A Guide to Profitable and Strategic Investing in 2024
After experiencing a difficult and uncertain transaction market in 2023, we anticipate a resurgence in acquisition opportunities in 2024. It's been a hiatus of over a year since we closed our last deal, Walnut Tower, during which we dedicated our focus on asset management and unlocking value drivers at the property. We believe, however, that new opportunities will soon present themselves by way of market distress. Securing new investment properties at the right basis remains paramount for a successful investment, prompting us to refine our underwriting standards and approach as we re-engage in the market.
As we prepare for the upcoming year, let's revisit some fundamental principles. Effective multifamily underwriting is critical for success in real estate investment, involving a comprehensive evaluation of a property's viability and profitability. Here are some key techniques to enhance multifamily underwriting:
Thorough Market Analysis:
Understand the local market dynamics, including supply and demand for rental properties. Going forward we'll be adding to markets that we're already present in so our economies of scale and ability to execute will grow.
Analyze economic indicators, job growth, and demographic trends, focusing on markets that are projected to experience continued growth and have a story, rather than merely "hot" markets.
Property Inspection and Due Diligence:
Conduct a detailed physical inspection, including walking through every unit to understand the true condition of the property.
Review property documents and engage third-party vendors for inspections of major elements like HVAC systems and roofing. Due to the 1960’s vintage of Walnut Tower, we conducted extensive third-party inspections on the property and worked with the seller to address all major issues prior to our closing date.
Financial Analysis:
Scrutinize historical financial performance, avoiding reliance solely on a seller's T12.
Project future income and expenses with realistic assumptions, emphasizing stress testing for long-term success. Now more than ever, it is so important to remain conservative and disciplined with underwriting assumptions. Never do a deal just to do a deal!
Cash Flow Analysis:
Evaluate the property's ability to generate positive cash flow. With significant increases to taxes, insurance and payroll costs this past year, this must be factored into future operational projections.
Consider the debt service coverage ratio (DSCR) to ensure sufficient income to cover debt obligations. We always want to have a sufficient “buffer” in order to have the ability to ride out any turbulence in the market.
Cap Rate Assessment:
Calculate the tax and insurance adjusted cap rate and ensure positive leverage by having a higher cap rate than the cost of debt. In 2023, we have seen very few deals with positive leverage, which is the primary reason why the transaction market has been completely stalled. However, once distressed opportunities begin to flood the market, we believe that cap rates will begin to rise to more advantageous levels.
Compare the cap rate to similar properties in the market for benchmarking. As the transaction market begins to pick up in 2024, we will have more datapoints to compare deals to.
Understand Financing Options:
Explore various financing options, considering long-term fixed debt as the ideal solution. However, with rates most likely falling over the next 2 years, it's important to think about other options to capitalize on that decrease.
Evaluate loan terms, interest rates, and loan-to-value ratios, opting for more equity if necessary. Raising additional equity or layering in a preferred equity piece can help de-risk the investment opportunity.
Risk Assessment:
Identify and assess potential risks, including market volatility, interest rate fluctuations, and changes in local regulations.
Consider potential economic downturns and their impact on rental demand and property values. Fortunately, past recessions offer hope that multifamily is one of the best performing asset classes during that time.
Exit Strategy Planning:
Develop a clear exit strategy aligned with investment goals, such as a long-term hold or renovation and resale.
Consider potential exit hurdles and maintain flexibility in the plan. Whether it's a sale or refinance, our goal is to give ourselves a window and not just have a firm "five year hold period".
Legal and Regulatory Compliance:
Ensure compliance with local zoning laws, building codes, and regulations.
Be aware of any pending legal issues, potential liabilities and insurance claims associated with the property.
As we look to build our portfolio in 2024, let's leverage these multifamily underwriting techniques. Informed decisions, risk mitigation, and maximizing potential are key to a successful and profitable investment in the multifamily real estate market. It’s time to put 2023 in the past and look forward to a successful 2024!
