As someone who has been described as a “deal junkie,” I look at A LOT of properties every day.  My eye immediately trains on what could add value to a property I’m considering for purchase or one we are already managing for a client or one that I own.

To develop the “eye”, there is nothing like getting experience leasing your own properties.  The invaluable time spent advertising your units and coming up with a hook to interest prospective residents so that they ignore the hundred other vacants and call you will hone your attention to your competition.  Then showing, negotiating and closing the deal for a new resident is an experience which imbrues what tenants want and will pay for.

The knowledge garnered from being my own leasing agent revolved around what sets my unit, property, neighborhood and management apart.  Why should someone rent my apartment and how can I generate more income were questions which rolled around my head 23 years ago and still do every day.  If spending a week leasing one of your units isn’t feasible, consider spending time with one of your leasing agents so that you can see the process firsthand.  This is invaluable experience and should be done at least once per year.

As all real estate is local, it is important to understand the pluses and minuses of the neighborhood your property resides.  If you have time to get personally involved with Neighborhood Watch or the City Council or even the School Board, it is a positive.  Making your community better from an organic level is great for your property and for those who live in and around it.  If like me, you have many properties in many neighborhoods, encourage your team who works for you to get involved.  We support politicians and organizations which we believe add alpha to the surrounding area.

Even more local than your city and neighborhood is your property.  Visiting properties, particularly newly constructed or newly refurbished by large institutions can inspire new ideas.  Many of the largest owners hire consultants who poll residents to see what they are looking for and they vet the newest trends.  In other words, you can draft off of the most fashionable ideas for the cost of your time touring the properties.

One trend we picked up on is open meeting space.  Even though everyone has their own unit, a popular amenity is a comfortable lounge in which to connect to Wi-Fi (another popular feature).  Just like everyone could enjoy coffee in the comfort of their own home, many people enjoy a cup at their local gourmet coffee shop for the experience.  Plus it offers a place for collaborative work space away from their own apartment which may be unkempt.  Lastly, all properties have a roof but very few offer a roof deck (another place for a meeting space particularly if you own in area with a temperate climate).

A fitness room can be simply added by purchasing a couple of aerobic machines (i.e. elliptical and stationary bike) and a stretching mat.  We recently did this in a large laundry room in a hip area of Atlanta.  Add a flat screen television and some mirrors and you have a valuable amenity which in our case caused a spike in laundry revenue since people brought their dirty clothes with them to the fitness/laundry room.

More and more residents care about their carbon footprint.  One thing we advertised in Austin, Texas and Las Vegas, Nevada was our extremely low water usage in “zeroscape” landscaping.  The best part for us is that both cities offered rebates to install hearty low water foliage along with rock instead of grass.  It looks very good and our water bill shrank significantly.  A win, win, win situation.

Lastly, the apartment itself needs your eye.  As boomers are getting older, making bathrooms handicap accessible by installing handrails near the toilet and in the bath tub has become popular.  Things to make life easier for older residents might keep them from leaving your apartment for another property.

We have found that adding a small pony wall in a large studio can create a delineation that feels almost like a bedroom has been added.  While we don’t call the new unit a 1 bedroom, we do label it a “Grand Studio” and charge a premium.  It is rare for me to walk into an apartment and not find something that could add value.  Test your eye by going into one of your units which you haven’t seen in some time.

The last thing to set you apart is good management.  If you make use of a third party management company, audit them by popping into your property and calling the phone number to see if someone picks up right away.  Check their advertising by going on-line as a prospective resident.

Are maintenance requests handled in a timely fashion, is the property kept clean and appealing and is the manager friendly and responsive to residents?  Does management show good form in enforcing house rules and collecting rent?  These are valuable questions to constantly ask in making sure that you set yourself apart from your competition.

It is a huge positive to develop and hone your “eye” as you will benefit directly from this skill.

