At RealtyMogul, we offer all members access to the multifamily sector of commercial real estate through investment in our public, non-traded REIT, MogulREIT II.
In this article, we discuss some of the due diligence that is routinely undertaken by our management team in evaluating apartment buildings for potential addition to our multifamily REIT.
To begin - as a general rule, the value of any income property is a function of the cash flow it generates. Sometimes investors are willing to pay very high prices (low capitalization rates) because they expect significant ongoing increases in the cash flow of a property, or because the value of the land offers a separate source of value. This is not usually true of apartment buildings; cash flow typically grows over time, but physical and functional obsolescence, and sometimes local rent control, usually cause cash flow growth expectations to remain modest.
Location. The area or community in which an apartment complex is located is of prime importance. The regional economic drivers and employment levels are important, but a more detailed study of the particular neighborhood of the property is also essential. Is the area already popular, or at least seeing an upswing in perceived appeal? Are other neighborhood demographics, like the age distribution and average household size, favorable to apartments? Local economic activity is also important. Are new jobs likely to be created nearby, or are nearby base industries on the decline? Access to transportation is also valuable – are freeways or light-rail lines nearby to provide access to downtown areas or other employment centers?
Physical Plant. As with any property, the physical state must be assessed to evaluate deferred maintenance items that can materially affect the operation and value of the apartment building. A prospective owner should evaluate the plant’s foundation, roof, heating and air conditioning systems, electrical, plumbing, elevators, and the building’s “envelope” (the windows and walls). Expected future repairs or improvements should be analyzed with an anticipated timeline and the associated costs, in order both to better negotiate the purchase price of the property and to perform appropriate financial planning for the investment.
Competing Supply. Construction cycles occasionally result in an over-supply of apartment buildings and other commercial properties. An analysis of new construction permits and other housing statistics can provide a feel for whether the property is in a relatively stable market or one where competing properties are shortly due to come on-line. Construction is also affected by local or regional restrictions such as zoning, building codes, and environmental impact studies and fees. Over the long run, such restrictions may cause local price appreciation to be greater than in other areas.
Vacancy Rates. Complexes with more than 7-8% vacancy rates tend to be either in an unfavorable market area or in need of renovation or other re-positioning. Sometimes, however, such adverse figures are simply due to poor management. Apartment buildings are management-intensive, and tenant relations, proper maintenance, and the showing and renting of space are key components of the property manager’s responsibilities. A review of current and historical occupancy rates, both for the property and for comparable properties in the area, can give an investor a better understanding of a property’s potential competitiveness.
Value-Add Opportunities. Sometimes a smartly chosen remodeling project can markedly boost the attractiveness (and rental rates) of a property. A re-fashioned façade, or the remodeling of kitchens and baths as units become vacant, can oftentimes justify higher rental rates and increased cash flow. Apartment buildings are also often in a position to generate ancillary sources of income. Coin-operated laundry facilities (using energy-efficient equipment) and vending machines are some of the best sources. Parking spaces can often be charged for separately, and are usually not subject to rent control regulations. Mini-warehouse facilities and furniture rental arrangements, among other things, can also add to a property’s top line.
A key aspect of any passive investment is to also perform due diligence on a project’s sponsor. Operators with a track record and a solid understanding of the local market are often well positioned to update poorly performing properties and run them more efficiently.
Interested in learning more about multifamily investing or MogulREIT II?
Properties Currently Included in MogulREIT II