Josh Cantwell: So, hey there, guys, Josh Cantwell here. So glad you could join me on Accelerated Real Estate Investor. In this podcast, I’m going to walk you through number 1, a 360-unit that we’re going to be offering at roughly $50,000 a door in the Cleveland submarket. Number 2, I want to tell you about the current financials and where we can win. Number 3, I’m going to tell you about the muck of underwriting. Number 4, I’m going to tell you about how we plug in our future values and our business plan and how we were able to look at 12 different comps and determine that practically every property in this submarket was the same, carpet, laminate, brown, and how we’re going to pivot the building and hopefully, raise the value from $18 million to $27 million by instituting LVP, butcher, and white shaker. I hope you enjoy this case study and this deal evaluation podcast with me, Josh Cantwell. Here we go.

[INTERVIEW]

Josh Cantwell: So, hey there, welcome back to Accelerated Real Estate Investor with Josh Cantwell. Today, it’s just me, and I want to talk to you today about a 360-unit property that we are underwriting and about to make an offer on and talk a little bit about our analysis of this property. And so, let me give you some of the details, 360 units, it was built in the 1960s. It’s been owned by the same owner for 10 years. The blended rents are an average of $640 dollars a month. This is in a very big class part of Cleveland, just outside of the city of Cleveland, and one of the first-tier suburbs. School districts are okay. They’re B rated, like 6, 7 on a scale of 1 to 10, fairly low crime, a lot of blue-collar type of jobs and some white-collar type of jobs. I’m not going to be much as far as rent growth, maybe 1% to 2% per year.

And so, when I looked at this property, I looked at all the numbers, I looked at their financials, and they’re driving in over $2.6 million a year in gross income. Then I looked at their net operating income, it was only $1.1 million. And so, the first thing that kind of went off in my head was the fact they were about a 60% expense ratio, sort of stabilized building with low rents, very high occupancy, usually like 98% occupied. I’m thinking, well, why are their expenses so high? The real estate taxes did not seem high. The utilities did not seem very high. And so, one other thing that I really looked at, but I encourage you to look at when you’re underwriting is really what I call the muck.

Alright. So, when I look at a deal, there’s a couple of steps, really five steps that I’d look at, when I put in the current financials, whether I get the offering memorandum from the broker, whether I get the rent roll, the T3, the T12, the T24, the last 12 months of financials, I pour that into the current financials and look at, first of all, first thing I do is put in the current gross revenue from rent. Then I put in the current other income and I come up with their total current income, in this case, about $2.6 million. The second thing I put in is the taxes on the insurance because generally, they are what they are. The taxes might go up if they’re reassessed, but generally, that’s easy to find on their financials, easy to find another operating agreement, just plug that in, the real estate taxes and the insurance. That’s number two.

Number 3, I put in their utilities, so trash removal, snow removal, gas, electric, water, and sewer. The only thing there that I’m really looking hard at is the water, the water and sewer, because we can institute a water conservation program that may save between 25% to almost 40% on the water bill by installing low-flow toilets, fixing leaks, and also low-flow shower heads, aerated shower heads, those kind of things that will allow us to cut down on the water usage and run a water conservation program. So, when I run my pro forma to look at the future value, I’m going to take their water usage and I’m going to cut that down by 25%. Write that down, okay? That’s the next thing I put in, that’s number 3, is the utilities.

Then, number 4, I put in the property management.  Every deal is going to have a property management fee, especially larger buildings, somewhere between 3% to 5%, but what I’m going to look for there primarily is, are they including the property management payroll in their property management fee? Or are they separating it out? So, they might charge a 3% or 4% property management fee, and then have additional payroll, or vice versa. Or they might roll a charge, maybe a 5% property management fee or 6%, and then put all their payroll in the property management fee. So, that’s number four.