Last month I discussed whether we are in the late innings of the current apartment recovery/boom.  This month, I’m going to share some thoughts on data swings away from homeownership and towards renting.

Since the Great Recession, total debt to GDP has increased by nearly 35% across the major economies.  The biggest borrowers are Japan, the Eurozone and China.  The graph in Figure 1 supports my theory that bank balance sheets were simply moved from investors to taxpayers.  I was surprised that the US’s share debt to GDP has shrunk given the rise in deficits and Quantitative Easing measures.

Figure 1

Source: Mauldin Economics / Hoisington Management

In any case, the government debt loads have increased substantially which will be a burden on businesses and taxpayers going forward.  In the United States, we are seeing a net loss of businesses.  In Figure 2, you can see the trend over 33 years (ending in 2011).  As a business owner since 1993, I’ve seen the environment (particularly in California where I’ve resided my entire life; I have done business in many states and in 2 other countries) continually become more onerous.

Figure 2

Source: Mauldin Economics

In Figure 3, we have had an uneven recovery.  While the low wage earning jobs have more than fully recovered, mid and high wage earning jobs have not come back nearly as quickly.

Figure 3

Source: www.nelp.org/lowwagerecovery2014

So how has this effected real estate?  The housing market’s recovery is owed to investors who have been the largest buyer of homes since the recession started.  New Real Estate Investment Trusts were formed to turn those purchases into rentals.  In Figure 4, we see that the young is less likely to own a home now than in the past.

Figure 4

I have read a number of articles wherein the description of Millennials (born between the early 1980’s – early 2000’s depending on the source) are a group of people who care less about ownership.  They will favor renting everything from bicycles and cars to computers and housing.  As someone who employs many millennials, I have seen a mastery and comfort of technology along with technological change.  I haven’t heard of a desire to own any less but have noticed this younger generation has come out of the starting gates strapped with debt.

In Figure 5, we see the rise in student loans (along with defaults) over a 10 year period.  I would argue that the reason for the low ownership in Figure 4 is due to fewer high paying jobs in Figure 3 and higher debt in Figure 5.  Furthermore, the world debt to GDP levels and fewer business starts portend economies which push businesses and taxpayers evermore towards less take-home income.

Figure 5

As we are a nation of immigrants and new arrivals to our country rent on average for over 10 years coupled with our youngest generation of adult Americans who are saddled with loans, I feel comfortable that rental housing will be a strong business for many years to come.  As apartment owners, the data showing a growing market of tenants is certainly in our favor.

I’m constantly on the lookout for great deals to buy, new strategies to improve management and information so that I can analyze the market.  Always on my mind is whether the timing is right to purchase the next deal.

A number of Observations have given me pause and I’ll share them with you:

1.      Prices of buildings by any measure in Southern California, Las Vegas, Austin and Atlanta have gone up at a faster pace than rent increases.

a.       At the same time, interest rates on mortgages have moved up.

2.      The volume of letters and calls directly from buyers who are targeting properties which I’ve purchased over the last 3 years has increased dramatically (I receive calls from brokers on a continual basis so that is almost impossible to use as a measurement).

3.      Properties being sold prior to be fully repositioned and/or with financing that must be assumed (in other words, many sellers are rushing buildings to market earlier than planned).

4.      Offers from equity lenders.

 While the first three observations in and of themselves do not necessarily mean that we are at a point of going to the sidelines, the fourth point caused me to re-evaluate my strategy very carefully.  The person who met with me works at a very large debt and equity group with a nationwide footprint.  They provide all levels of debt including a portion of the managing partners down payment which is loaned against the managing partner’s equity and also fees for operating the partnership.

He said that institutional equity (majority of the down payment) is still demanding an Internal Rate of Return (IRR) in the mid to high teens (typically 15-18%).  I asked how one could achieve this as I thought about observation #1 and #1 a. above.  He said that my fellow property syndicators had abandoned fixed rate debt and instead went with “structured adjustable rate mortgages (ARM’s) which initially would lower the interest rate by as much as 3% (in comparison to a 10 year fixed rate loan).

