You’ve found a deal, but your work has only just begun. The majority of the deals you come across will not pan out, while a small percentage of them will be smoking hot. How does one tell the difference? Well, here is a list of 11 questions that once answered, will let you know where or not you are sitting on a golden egg or a rotten egg.
How did you find the deal?
If you’ve found a deal, typically, it is either an on-market deal or an off-market deal. If it is an on-market deal, that is okay. However, expect to face a competitive bid situation. You can find good deals that are on-market, but it is important to understand up front that the price will likely be driven up due to competition.
If you have uncovered an off-market deal, you are sitting pretty and it is worth digging into further. More likely than not, there won’t be a bidding war, have a direct line to the seller, and have the potential for putting together a more creative financing structure.
Why is the seller selling?
You will likely hear a story from the seller as to why they are selling, and it won’t be 100% accurate. However, if you continue to ask the same question, in time, you will hear enough recurring themes that you will have some semblance of what the truth actually is.
Do you have all the necessary information to evaluate the deal?
At the very least, the three documents you need to evaluate a multifamily deal are (1) the trailing 12-months of financials – 24-months is ideal – that is often referred to as the property and loss (P/L) statement, (2) the rent roll, which will show you the current rents, and (3) if it is an on-market deal, the offering memorandum, which is the package that the broker puts together containing all the deal information.
Without these items, you won’t be able to evaluate the deal accurately.
What is the deal upside?
When buying a multifamily property, it is important to know, specifically, how you will add value. The majority of people investing in the multifamily niche are doing so because they are trying to add value and in turn, force appreciation. Therefore, it is important to understand the potential upsides before purchasing the deal.
For example, if you plan on investing $5,000 into each unit and increasing the rents by $75, you need to know exactly how you will increase the rents with the $5,000 in renovations, as well as if the market can actually command that type of rent premium.
What is the net operating income (NOI) when YOU underwrite the deal?
The key distinction is that you are underwriting the deal and calculating the NOI, and that you are NOT simply relying on the broker’s pro forma. Make sure that you underwrite the deal and that your property manager partner signs off on your results. It is one thing for you to come up with a NOI, and another for the property manager partner to validate those numbers based on their experience and knowledge of the market.
What is the market cap rate?
It is important to know what the entry cap rate is so that you know you are buying the property at a competitive price. But, it is even more important that you project, as accurately as possible, the exit cap rate so that you can understand the exit strategy.
What is the value of the property?
Once you’ve determined the NOI (question 5) and the market cap rate (question 6), you can calculate the property value (NOI / Cap Rate).
Can you exceed the goals of your investors?
This question assumes that you have investors in the deal. Can you exceed your investor’s goals, while still receiving adequate compensation yourself?
If you don’t have investors, then ask yourself, “Can I exceed my goals?”
On a scale of 1-10, how well do you know the sub-market?
Your level of understanding of a market will make or break a deal. It is all about knowing the market, submarket, demographics, school quality, etc.
Who are your local team members in the sub-market?
Do you have a local team in the subject property’s market? If so, have they successfully implemented a similar business model in the past?
What type of financing is on the property?
Does the seller have an assumable loan? What are the terms of the loan? If the seller doesn’t have an assumable loan, what new financing will be put in place? A bridge loan to long-term financing? Long-term financing? Something else?
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.