valuation of $13.4 million. We should, through these additional unit turns, be able to raise the income, we’re not going to have much additional expense. And so, add another $2.4 million to the original $13.4 million, that puts us at a $15.8 million valuation in roughly two years from now.
So, we’re excited about this deal still, because now, guess what’s happening? My kids went back to school this morning. College kids are returning back to school. The hospitals again are performing not only COVID-related treatments but all kinds of regular treatments. So, the hospitals are full. The nurses are working. The doctors are working. The teachers are working. The students are back in school. They’re all going back and filling up this building. And so, we’re excited about that.
So, at the end of the day, we are excited that our cash flow is actually going to be north more than what we originally projected instead of $217,000. For the next two years, that might stay around $220,000 because we have to do those remaining unit turns, but after the unit turns are done, we’ll have an additional $2.4 million of valuation bump and then we won’t be using the money, the cash flow, to pay for the unit turns, so the net free distributable cash flow will jump all the way up over $300,000, closer to $400,000.
So, here are my points with this, I think here are my takeaways. Number 1, I want to give my business partner, my buddy Jack Patrick, some kudos here. Jack was our boots on the ground, our general partner who was operating this building with us and for us in the middle of COVID. So, Jack did an amazing job of operating the building, operations just everything from leasing to unit turns to make ready’s, evictions, dealing with COVID, dealing with residents that were literally fearing for their life, dealing with any kind of government subsidy we could get to offset the eviction moratoriums and get the slush money from the government to pay the rent. Jack worked with the former owner’s daughter, who’s the primary property manager, to execute on that plan. They did a fantastic job.
So, regardless, I’ve got a lot of other buildings that performed really, really well, and I got a couple that are not performing well. And I can tell you that the difference is the operator, it’s the boots on the ground operator. That’s the difference. It’s not the market. It’s not the resident base. It’s not whether it’s A class, B class, or C class. It’s the operator. It’s the guy, the jockey who’s driving the horse or otherwise managing the building as an asset manager. That asset manager does a good job, which Jack did a phenomenal job.
Now, I have another partner who is not as good of an operator, and those buildings are not doing as well, not nearly as well, but because the market’s going up, those buildings are still going to sell for a profit, and the market is essentially going to bail us out. We’ve got two or three of those because the operator, frankly, took his eye off the ball. Now, we’ve got 15 syndications. We’ve got 12 or 13 that are going really well, and we’ve got two or three that are just kind of ehhh. And we’re still going to sell those for a profit because the market’s doing well, but the takeaway is, look, the asset manager, the boots on the ground operator is crucial to everything. That person has to have so much insight into what’s going on from leasing to evictions, to move-outs, to move-in, to make ready’s, to managing their CapEx budget, to managing expenses, the school board payment, all of those things, the refi timeline, all of that stuff is something that Jack did really, really well and we partner with on him and did really well with that.
Number 2, the property manager matters. The former owner’s daughter did a phenomenal job, she sits right at the main desk, did a phenomenal job of using the software, using AppFolio, tracking all the residents, communicating with the residents, and those residents trusted her even in the middle of COVID to have their best interests in mind.
Number 3, our lender helped us navigate the right time to get the appraisal done, to apply for the loan, to get the term sheet going. Frankly, the refi process took almost six months from start to finish because of COVID, but we had a great lender that we worked with, a great broker, and they helped us navigate all the things that we needed to get through the refi.
Number 4, we have very understanding private investors, private investors that we had to give them transparency. We had to tell them what was going on with the buildings, how it was going to go, be as transparent as possible, not hide anything because they’re the ones that invested in the deal that need to know what’s going on with the deal and what’s going on with their money. Don’t hide when things go wrong. Don’t hide, don’t give crappy updates every quarter, don’t not share your financials because you had a bad quarter or because you took your eye off the ball. I have an operator partner who I’m not very happy with, but Jack was transparent, honest, shared the financials, shared the story, what’s going on, what’s the transparency, how are we doing with this building. And the investors that are in this deal, it didn’t go exactly the way it’s supposed to, but they’re going to all reinvest because they trust us. They trust us.
I think another takeaway from this, number 4, is that we bought an A-class building in an A-class area, not C class, not a lot of work, not a rough tenant base, but an A-class building in an A-class area that’s going to snap back. It’s going to snap back. When things go well, it’s going to snap back, the valuation is going to go up even more.
So, those are some of the takeaways from 164 Heights with our refi proceeds, our business plan, what worked in our favor, what didn’t work in our favor, and some of the lessons we learned along the way. I’ve enjoyed this case study. If you enjoyed the transparency to learn the real numbers, to learn what’s actually going on, let us know. Leave us a comment. Leave us a rating, a review, literally open up your iPhone right now, tap the five-star button, leave us a rating. You can do it right from your phone while you’re listening to this, while you’re at the gym, while you’re out for a walk. Go do it now. It would mean so much to us to know that we’re having an impact on you, and we could share this.
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