Then, I get into the muck, the muck of underwriting, and that means all the operating expenses, the administrative expenses, the legal and professional expenses, the marketing and advertising expenses, all the muck. And this is where all operators and every financial statement looks different. The gross income, the other income, the taxes, the insurance, the utilities, the property management fee all typically looks about the same with every deal that I underwrite, but after that, you get into the muck. And even when I’m coaching my multifamily students in our program, we call it FPI, Forever Passive Income, even with that program, I tell them we’ve got to pay attention to the muck.

And this is where we’re going to find every owner, every operator does their finances a little bit different. You’re going to have admin expenses, which could include cell phone bills, office supplies. It’s going to include their maintenance expenses for payroll, maintenance expenses for materials, their make-readies, the paint, carpet, carpet shampooing. It’s going to include all of their muck in one area. And so, then when I go to the proforma and I look at, okay, what does this thing have to look like two to three years from now? We own it. We’re optimizing it. We’re trying to run the thing at a 50% expense ratio, okay? We’re trying to run the thing more efficiently than they have. How are we going to win? How are we going to make things better? The question becomes as well, what’s our business plan?

So, I’ll give an example. This week, I walked a 360-unit, asking price is around $50,000 a door, it’s about an $18-million-dollar deal. We’re going to make an offer on it right in that $17 to $18 million range. I’ll be writing up the LOI next week. And when I looked at the deal, I’m like, you know, we can run this thing a little tighter. We could run maybe at a 50% expense ratio. There’s ways to cut. They have four full-time maintenance guys, they have a full-time housekeeper, plus they have a property management team, plus they have a leasing agent. So, it feels like they’re a little bit overstaffed by about 50,000 bucks. They also are paying a lot more than I would in their maintenance department. Their maintenance expenses are a lot higher than I would spend. Usually, when I pro forma deloitte, I’m going to use a rule of thumb of about $750 per year per unit for maintenance and maintenance materials and those kind of things. So, 750 is the number that I use.

Again, they were overpriced there by about $50,000. So, there’s about $100,000 in savings, but that’s it. That wasn’t like a whole lot of other areas where I could really save, maybe cut the water bill down again 25%. Twenty five percent of the water bill is $200,000. So, the water bill, 25% of $200,000 is 50 grand. So, let’s say, this is another $50,000. So, there’s about $150,000, maybe $175,000 in savings to get that expense ratio from 60% down to 50%.

Here’s where I think we’re going to be able to win. When I looked at the comps, I looked at 12 different buildings, 12 different comps, all in that area right in that submarket, I didn’t reach out to other submarkets that were not comps. I looked right in that same area where the incomes were the same, the zip codes were the same. And I found that apparently, every building was the same, meaning carpet, laminate, and brown cabinets, boring, boring, boring, carpet, laminate, brown, carpet, laminate, brown, carpet, laminate, brown. Every single comp I looked at, carpet, laminate, brown, some were carpet, laminate, and then white old cabinets.

So, it’s like, hey, okay, if we’re going to be able to charge more and increase the value of our building. So, let’s say, we buy it for roughly $18 million. Where can we push the value? Where can we really push the value from $50,000 a door to maybe $75,000 a door? And that right there became a glaring, glaring opportunity. Carpet, laminate, brown should be LVP, should be butcher block countertops, should be white shaker cabinets, LVP, butcher block, white shaker. So instead of carpet, laminate, brown, it was LVP, butcher, white shaker. So, if I looked at that, I thought, okay, now we’re going to talk about how we can win. Now we’re going to talk about taking these on a cosmetic basis, buying the building, and listen, over the next couple of years, if we can see organic rent bumps and take them from $650 to $750 over the next three years and reduce the expenses at the same time by about $150,000 to $175,000, that’s a win. That’s going to take our value from– on a 6.25 or a six and a half cap, it’s going to take our value from $18 million to roughly $22 million.

Now, how do we push the value to $25 million, $27 million? The answer, LVP, butcher, white shaker, because nothing else in this submarket has that. And so, is it reasonable for us to say, okay, we can get the organic rent bumps from $650 to $725, and then forced appreciation from $725 to $800. In this submarket, can people afford $800 versus $650? The answer is absolutely yes, absolutely yes. That’s not going to be a material difference for these people to be able to afford $800 versus $650. And for us, now, if we get $150 rent bump and we get to save $150,000 to $175,000 on the expenses through water conservation program, its reducing payroll, and those kind of things, now we’ve got a significant value add where we can significantly jack up the value from $18 million to possibly $25 to $27 million. That right there is a win.