They also moved their buying to tertiary markets where they could achieve another 1 – 2% in Capitalization rate (Cap Rate).  Instead of Atlanta, deals were being bought in Selma, Alabama.  Instead of buying in Charlotte, North Carolina, deals were being bought in Winston Salem.  In California, buyers were passing on Los Angeles and San Jose and were pursing buildings in Fresno and Bakersfield.

Lastly, a syndicator could leverage their own down payment (a portion of the equity invested typically comes from the General Partner) by borrowing half of what they were going to put in.  The cost of this loan would be a hurdle rate (a guaranteed rate of return of 10%), a portion of the profit at refinance and/or sale and also a portion of the fees charged by the General Partner.

If everything goes right in the deal (interest rates stay low, the tertiary market stays strong, income is raised through a reposition and/or market rent growth and the property is sold at a higher price), the General Partner and the investors will do very well in this structure.  If one or two of these factors goes wrong, the margin for error is slim.

That is the point of observation #4, the risk / reward ratio has become more risky.  Given all of the factors, I am deeply concerned and made the decision to avoid tertiary markets.  I still favor fixed rate loans as an insurance policy against a rising interest rates so with my risk aversion, it would make hitting 15-18% IRR’s far more difficult.

While I am still bidding on properties to purchase, it feels like we are getting into the late innings when investors throw more and more caution to the wind.  I hope buyers lower their risk profile organically but people and markets rarely work that way.  It won’t take much to go askew for many of the latest purchases to go wrong which should be a reminder that real estate is a cyclical business.

Definition: The black swan theory or theory of black swan events is a metaphor that describes an event that comes as a surprise, has a major effect, and is often inappropriately rationalized after the fact with the benefit of hindsight.

It is hard to believe but I have been investing in real estate for 22 years.  Thus far, I am proud of my track record of both investing and also sitting on the sidelines when deals stopped penciling.

As a history major in college, I enjoy viewing past as prologue and don’t mind being viewed by others in the industry as overly cautious.  During the boom days of the mid 2000’s, I called myself Chicken Little as I knew the sky would fall.

Today, my tea leaves tell me that we (the world) survived a massive overleveraging of the intertwined financial system.  This was done through some fantastic financial engineering by various governmental organizations who simply moved the liabilities from banks to taxpayers all over the globe via opening up their balance sheets (printing money / running deficits).  Not to mention savers all over the world who saw interest rates drop below inflation and were encouraged to buy (prop up) assets or face the punishment of losing purchasing power for doing nothing.

What I’m saying is that I believe that the bill for the tech bubble and then the credit bubble (fostered to get us through the dot bomb explosion) never got paid and is hanging over all of our heads.  I am convinced that this house of cards will collapse and the balance sheets of last resorts have been used.

While I don’t know where or when the Black Swan will appear, I suspect it will be a sovereign debt / bond crisis in China, Japan, Europe or the US and will spread quickly around the globe.

Unlike the last bubble period when I found comfort on the sidelines and keeping my cash, I believe my money is safer in hard assets which provide yield.  This is because I don’t know any currency around the world which is tied to anything but investor confidence in that country’s ability and willingness to pay its debt.  So instead of overleveraged fiat currencies, I continue to favor the following: Distressed real estate in Southern California, Las Vegas, prime areas of Atlanta, Austin and farms in Southern Georgia.  I have a few properties in escrow in Southern California but am not sharing any details since I’m working through the due diligence and will be retrading on the price.  I also put a distressed medical office building in Las Vegas under contract but again, it is far from a lock that I’ll make that purchase.  I share these to let you know that I am ready to put my money where my mouth (or pen) is and am actively pursuing that next smart deal even if I come home with nothing in my nets for many months or years.

