March 24, 2017

JF934: How to Find DEALS in a HOT Market #FollowAlongFriday


Appears to be impossible right? That’s only because you think that way, deals are ubiquitous yet you just need to know who to talk to. Hear how Joe’s partner reached out to a very important contact and found a smoking deal, all he did was add a little more value then the next guy.

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follow a long friday

Joe Fairless: Best Ever listeners, how are you doing? Welcome to the best real estate investing advice ever show. I’m Joe Fairless; this is the world’s longest-running daily real estate investing podcast. We only talk about the best advice ever, we don’t get into any fluff.

Today is Friday, so we’re gonna do the special segment, Follow Along Friday with my friend and co-host for these segments, Theo Hicks. Theo, hello.

Theo Hicks: How’s it going, Joe?

Joe Fairless: It’s going well. And also, with our mascot Jack, the Yorkie who has been on a hunger strike over the last week or so, but now he’s eating again. I don’t know what he was protesting, but he is now officially eating brown turkey, and all is well in Jack’s world, too.

Theo, how do you wanna approach today?

Theo Hicks: So we’ve got a new deal we’re closing on as of today’s recording; it will be two days when I actually post this (two days prior). Like most of your deals, usually after you’re done, or at least towards the end, we’ll go back and analyze any lesson that you can learn, that you’re gonna apply moving forward. Today the topic is around finding deals in a hot market.  Let’s go over the lesson that you can learn, and maybe some more details on the deal based off of that.

Joe Fairless: Yeah, so let me tell you the story about it. We have actually two deals that we’re closing. One is today, and the other is in a week and a half, on 3rd April. The reason why I’m mentioning both of those deals is because that’s what ties into how to find a deal in a hot market. The answer to that is you have to create the opportunity, and now I’m gonna get more specific on what “create the opportunity” means.

There was a deal that was highly publicized and marketed by a broker, it was an on-market deal. We loved the deal, but because it was marketed, the price kept getting pushed up, so we weren’t sure if it made sense to purchase because of how competitive it was. So what we did is we looked across the street and we saw another apartment community. The apartment community that was highly marketed is over 300 units, and it is primarily one-bedroom apartments. The one across the street, over 200 units, and it’s primarily two and three-bedroom apartments, so they naturally complement each other very well.

We have a very good relationship with one of the brokers in Dallas, and he actually knew the apartment owner across the street.

Theo Hicks: There you go.

Joe Fairless: He reached out to that apartment owner across the street and we negotiated the purchase, not only the on-market deal at the price that it was going for, but the off-market deal at a significant discount because it was an off-market deal. So we could afford to buy the on-market deal at a price that we were still comfortable with, but it was really at the threshold of comfort level, because we would have economies of scale from operations, management, maintenance staff etc, plus a natural referral source, because you’ve got one-bedrooms in one apartment and two-bedrooms and three right across the street. We are closing on one of those, actually the two and three-bedroom one today, and we are closing on the primarily one-bedroom one on 3rd April.
That is how in a hot market you find deals. You don’t just look at what the brokers are giving you, but get creative and look at what else is around there, and maybe you can package two in one transaction, and I can tell you that nobody on the face of this earth was doing that for this deal. Everyone was looking at the on-market deal, but they weren’t looking at other stuff. If they had, then they might have seen the same thing we saw as a natural opportunity to combine the two from an operations standpoint.

The numbers are working out really well, and I can also tell you that we have never purchased two simultaneously before, and we had to go through our own personal self-reflection. Like, “Okay, if we get this one deal, then can we really pull it off from an equity standpoint if we have both deals? We know we can do one, but can we really deliver?” And we just had faith based on our track record of delivering on every other deal, and lo and behold, we actually had one investor who’s invested with us in the past on multiple deals; he put it all the equity that we needed for both of them, minus the money that we’re putting into it as well. So it was a learning experience across the board, from how you find deals in a hot market (you create opportunities) and also when to strategically stretch yourself based on a situation at hand. We’re closing today, and we’ll be closing another in a week and a half.

Theo Hicks: It’s an amazing story. It’s so interesting that out of all the people that were competing on that deal, they didn’t think about asking about the deal across the street. My question on that is how did that come to be? Were you there visiting it and said, “Oh, there’s apartments across the street… Let’s just reach out to that guy.” Or did the broker mention it to you that he knew the guy that owned the apartments across the street? How did that come about?

Joe Fairless: It was my business partner Frank’s idea. I believe he reached out to the broker directly, or maybe the broker was talking to him about the guy who he knew, or “Hey, there’s another deal across the street if you wanna combine two.” I’m not exactly sure how it transpired… The takeaway is to 1) have the right team members, and 2) have the right relationships in the market, because if we didn’t have the relationship with that broker, then we wouldn’t have purchased the deal across the street, and most likely we wouldn’t have purchased the one that was on market either, because it wouldn’t have been as healthy of a return.

