Announcer: Welcome to Creating Wealth with Jason Hartman, President of Platinum Properties Investor Network in Costa Mesa, California. During this program, Jason is going to tell you some really exciting things that you probably haven’t thought of before and a new slant on investing, fresh new approaches to America’s best investment that will enable you to create more wealth and happiness than you ever thought possible.
Jason is a genuine self-made multimillionaire, who not only talks the talk, but walks the walk. He’s been a successful investor for 20 years and currently owns properties in 11 states and 17 cities. This program will help you follow in Jason’s footsteps on the road to financial freedom. You really can do it. And now, here’s your host, Jason Hartman, with the complete solution for real estate investors.
Jason Hartman: Welcome to another edition of Creating Wealth. I’m your host, Jason Hartman, and today, I’d like to play for you a very recent interview I did on multi-family or apartment investing. As you know, my favorite type of real estate investment is housing.
My absolute most favorite investment of all is single-family, detached homes. I’m not crazy about condos. I’m not crazy about condo conversions. Once in a while, they make sense. There are spotty opportunities here and there that work, but overall, I’m not so crazy about those. I like single-family homes. I like duplexes. I like four-plexes and I like apartment buildings because remember we are trying to stick within the universal needs that every human being has: food, clothing and shelter. And my favorite business is the shelter business.
The population in America and around the globe is dramatically increasing, increasing the demand for housing over the next few years and the next several decades as well, and also, increasing the demand for the commodities, building and construction materials it takes to build these houses.
So I’m happy to share with you this interview on multi-family housing. I think you’ll learn a lot. It’s something we haven’t covered very much on our prior shows. Here it is. Let’s listen in.
Jason Hartman: I’m here with Jon Swire, who is a very accomplish, multi-family real estate agent, and he has written a new book called, “There’s No Free Lunch in Real Estate: Simple Tools for Creating Life Changing Wealth.” Jon, welcome to the show.
Jon Swire: Thank you.
Jason Hartman: Good to have you here. I want to talk a little bit about a subject we’ve touched on in previous shows, which is multi-family investing, and as you know from our conversation prior to recording today, I am really a big, big fan of housing. I mean the demographics coming at housing are phenomenal. We have pretty much focused our business on single-family homes, duplexes, four-plexes, etc. A little bit of multi-family, a little bit of commercial, but we really like apartments as far as the larger, housing-oriented deals. I mean the demographics are phenomenal. Thirty-one years and another 100 million people in population in the U.S. By 2050, they say we’ll have another 138 million people in the country. That bodes very well for housing in my opinion. So tell us about why you like apartments and multi-family, larger housing projects.
Jon Swire: Well, you know multi-family gives your investor base to put more capital or more equity to work in one point. The average median price of a home around the U.S. is $200,000.00 – $250,000.00. If you go in with 10 percent down, you’ve got $20,000.00 – $25,000.00 in capital invested. This gives those investors that have $200,000.00 – $250,000.00 or more available the opportunity to put that money to work for them all at once. Rather than having ten units sprinkled around, they could have one apartment house with ten units in it.
Jason Hartman: Yeah and you’re definitely right about that. I mean I always tell our investors the one flaw with our plan is that if you want to go big, it’s difficult because when you get to about 30 single-family homes, it becomes a real project to manage all of those. We like the diversification, not having all your eggs in one basket, spread out into different cities, but after that, you’ve really got to go look at larger stuff and hopefully own a few different apartment buildings in several different cities.
So definitely a good point there; ease of management, I agree. And of course, housing is good, too. Tell us about the process of purchasing an apartment building or an apartment complex. You go through a process just like you do everything else, but give us your take on that if you would.
Jon Swire: Sure. It’s a little bit different than what people are used to with single families. We’re all used to driving by a house, maybe going into an open house, or having our agent take us into the house to see it before we put an offer on it. It’s a little bit different with multi-family. Typically, you make an offer on a property and you’re given access to the property after your offer has been accepted.