Overseas, Berlin and Shanghai proved to be smart purchases in the past so I plan on investigating potential opportunities in Southern Europe over the summer.    We’ll see if distressed real estate in the most fun places across the Atlantic looks interesting.

Another area of interest is marijuana.  I see the legalization of that green leafy plant to be a when and not an if and it will eventually happen nationwide.  The significance is that it is a multi-billion dollar industry which is largely being run underground.  Legalizing and legitimizing the industry will open up a massive opportunity for entrepreneurs everywhere.  Like I did when I investigated farm land opportunities in Georgia (consulting with farmers and agriculture professors), I plan on doing the same regarding land in Northern California because it is in my backyard and there is a long history of cultivation in that region.  Again, this may all lead to nothing but I’ll be reporting back my findings.

Too often I hear people lament that the best opportunities to invest in anything were in the past.  While hindsight is indeed 20/20 much like knowing yesterday’s lottery numbers, people will look back at today with the same nostalgia.

I am often asked for the recipe for success in real estate.  While my quick response is always “buy right,” that only scratches the surface.  What do you do when you close escrow to maximize your investment?  This is a different answer.

The secret is to LISTEN.  While it is easy to simply think, “of course I already do that” but then you wouldn’t be listening to me.  My entire career has been built on what has come through my ears and I’ll explain through my story.

My father told me while I was in high school that investing in houses had been very profitable for him.  I asked him to tell me why and I learned a valuable lesson: most people will share their knowledge if asked (even if they are not your Dad).  He gave me many ideas to think about and a seed was planted which would later germinate.

After college, I decided I wanted to find a way to make some extra money and enhance a future retirement so I thought back about the conversation with my Dad.  I then signed up for a seminar given by a person who had been very successful in purchasing distressed homes.  At this seminar, I listened intently and asked many questions (and followed up by calling with even more questions).

I bought some houses and was enjoying some success in my new part time venture.  While hanging out with one of my childhood friends, his father (who had never discussed business with me in the past) asked about the investing he heard about from his son.  After sharing, he told me that I should look at buying apartments and explained the lower cost per door and economy of scale.  I listened to him describe the “right deals” for him and how he had made a lot of money buying multi-family properties.

While under contract for my first apartment purchase (a 7 unit foreclosure), I hired some professionals (plumber, roofer, electrician and contractor) to assist me in inspecting the property.  I listened intently as they shared likely problems I was going to have as well as issues that had to be dealt with right away.  In some cases, I have opted to not buy properties which I thought were going to be smart investments based on listening to those who know far more than I do about these different trades. For this initial apartment purchase, their reports assisted in my getting a price reduction from the bank.

When I am at an apartment complex, either one which we own, manage or are considering buying, I ask, “how do you like living here?”  The answers I’ve received are often astonishing and have lead to further investigations which have caused management changes, tenant evictions, police intervention, my not buying a deal or my completing a purchase.  What better local expert than someone who lives at the property and in that submarket?

Further on that thought, who better on your team than the on-site manager to share the problems at the property and more importantly how to fix them.  The danger that we all face after attaining success is that we can fall into the trap of thinking we have all of the answers and dismiss other opinions too quickly.

At different industry events, I’ve met people who have given me fantastic advice and also leads on some great purchases.

My wife who is a traveling occupational therapist was treating a client in their residence which was an apartment in a 51 unit building.  They mentioned that I should buy this building since the owners died and nothing was happening.  I listened intently and did not discount that many leads do not pan out as you just never know.  It turns out that we were able to buy the property through probate at a deep discount.

While I could attribute my success in the apartment business to many different factors, none are more important than the ability and discipline to LISTEN intently.  Besides, the easiest way to convey respect to another person is to simply listen.