Theo Hicks: Okay, so since you’re buying two properties, as you mentioned, based on the economy of scale, the deal itself made sense, whereas if you were just buying the one on-market deal it might not have made sense because of the higher expense. How do you guys calculate that when you’re underwriting it? The economy of scale difference…

Joe Fairless: There are certain items on expenses that can have efficiency. One of them is the lead maintenance person. Instead of having one person on-site and you’re paying him 50,000/property, you can now split that cost across two properties, because it’s literally across the street. There are economies of scale for marketing and advertising, that’s for sure, and I’d say especially we also have the leasing staff salaries and commissions, and then you also have the ability to just have a natural referral source because it’s one-bedrooms primarily; we’ve 291 bedrooms at one property, and about 182 in three-bedrooms on the other property. These two properties just naturally made sense because of the unit mix, and that’s something that you’ve gotta look at as well. It’s not just “Okay, there’s two properties next to each other, let me buy both.” They’ve gotta complement each other really well.

We are not combining them into one property. We’re not renaming them to one property, and the reason why is because even though they’re directly across the street – you could probably throw a football from one driveway to the other driveway – it’s a really busy street, so we’re not gonna have our leasing agent take a golf cart and tour it with first [unintelligible [00:10:22].21] but instead we are going to have two separate properties, but then just refer them back and forth and be completely connected through the on-site management and know who’s sending who to where.

So there’s economies of scale, but then also because these two fit naturally, we’re able to cut down significantly on the marketing and the lease-ups.

Theo Hicks: Do you think this strategy or this content applies just as well to smaller duplexes or fourplexes? For example, if I’m gonna buy a duplex in an area and it’s on-market, and I see a bunch of duplexes across the street, and the numbers make sense, but it’s a stretch kind of situation… But there’s a duplex across the street that’s off-market – would it make sense to reach out to them if I can get that for a lower price? Does the economy of scale apply to that, too?

Joe Fairless: That’s a good question. When we’re talking duplexes at that price point, you also wanna consider the type of financing, because you might get a better loan for a higher amount of money being financed, therefore it might not be as much on the operations, although certainly when you talk to any property manager who manages one house versus thirty houses, and she’ll tell you “Yeah, you get some economies of scale with 30 houses” and in fact some property managers won’t take on a new customer or a new landlord who just has one house, because it doesn’t make financial sense.

Theo Hicks: Yeah, that’s big right there, too.

Joe Fairless: Yeah, so I’m sure it would make sense, it would help them at least lower the management fee if they’re not managing the properties, because they’re bringing more income to the property management company – at minimum it would do that, if they’re not managing themselves – but then also it could help with debt financing being more favorable, because you tend to get better terms the more you borrow.

Theo Hicks: Yeah… Or something that’s really small, but if you’ve got two properties right across the street from each other and you’re managing it yourself, it would be easier just to drive to one property, walk across the street, do whatever you have to do, instead of having to drive across town multiple times. It’s a smaller win – gas money and time.

Joe Fairless: Yeah, it’s true… And vendors who you contract out, they would be probably cheaper. They might have a fee for just showing up, and if you have two properties next to each other, then there is one fee for showing up, versus multiple fees because they have to drive from this place to two miles down the road. That could be certainly some real dollars that are being saved if they’re all within the same area.

That’s a great question, because I didn’t think about that for smaller deals. Maybe I’ll think about that for my personal portfolio too… Instead of just looking at just a couple that are on the market, also look at right across the street and try to — the challenge is with the smaller deals, especially if we’re talking single family homes… You very well could be dealing with a primary residence person, versus an investor, and then it’s a totally different conversation. But if there is groups of fourplexes or whatever, then yeah.

I can tell you, one of my friends, Jered Sturm and Andy Sturm, who have both been on the podcast before – they have a 30 or 40-unit in Cincinnati, and they are buying I believe 12 units, three fourplexes right across the street from their larger property. It was that same thing where they bought a place, and right across the street they saw it made sense. I believe they’re actually adding those 12 units into their current portfolio on the loan. They’re just rolling those units into the same loan that they have with the community bank.

There are all sorts of creative ways, we just have to actually create opportunities and have an abundance mindset, and don’t look at deals the same way everyone looks at the deals, otherwise you’re gonna have the same price that everyone else has, and you’re gonna be competing based on price. You wanna compete based on value, and how you compete based in value is you’re the only game in town to that particular seller, and you’re able to combine that with a deal like what’s on market.