Now, guys, I think about it all the time, like Kevin O’Leary, when I met with Kevin, and Kevin was on my stage and at my event, Kevin said, “Look, in Shark Tank, the deals that got an investment are deals where the guest who is coming on Shark Tank to pitch their business was able to pitch their business in 90 seconds or less.” So, if I went to an investor, I said, “Look, I’m going to buy this building for $18 million, $50,000 a door. I’m going to cut the expenses by $150,000 to $175,000. I’m going to bump the rents by $75 organically. I’m going to bump the rents another $75 by doing LVP, white shaker, and butcher. I’ll be able to take the value from $18 million to $27 seven million. Will you invest in this deal with me, if I give you an 8%, 10% preferred return plus equity?”

I just said that whole thing in less than a minute. That’s our business plan. Done, done, in less than a minute. Cut the expenses by $150,000 to $175,000 through a water conservation program, cutting one of our salary, cutting one of our staff, and saving some money on those utilities and saving some money on the management fee, and bumping around $75 organically, another $75 through a unit turned business plan, and taking the value from $18 million to $27 million, does that make sense when you invest in that? A lot of people are going to say yes. And so, that ultimately is what this comes down to, is looking at deals, looking at the current financials, and then ultimately looking at what is your plan for the pro forma? What do you think you want this thing to look like?

The other thing, I actually got this idea from my buddy Jorge Abreu from JNT Construction. He’s a partner of mine in a couple of apartment buildings. He’s also a general contractor of mine in my 552-unit down in Houston. And Jorge loves putting in soccer fields. These are fenced mini soccer fields. So, like kind of rectangular, you imagine a soccer field, but they’re fenced in. It’s almost like playing indoor soccer, but with a chain link fence with a black coating on it. So, the chain link fence is not dangerous if you bump into it or kick a soccer ball into it, but these mini soccer goals are off the back of this building, there’s all kind of green space, and it’s also right against the ravine. 

So, the other thing I didn’t see and determine was that there were about 30 to 40 units along the ravine that were not charging rent premiums, even though they have a beautiful view of the river and the ravine. So, this is another $30 to $45, plus an extra 50 bucks to live on the ravine that also bumps our income. Alright. So, that’s another opportunity there to push the value of the building, then add the soccer field, it gives you another amenity. The property already has a pool. And so, amenities, cut expenses, raise rents, how are you different than everything else in the marketplace? That’s how you win the multifamily game.

[CLOSING]

Josh Cantwell: So, there, guys, I hope you enjoyed that podcast. And listen, if you want to invest in our deals going forward or take a look at some of our deal flow, go register on our investor portal at FreelandVentures.com/passive. There you can register absolutely free. Of course, you’ll be opting in, so I’ll have your email address, but I’m not going to send you a bunch of spam. I’m not going to send you a bunch of garbage. I’m going to send you our podcast. I’m going to send you our information. And when we have a deal that we’re raising for, a deal that we’re looking for limited partners, we’ll let you know. And you and I can get on the phone. We could set up an appointment, get to know each other a little bit better, and see how we can help each other going forward. So, don’t forget to register FreelandVentures.com/passive.

Also, don’t forget the subscribe button, hit the subscribe button, hit the subscribe button so you never miss another episode. Also, don’t forget to make sure that you subscribe, not only wherever you get your podcasts, on iTunes, but also on YouTube. Okay. A lot of you guys like to listen to stuff on YouTube. We’ve got, I think, 13,000 subscribers on YouTube, a couple of million views, and we’d like to keep jumping that up. Also, don’t forget to join our private Facebook group, go into Facebook, look up Accelerated Real Estate Investor, and join us today. Thanks so much for being here. We’ll see you again next time. Take care.

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