And the fringe benefit of listening: “Better to remain silent and be thought a fool than to speak out and remove all doubt.”– Abraham Lincoln

Listen up!  An amazing education awaits…

As we start to get rolling in our new year and the President of the United States has given the State of the Union, I want to share my State of the Real Estate Market.  Over the last couple of years, Capitalization Rates (Cap Rates) on apartments around the US have dropped and this includes the last 12 months when at the same time, rates on the 10 year Treasury have risen.  We can see in Figure 1 that the bottom was in May and the high was in December.  From peak to trough, in 8 months, the rates went up 138 basis points.

Figure 1

While rates were rising, the Federal Reserve was increasing its holdings of US Treasuries.  The Fed Chairman Ben Bernanke has indicated that Quantatative Easing will be tapering once certain benchmarks are reached and one would believe that those policies will continue under the soon to be Fed Chairperson, Janet Yellen.  In Figure 2, it is clear that while the US is not alone in expanding its balance sheet, its pace of late is the fastest.

Figure 2

The Fed has indicated that for tapering its bond purchases (or money printing), it is focused on lowered unemployment and also a target of 2% annual inflation rate.  Almost all of the pundits talk exclusively about unemployment while ignoring inflation.  In Figure 3, we see the unemployment rate (the U3 from the BLS) has gone down for the last three years.

Figure 3

The other part of the Fed’s stated equation on ending Quantitative Easing can be seen in Figures 4 and 5.  Clearly government measures of inflation doesn’t seem to be very strong and my bet is that while the Fed continues to give positive sound bites, it will not stop its purchasing in the foreseeable future.  Remember that the rates went up when there was only a discussion of slowing the bond purchases even though they didn’t actually taper.

Figure 4

Figure 5

Generally speaking as someone who operates many thousands of apartments around the United States, it feels like the economy is doing alright.  Not as strong as the bubble years but stronger than 2008 – 2010.  In Southern California, most buildings have few vacancies if any.  With Cap Rates teetering around the level of the borrowing rates, we are in bubble territory again unless one believes that rents will be rising faster than expenses and interest rates.

Remembering that I have stayed out of financial trouble through my investing career by not gambling on greater fools buying from me so that I can flip for a quick profit, I am focused on cash flow and hopeful upside potential.  Distressed properties are disappearing and an example is Figure 6 showing home sales in California which was one of the worst five markets in the US after the bubble popped.

Figure 6

My biggest concerns revolve around a potential economic shock which hampers occupancy and/or collections.  Most purchasers don’t factor a down market into their numbers.  The other concern is stagflation which would mean higher interest rates without a rise in rents.  While I don’t think this is likely, I could see several scenarios where it could occur.  Remember, it is always healthy to picture the rainy day and how you would react if such a situation happens.

I am currently looking for opportunities to purchase in three states and of course will not buy if there is negative leverage in the pricing. For downside protection, I am putting more money down on my deals and taking on less debt.  While this might well lower my future Internal Rates of Return, it is my insurance policy just in case a nasty scenario plays out.

Positive thoughts alone don’t win championships.  Meticulous planning and focus of attention are essential as well.  Legendary coach John Wooden said that “luck is the residue of hard work.”

As we enter 2014, how will your properties perform?  Will they be champions or will the results be subpar?

As all properties and markets are different, let’s discuss the strategies necessary for successful operations.  First, we must define what a successful year looks like.  I compile the previous 12 months numbers (commonly known in our industry at the “Trailing 12”) and break it down from top to bottom.

Here is my check list for the income generation:

1.  Are your rents at market?  It is important to know what the comparable units in your submarket are renting for.

2.  Are your rents level?  Is there a big difference between what you are charging for two similar units?

3.  What was your vacancy, delinquency and concession loss?  Were those better or worse than the market?

4.  If there is on-site personnel, have you evaluated their performance and their compensation?  Be careful not to be penny-wise and pound foolish with the team at the property as they are the most important people other than you in the operational equation in my opinion.

a. Consider a competitive compensation structure with a generous bonus system which rewards the team in a way that aligns your interests with theirs.  For example, giving bonuses based on collections and not simply rentals.  A new warm body occupying your apartment doesn’t do you any good if they are not paying.