Theo Hicks: Awesome. Something else that I also wanted to at least bring up in this conversation was I was underwriting a deal for one of your clients, and we ran into a situation where he had a property that was 50% vacant, so we had no one living in it. The owner had $20,000 in delinquent taxes, and it had a lot of deferred maintenance; I can’t remember what the [unintelligible [00:15:08].17] but it wasn’t stabilized at all and it was not stabilized anywhere near in the past at all, so it was kind of like “How do you underwrite that loan?” and I had no idea.

We asked your partner, Frank, and he gave us an answer which I thought was very interesting and I wanted to share it with everyone, if they run into similar situations.

Essentially, what he says is kind of like a four or five-step process. The first thing you wanna do is you wanna find the value of the property if it were fully operational and fully stable. Fully stabilized is 90% occupancy, right? Something along those lines, and hitting market ramp. So figure out what that price is, [unintelligible [00:15:42].00] the cap rate and the value of the property.

Step two is find out how much it’ll cost to cure all the deferred maintenance and renovations to get up to fully operational and stable, and then you’ll have a number there. So you’ve got two numbers.

Next you wanna find out how long it will take from purchase price to stabilization. Let’s say you figure it’s gonna take a year to get the renovations done and get to 90% occupancy, and there’s a dollar value you can calculate based off of that year time span, and he said find out essentially how much money the project will lose during that time.

From my perspective, I was thinking basically like lost rent that you’re gonna lose, plus the amount of money you’ll spend on the loan – I’m not sure what the word for that is, but all those costs – holding costs, I guess… So you got the third number. And essentially, what you wanna do is that max purchase price for that property – it’s gonna be that first number, that stabilized value of the property, then you subtract out all of the forward maintenance costs that you budgeted for, and then you’re also gonna subtract out the stabilization expense loss (holding cost) and that’s a [unintelligible [00:16:52].26]

For this specific example there is the added expense of the delinquent taxes; he said, “Make the seller pay that tax”, a tax lien before we buy the property. If not, that’s another expense to subtract in order to calculate a max purchase price.

I thought that was very interesting, because I was [unintelligible [00:17:11].17] numbers, we get rent rolls, and the previous 12-month expenses, but for this situation that’s impossible to do. You obviously don’t wanna just make a number in your head and be like, “Oh, I was gonna buy it for this number, but I’m gonna buy it for whatever it’s listed for”, because again, the list price doesn’t matter, at least to me.

It seems like kind of a fast way to do it, but from my perspective it sounds like it’s the best way to calculate a purchase price for a property that’s in disarray like that. What are your thoughts on that?

Joe Fairless: Yeah, for fix-and-flippers who are listening, they’re like “This sounds very familiar”, and it’s true, right? If you’re buying a distressed house, then you need to know what is the after-repair value…

Theo Hicks: That’s a good point.

Joe Fairless: And then once you know the after-repair value, you need to know how much is it gonna cost to put into the property, and once you know how much you put into the property, then how long it will take my crew to do that, and what’s the holding cost, hard money cost, whatever… And then I also wanna make a profit on the flip, so what do I need to buy it for, knowing that those are the costs involved and this is the timeframe, and we’re doing that on a larger scale, with a multi-family property.

There’s certainly a lot of similarities with single and multi-family deals, and from a distressed standpoint it shows right there the couple challenges for this scenario that will need to be identified. One is even though you know what the stabilized income would be, you also need to know what the current cap rate it for the market (the prevailing cap rate for the market), because otherwise you wouldn’t be able to come up with a valuation on what it would be stabilized.

Then also there will be an art and a science to the holding costs while you’re renovating it, because there’s all sorts of tricky things that can come up with CapEx expenditures, depending on the type of renovations. Ask any fix-and-flipper what happens when you open up a wall – a big black hole where you dump money into usually takes place. So there are some more unknowns and you have to factor those unknowns into your purchase/acquisition price.

What you don’t wanna do is you don’t want to factor in how much is the cost to get fixed up, what are my holding costs and then make an offer price subtracting that stuff without actually subtracting the profit that you also wanna make on the deal, because we could be so excited about wanting to get a deal and we’re like, “Well, this deal does make sense, because it’s this, and this, and this, and this is the purchase price”… But also subtract out your profit that you wanna make from it, because you’re doing a bunch of work.

Because you also gotta take a look at “Okay, after I do all this stuff – go through zoning approvals, getting permits and all this stuff over this period of time, and I’ve done all this work… Wait a second, is this actually the same profit I’d be making on a stabilized property, if I just bought a stabilized property?” You have to factor that in, and a lot of the times people get so caught up in “Oh, it’s a good deal because the distress will — ” timeout! Make sure you’re factoring in the profit you wanna make, because it might be at the end of the day the same profit you’re gonna make if you just buy a freakin’ stabilized property.

