1. Targeting a Qualified Property
The first step is to locate an apartment investment with value. I look for inefficiency in the market. I want to find an apartment investment that appears to be able to be acquired at a discount to its true value. It is easiest to do this by analyzing as many properties as possible. My acquisitions team subscribes to the 100-10-3-1 rule: review 100 properties, offer on 10, negotiate 3, and buy 1. In my experience, the more apartment investments I evaluate, the clearer the potentially great deals appear to me.
2. Communicating With the Seller/Broker
Once I’ve found a deal I’m interested in, I speak to the seller or broker as soon as possible. During the first conversation I really have two main goals: to communicate that Worcester Investments is a serious buyer, and to quickly determine what value I might be able to add to the property in question. My goal is to help the seller, to make his/her life better. I try to accomplish these goals by asking pointed questions that provide clues as to how I may solve a problem the property struggles with and that portray that we are a serious buyer. For example, I may ask any of the following questions:
“What is the situation with the seller and why is he/she selling?”
“What is the seller’s ultimate goal?”
“Where do you think this will trade?”
“Who pays each utility: Gas? Water? Electric?”
“How many units are there ad what is the unit mix?”
“What is the average in-place rent?”
“Should I submit an offer now, or are you going to wait for a call for offers?”
“If I were to offer _______, what do you think the seller’s response would be?”
While I complete these initial questions, I always request access to extensive property information: a recent rent roll, a recent, preferably trailing, operating statement (also known as a profit and loss statement), and a property package (also known as an offering memorandum). It is necessary for me to obtain these in order to underwrite the property at the standards we have in place, so it is best to request this information as early as I can. Next I will request to schedule a tour of the property. If I have strong interest in the property, I will try to get this part done as soon as possible. Whether I underwrite or tour the property next doesn’t necessarily matter, as long as both are completed, ideally within a few days of each other.
3. Touring the Potential Property Investment
I try to arrive at the property at least 15-30 minutes early so I can drive the neighborhood to get a feel for the surrounding area. I always record my drive-around, and even parts of the tour, so I can reference them later if necessary. The first thing I do when the tour actually begins is interview the property manager and/or whoever has been working at the property the longest. In my opinion, the interview is the most important part of the entire tour. I may ask any of the following questions:
“What is the unit mix and number of bathrooms in each unit type?”
“What is the square footage of each unit type?”
“Does the rent roll I have portray the actual in-place rents?”
“How long has it been since the rents have increased?”
“Do you offer specials or discounts? If so, please elaborate.”
“Who pays the gas, electric, water/sewer, and hot water?”
“Do you have any unusual contracts I should know about?”
“What other income do you collect, including RUBS (resident utility billing system)?”
“What is the delinquency?”
“If you have an opportunity to put money anywhere into the property, where would you make your first improvements?”
“What are your reoccurring problems, things that annoy you about the property?”
“How do you generate your traffic?”
Once I have completed the interview, I check out a sampling of 4-8 units, recording and photographing this part of the tour as well. I ask questions and take notes, documenting anything that may be of interest. Before leaving, I try to speak candidly with the broker or owner and give them my immediate thoughts and get further feedback on the pricing and other desires of the owner, such as why he or she is selling.
4. Underwriting the Financial Performance of the Property
Underwriting the property is perhaps the single most important step to the entire investment, as it allows for financial analysis and risk mitigation. Using the rent roll, profit and loss statement, and offering memorandum, extensive and accurate underwriting helps us determine whether or not the property is capable of redeeming its value, and in what areas we can improve the financials. The numbers we come up with in the underwriting process determine what a comfortable strike price (the price we feel comfortable paying) would be, which is why we underwrite a property multiple times before closing.
The documents we require have very specific functions in the underwriting process. A rent roll is a list of every unit, vacant, occupied, down, and leased, that the property consists of. Rent rolls typically include information such as the current rent per unit, the length of each lease, other income the property receives from each resident, and what kind of discounts any of the residents currently receive. An operating statement lists all of the expenses and income of the property. These are typically broken down into specific categories (we use eleven), which allow us to more accurately determine where the property spends too much or too little. The offering memorandum typically contains information like the unit mix, square footage of each unit type, and useful statistics and pictures regarding the property and the neighborhood. Oftentimes, the documents required for us to underwrite a property are unavailable or outdated. It is important to be persistent in obtaining the most recent copies of these documents, but that isn’t always possible. We try to be prudent in our estimates anyway, but we are even more so when this is the case.
Over the past several years, our underwriting template has evolved frequently to become what it is now. We use an Excel-based proprietary document that lets us quickly plug in numbers without having to manually calculate advanced equations for each new property. This saves us time and stress, but we often make it a point to double check some of the key figures manually to ensure its accuracy.
5. Negotiating the Purchase Contract
If you believe, like I do, that doing business is making someone’s life better, then executing a contract should be mutually beneficial. A contract is a written agreement covering necessary terms executed by all parties, with the purpose of providing everyone their end goal. When I am negotiating a contract with a seller of an apartment community, the single most important factor in determining my success is my understanding of what the seller needs, wants, or doesn’t want. I consider it a successful interaction when I can understand the seller’s desires and respond accordingly, while maintaining a healthy relationship. Oftentimes I do not end up buying the property for sale, and that is okay, as I often am not the best buyer to meet the needs of the seller. But when I am the best buyer to meet his or her needs, I try to structure the contract such that it does just that.