5.  Do you see positive momentum in the rents?  If so, budget increases during the year.

Once these questions are answered, you are ready to budget what a successful 2014 will look like for your rental collection amounts.

The check list for expenses also continue with a review of your Trailing 12:

1. On a macro-level, did you have any expense items which jumped out as surprisingly high?  Often times when I am considering buying a property, I notice that roof or plumbing repairs grab my attention.  After due diligence, it is clear that a major capital expense to replace either of these systems is needed which will drastically lower the expense item in my budget going forward.

2. The biggest line items are typically property taxes, insurance and utilities.a. For taxes, can they be contested as too high per the local laws?  If so, in many areas around the world, there are services who will handle this for you and their payment is a percentage of your savings.

a. For taxes, can they be contested as too high per the local laws?  If so, in many areas around the world, there are services who will handle this for you and their payment is a percentage of your savings.

b.  Insurance should be bid out annually to ensure that you are getting the best coverage at the best prices.

c.  Regarding utilities, there are several ideas:

i.      Can these be lowered making you a more green owner with more green in your pocket?  In Las Vegas and Austin, we changed our landscaping to “zero scape” which will cut our water bills.  In Las Vegas, the city heavily subsidized this procedure.

ii.      There are often utility programs (i.e. lighting and insolation) which are subsidized by the utility companies or government which can lower the property’s usage.

iii.      Can you submeter or institute a RUBS (resident utility billing system) whereby the residents pay for a portion or all of the utilities?  When people pay for something, they are far more likely to monitor its use and thusly it is common for usage to go down after the payment responsibility transfers.

3. Have you negotiated with your biggest subcontractors?  When you are going through your last 12 months of expenses, you might be surprised how much you paid for painting, flooring, plumbing and landscaping.  Bidding the services out annually is healthy.

As you review your expenses, be careful to make sure that your property looks sharp.  You want to be able to compete favorably with your competitors who will be vying for the same residents.  Be realistic in your spending so that you do not cut your nose off to spite your face.  This includes taking care of your residents.

It is nice to include at least some amount of money for resident appreciation.  It can be for prizes at Halloween or a community building activity where a BBQ is hosted or sandwiches are catered.

I recommend breaking the budget down for all 12 months and then comparing the year-end 2014 totals with your 2013 results.  Hopefully your budgeted profit will be up from last year.

Now that you have completed the budget, it is important to review on a monthly basis.  When I go through my numbers, I do it via a budget comparison which shows how the properties are doing that month and also year to date against the budget I created.  Adjustments often have to be made during the year for unforeseen situations but that is what property and/or asset management is all about.

If you take the time to define and plan for success and then actively review that plan throughout the year, you will enjoy positive results.  Good luck as you enter the 2014 season with your building(s)!

I am very lucky to be able to enjoy a career investing in and managing commercial real estate throughout the world.  To boot, a wonderful company in WASH Laundry thought my writings were interesting enough that I have proudly been their Apartment Reporter for several years.  I’ve chosen a career which I love and because of that I don’t really consider anything I do to be work.

That said, because I care deeply about my reputation with investors, clients of our management and you dear readers, I stress the little things.  In fact, this is my second draft for the December Apartment Reporter.  The first was my perspective on the strong Chinese demand for California and Vancouver real estate, respectively and the effects on those markets.  I also wanted to share why I believe we are in the midst a long-term economic shift in the United States whereby the population is going to be renters as opposed to owners.

And then over Thanksgiving Day, I took stock of 2013 and began my annual plotting of goals for the next year.  Four wonderful people who were important in my life (3 of them were in their 50’s) passed away in the second half of 2013.  As I thought about the state of the world and how best to own, manage and write about real estate, I needed to take a moment to reflect about having an attitude of gratitude.