Theo Hicks: Yeah, so in this formula you need to add in some sort of contingency percentage, as well as… When you compared it to fix-and-flip, I was like “I’m gonna need to think about that.” [laughter] And I know about that formula, because it’s basically the exact same thing, and you add in basically what equity you want to earn based off of the work you put in. So yeah, it looks like I’ve got a couple of things to add to this formula and send it to clients.

Joe Fairless: Yeah, absolutely. Cool. I just got good news. Literally, a text message right before we started recording… We most likely have been awarded another deal in the Dallas-Forth Worth area. I got a text and I need to have a conversation. We had a best and final call yesterday with the seller and the seller’s representatives that went well, and we received some initial good news today.

Actually, right after get done with this, I’m gonna jump on a call and talk through that and see where we’re at.

Theo Hicks: Awesome.

Joe Fairless: That would be really exciting. If we do get awarded this deal, it will be a very nice property. More to come on that, because I wanna make sure that everything’s aligned and set up. That’s something that’s pretty cool, because we’ve been making a lot of offers, and just haven’t been able to get to the purchase price that have been winning deals, and we found this one and it made sense. It looks pretty good.

Theo Hicks: Off the top of your head – probably you don’t have an exact number, but how many offers did you out in…? Since your last offer got accepted, how many offers did you put in before this deal came out? Just to give an idea of how many offers you’re putting in.

Joe Fairless: The larger number is how many deals we received. We’ve received probably a hundred within the last two and a half months, since the last time we closed on a deal.

Theo Hicks: Okay.

Joe Fairless: And we’ve made, I’d say about 15-20 offers, letters of intent. We’ve been in best and final round about 4-5 times, but we haven’t budged, or didn’t budge enough for what they wanted, and they went with someone else. In some cases significantly more than what we were offering, in other cases not as much. So 100-120 or so, and then we’re in best and final on a handful now. We’re getting accepted on this one.

Theo Hicks: Out of five you’re putting in offers on, and then one out of 25 you’re actually getting involved in the last steps, and then one out of 100 you’re most likely accepted. I just wanted to know for myself personally the number of deals it takes to find one. It’s not just like sitting here and a deal comes, and you’re up for it! It’s not like you’re getting a hundred percent hit rate, not even close.

Joe Fairless: “Click to purchase…” Yeah, I like that. There’s a big button on my computer that says purchase, and we just purchase it. [laughter] Not quite… It is a process. That ratio also will be dependent on your team’s track record, because the more we do deals, the more likely our offer is gonna be accepted, because of our track record. The call yesterday went really well and they were very impressed with our track record in that market.
Sellers are likely gonna go with people who have experience in that market. That’s not rocket science, I just say that for the point of the ratio. The ratio is a little bit more favorable for us than someone starting out, but not as favorable for us than someone who has more deals completed in a particular market than us.

Theo Hicks: Okay.

Joe Fairless: Cool. Well, Theo, anything else…? Where can the Best Ever listeners get in touch with you?

Theo Hicks: is my podcast. I took a little hiatus from it, but I’m back. I’m gonna make it a commitment now to do two podcasts a week.

Joe Fairless: Wow, two episodes a week!

Theo Hicks: I’m upping the ante. I did one on Monday for the first time in a while, and it just feels so good, doing it, just speaking your truth… That’s the goal. If you’re interested, I’m gonna try to post on Mondays and Thursdays.

Joe Fairless: There is fulfillment in creation, not maintenance, that’s for sure. When we create stuff, we get fulfilled, we get excited. When we just maintain things, it’s not as exciting or fulfilling, that’s for sure.

Theo Hicks: Or just consume…

Joe Fairless: Or just consume, especially all the freakin’ Facebook candy and Instagram stuff… It’s just candy for your mind, it’s not actual substantive stuff for your mind that helps fuel… By the way, on that note – I didn’t expect to mention this, but if you’re looking for a freaking phenomenal book… Oh, man! One of my clients sent me this last night; I got it at 3 or 4 PM yesterday, I picked it up at the post office and I am about 20 pages away from finishing it. That’s how phenomenal this book is. It’s Mistakes Millionaires Make, by Harry Clarke. Holy cow! Everyone, buy this book and read it.

This book – it’s 30 stories about mistakes millionaires have made, and they’re real stories. These millionaires are telling these stories in this book. There’s really intelligent commentary, and they are very strategic mistakes that the millionaires made that will come up in our real estate investing ventures, from overleveraging to mezzanine financing, to acquisitions or deals with some unethical people, working with the government and how the government can just steamroll you; they have unlimited financing, if you get on their bad side…

They talk about the scooter store for elderly people or people who are needing a scooter to get around, and how that company just got steamrolled by the government. It is a phenomenal book, I highly recommend buying it… Mistakes Millionaires Make, I’m going to finish it.

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