For example, when we acquired the Northcrest Apartments for $3M in November 2010, there was at least one offer we know of that was higher than ours. If all I know is that the seller is asking $3.5M for the property, then my offer may not meet all of the seller’s needs. In this case, however, I understood that the seller of Northcrest desired to sell quickly for cash, as it was the end of the year and the bank wanted to move the property before the new year. I believe our ability to close quickly played a part in our offer being chosen over others, as the offer we submitted proposed a 30 day closing period with no financial contingencies.
6. Conducting Thorough Due Diligence
Due diligence is typically completed after the execution of the purchase contract. By the time we get to this point, I have typically toured the property, interviewed the owner or manager, and scrutinized the financials. The end purpose of due diligence is to verify that what I already assume to be true about the property is, in fact, accurate, matching up with all the findings of my previous financial analysis. If the property is accurately represented, we can close with no re-trading. (We always try to avoid a re-trade, which is why it is imperative to extensively complete the previous steps of the process.) If there are major items of misrepresentation, either intentionally or out of ignorance, then I may request that the seller compensate me to resolve the new findings.
We utilize multiple divisions of our company to conduct and oversee the due diligence process. We’ve developed a series of checklists that help us ensure we’ve done everything necessary to prepare for takeover. During the due diligence process, we thoroughly inspect each building, each unit, the parking lot, the foundations, all contracts and lease agreements associated with the property, all financial documents, utilities, the laundry set-up, roofs, and many more. Every part of the property is analyzed inside and out by qualified experts. We also interview the current residents and property staff. Conducting thorough due diligence is necessary in order to fully prepare for the stabilization period and all that it will require. The goal of due diligence is to truly understand what it is we are buying.
7. Placing the Capital that Funds the Deal
There are various ways to fund an apartment investment, but our investment funds typically come from two primary sources: banks and equity partnerships. My brother, Joel, manages the capital allocation of new properties. He will typically engage a bank to fund 75%-80% of the total investment, which includes the purchase price, closing costs, and rehabilitation costs. The other 20%-25% of the funds typically come from equity partnerships, meaning accredited investors put forth capital into the investment and gain an ownership percentage in return. Sometimes we will fund the investment personally in cash. During the capital allocation process, we create our own property packages (also known as offering memorandums). Our property packages include a summary of the property and the reasons we desire to own the property. We always make it a point to describe how we intend on adding value to the property and our strategy in bringing the property to its full potential. We also include maps that outline nearby attractions, such as colleges, commercial shopping centers, or large employers, and pictures of the property in its current state. The property packages always display the current financials of the property and the potential financials we feel we can successfully execute. This gives our investors and lenders a strong sense of our intentions and reasoning behind the purchase of the property and how we’ll add value to it as a whole.
8. Closing the Investment Deal
Closing does not happen until we’ve met all the criteria in order for us to comfortably take over: we’ve underwritten and toured the property, agreed upon a contract, conducted extensive due diligence, and allocated all the necessary funds. We have a proven track record of closing quickly, but that can’t happen until each piece of the puzzle is in place. The day before or of closing, we conduct a final inspection of the property to ensure that all things are as they should be. We verify that all the funds are in escrow and that all closing documents have been effectively executed. It is important to have these prepared well in advance to account for unforeseen circumstances.
9. Stabilizing the Acquired Property
The stabilization period is the time frame in which we begin all the preemptive work required to operate the property at its full potential, and the process begins on day 1 of takeover. My brother, Jesse, along with a team of over 80 employees, executes and oversees every aspect of this step in the process. In order to stabilize a property, we must first hire and train on-site staff, implement our policies and procedures, collect old debts, buy supplies for the property, shift the market positioning if necessary, conduct comparative market surveys, set up various vendor and utility accounts, create and prioritize cap-ex rehab wish lists, and begin capital improvement. This is a very brief description of stabilization requirements, as it is a rigorous and thorough process. Stabilizing a property requires unified efforts amongst the operations, capital improvement team and property management divisions, all acting with a long-term mindset. We maintain a very detailed account of the progress taking place, because the stabilization period is all about following through on our expressed plans with the property.
10. Operating the Investment Responsibly
The work doesn’t end when a property is fully stabilized. Operating a property is a continuous effort on all parts of our company. We have to keep in mind that each property is an extension of our brand, staff, and, most importantly, our investors. It is always a priority to operate our properties responsibly, as financial assets for our partners and as a housing resource for our residents. We always have to be prepared for anything, which means having the knowledge, funds and staff readily available to make real-time decisions that may be necessary in order to maintain performance. To do this requires unified effort from everyone involved. Brooke and Shelly, our regional property managers, do a phenomenal job of holding each of our property managers accountable to the high standards of excellence we have collectively put in place. Billy, who manages our construction team, directs all the recommendations on repair and maintenance items, and has cultivated and trained a highly skilled team of knowledgeable and talented individuals.”
Ultimately, operating a property and maintaining its true value comes down to the people behind it: the owners, the staff and the residents. We have seen success in the operation of our properties because we have accumulated a team of outstanding individuals, capable of exceeding and improving upon the high standards of Worcester Investments and Worcester Properties.