While there are many ups and downs in owning and managing real estate, we do have an opportunity to make a difference in peoples’ lives through providing quality housing.  Done right, we can epitomize the positive results of the “broken window theory” and begin and/or be part of the uplifting of a neighborhood which increases value for us and our neighbors.

I have found that I make the best decisions when I am in an appreciative mood.  When people are anxious, angry or upset, the mind resonates those feelings through the thought process.  For instance, while going through a list regarding residents on a list to being eviction proceedings, I was presented with a long term resident who lost her job because she wasn’t able to continue working while enduring chemotherapy.  They had gone through their savings and had fallen a month behind in paying their rent.  During that month, she was able to secure some steady work with flexible hours.  I took a moment and thought about when my wife was in the midst of her successful fight against cancer and how grateful I was that she survived and is still healthy.  When questioning the costs involved with replacing this many year resident, I was told that the building would need to offer a one month free rent incentive to the next inhabitant after replacing the carpet along with repainting the apartment.  I asked the supervisor if we offered a one month special to the current resident (which would wipe away the delinquency), would she and her family sign a one year lease?  The answer turned out to be yes and the story ended with a happy ending for our resident, the management team and the investors in the property.  My positive energy was flowing from being sincerely happy about my own life and trying to think of the best possible outcome.

Over the years, I look back at my best decisions from asking my wife to marry me to making what turned out to be astute investments and they almost always involved a mindset of gratitude.  When I draft an e-mail in response to something which has upset me, I now take the time to save the missive as a draft and will sleep on it before hitting “send.”  If I don’t significantly change the e-mail then I’ll simply delete it as my frame of mind shapes my responses in a night and day fashion.  It is amazing how different the world seems when your attitude goes from negative to positive.

As we close out 2013, I want to offer that I am thankful to be alive and am looking forward to a happy, healthy and prosperous 2014.  I sincerely wish the same for you!

There is a rush when you are told that you have a property under contract to purchase.  I got my first taste in 1991 and have enjoyed that high ever since.

Much of my work is done upfront during my underwriting when my team and I review the trailing 24 – 36 months of financials.  I also like to do a preliminary walk of the property even if it is done quietly by following a resident into the building.  As nearly every seller’s number one goal is to maximize price, I try to offer the amount at which I am prepared to ultimately purchase the property.  That doesn’t include the negotiations as it is rare to land on the final purchase price on the first offer (real estate people love haggling).

Once a property has been put under contract, I bring a physical inspection team with me and every unit is inpsected.  While many times “a sampling” is offered, I have spotted so many interesting issues over time that I insist on a complete viewing.  If I note any structural issues, I engage an engineer.  It should be noted that during the physical inspection, opening dialogue with the residents and the staff can uncover previously undisclosed problems.  I’ve had sink holes (soil issues), shifting buildings, flooding, roof leaks, mold and crime issues raised by people on the site visit which came as a complete surprise to me and ultimately led to more extensive investigations.

Whether you are a beginner or a seasoned veteran, I can’t emphasize enough the importance of taking the time and making the effort to be a part of the inspection.  I’ve avoided making purchases which later resulted in big surprises.  I’m not mistake free as I have been stung by overestimating the condition of the roofing and plumbing.  Nothing like an unbudgeted re-plumbing or re-roofing of a property to knock the return on investment for the year…

Another important aspect of the due diligence is a lease audit.  It is vital to make sure the people occupying the property have been properly screened and can actually pay the rent.  Sometimes a desperate or unethical seller will move people in so that the property is full and appears to be running well.  During the physical visit to the apartments, the team counts toothbrushes and makes a note of how many there are.  If there is only one and the qualification for the unit included the income of three people, red flags arise.

I also make a point to compare the bank deposits with the income listed in the profit and losses.  Just because warm bodies and furniture are in an apartment doesn’t mean that money is hitting the bank.  A friend of mine who owns several thousand units made a purchase and later found out that many of the residents were not qualified, couldn’t pay the rent and had to be evicted.  An extremely painful experience for a seasoned owner.

Go with your gut and ask questions.  I suggest putting on a detective’s hat with the mindset that issues are being hidden from you.  There are almost always surprises and sometimes it will include something which the seller knew nothing about.

On the positive side, I have found hardwood floors in pristine shape which were covered by carpet.  In a recent inspection, I was told that the property was master-metered for gas.  When I walked the property, I noted that the property used to have individual gas meters and then my plumbers verified that the building was still individually plumbed.  It may be a simple fix to add immediate value and cash flow to the property.

As your job as a property owner begins when escrow closes, it is vital to gain as much knowledge as possible about your investment BEFORE you own it.  Since it is highly unlikely that you closely observed the being built, a complete check-up is key so that you know the current health.

Some of the most valuable money I’ve ever spent was paid to thorough inspectors and a few of my best purchases were the ones that I didn’t make.

In Septembers article, when I said, “the pressure cooker is heating up and something has to give,” something indeed gave; The Federal Reserve.  The Fed unexpectedly left rates unchanged and made clear it would continue asset purchases thus causing the 10 year treasury yield to dramatically fall.

The recent squeeze of rising interest rates and lowered capitalization rates which I described should be a reminder or perhaps a warning that the interest rates are being manipulated.  It showed that treasury investors and their expectations affected interest rates since the players in the market currently have confidence in the Fed’s ability to contain interest rates.

As countries in Europe have demonstrated over the last several years, confidence can disappear over the course of hours and interest rates can skyrocket immediately.  While we real estate investors enjoy a portfolio of bricks and mortar and transactions which take 60 – 90 days after marketing the property for 30 – 60 days, that isn’t the case for bond investors.  They buy and sell with via a key stroke of a computer and thusly the real estate world can be turned upside down abruptly.

The quandary which I struggle with is the Federal Reserve’s asset purchases (money printing) which has worked in lowering interest rates to record lows (we are off a bit from those lows as I write this article) and has pushed real estate prices down relative to their cap rates.  With the rates artificially low then reciprocally the prices are artificially high.  Since I believe that the price the United States will pay for this policy is inflation, does converting greenbacks today to hard assets make sense?  My investment strategy says it does as long at 10 year financing is employed so that inflation has time to dig in once interest rates start to rise.  In other words, I am willing to pay higher interest rates for a 10 year fixed rate instead of lowered payments for a 5 or 7 year fixed rate.  Should rates stay low for 10 years then I will have paid for insurance that I didn’t need but I feel better with a longer runway before I have to refinance.

Further to my concerns is that the federal government is running a deficit approaching $17 Trillion and is benefitting from the artificially low interest rates along with the Federal Reserve’s purchasing of the debt.  When confidence wanes or adjusts and interest rates rise, a sizable portion of the government budget will need to be allocated towards servicing the debt and at some point in our future, austerity will be ushered in or foisted upon us.  Austerity (cuts in spending) usually brings about a drop in GDP and pain throughout the economy.

More immediate concerns are household income levels as that correlates directly on our ability to push rents.  In other words, rising median household income is great for us as apartment owners. In Figures 1 and 2, we see that while median income isn’t rising, it isn’t falling either and appears to have leveled off.

Figure 1

Figure 2

I’m hopeful that this income stabilization is a prelude towards a rise past 2007 levels.  Even though much of my concern is directed towards the actions of the Federal Reserve and our politicians in Washington DC who in my view have built a house of cards on debt/money printing, I am confident that the American people will weather the coming storm.  Plus people need a place to live which is the main reason why I predominantly choose multi-family for investment even though it is the most management intensive of the asset classes.

I’ve noted that the recent rise and fall of interest rates has brought a new urgency to many sellers.  I’m hopeful that I will be in escrow soon on a couple of deals which stalled because of the rise in rates but look more attractive given the recent fall.