Once your offer has been accepted and your agent has negotiated on your behalf for the best price and terms, you will have an opportunity during your due diligence period to go through, do a physical inspection the property, and at that point, you want to go in and make sure that everything is the way it needs to be. The plumbing is in good working order, the roof’s in good working order, and there aren’t any issues with the HVAC system, etc. It’s your opportunity to make sure if there are any major problems that you’re going to have down the road, to get them addressed now.
At the same time, what you’re going to want to do is start working with your lender to figure out what type of loan you’re going to qualify for, how much money you need to put down on that property, and how much your payments are going to be every month.
So multi-family works differently from single families. Typically, the lenders require you to put enough money down so the property debt covers.
Jason Hartman: And that’s one of the things I love about multi-family is that the property really does the heavy lifting on the qualifying for the loan. And that’s why when you look at larger deals you can really build a big empire because the property is doing the qualifying for you.
Now, I like that, too, Jon because it seems to me like the lender really offers something of a safety valve and a second due diligence check on the property. How intense is that and how much protection does your lender really give you in making sure you don’t make a bad deal for yourself?
Jon Swire: Well, that’s a good point, Jason, and it’s more true today than it was even 12 – 18 months ago. The credit markets have tightened up a lot and lenders are being a lot more cautious about the deals they underwrite right now. They are going out. They do a property appraisal. They will only lend against the value of the property, not the on-purchase price that you may be in contract on.
So for example, if you’re in contracted a million dollars and the appraisal comes back at $960,000.00, you’re going to have what’s called an appraisal shortfall and you’ll need to come up with more of a down payment.
So the lender’s going to go out and make sure the property appraises and secondly, they’re going to go out and do what’s called a property inspection. And that’s just a cursory physical inspection to make sure the property’s in a location that they’re happy with and it’s been maintained in a way that they’re happy with as well. If they go out there and there are any physical issues that they want corrected, they will make that a condition of the loan and they’ll either hold back funds or require it be done prior to close of escrow.
So the lender’s definitely looking out for you as well.
Jason Hartman: How about in terms of looking over the books and the rent roll of the prior owner of this building, and do prior owners defraud buyers a lot, or is it more subtle than defrauding? That’s a pretty strong word. But you get the rent roll, you get the specs, the financials from the owner, from the broker who’s got the listing on the property. Can you believe this?
Jon Swire: Well, look. You know the biggest difference between multi-family and single family during the due diligence period is it’s buyer beware. So you want to make sure as a buyer that you’re surrounding yourself with competent professionals whom you trust. And I would tell you right now as a caveat, don’t trust the information given to you by a seller. Your job during the due diligence period is to do exactly that. Do your diligence. Verify everything you’ve been given. Verify the current income. Verify the expenses.
For example, ask for 12 – 24 months of utility bills. It’s not difficult, but it’s worth doing. If something doesn’t look right, dig into it and find out why that isn’t right.
The lender is going to require, typically, two years of profit and loss, or P&L statements and they’re going to require a copy of the current rent roll.
Jason Hartman: So what is that owner going to give you? They’re just going to give you the QuickBooks file that shows you their P&L? And what are they going to give you in terms of the rent roll? What is that?
Jon Swire: Well, typically, the seller might provide you, depending on their level of expertise, anything ranging from something written out on a piece of paper to QuickBooks, or eve their schedule E from their tax returns.
Now, schedule Es from tax returns are actually pretty good. As an owner, they typically aren’t going to lie to the IRS about the income they make. They’re not going to overstate their income. Now, they may overstate their expenses, so you need to be careful there because obviously, if you overstate your expenses on your Schedule E, you’re underreporting the amount of income the property earned.
If they have a third-party manager, you’ll probably get a QuickBooks report and those are usually the most reliable.
Jason Hartman: The third-party manager.
Jon Swire: The third-party management reports are typically most reliable. However, you want to make sure that they owner doesn’t have two sets of books, okay?
Jason Hartman: They always say that in a business, there’s three sets of books, right?
Jon Swire: There could be the buyer, the seller, and the –
Jason Hartman: And the IRS, right?
Jon Swire: That’s right. So you want to be careful during your due diligence period. Make sure that everything looks the way it’s supposed to. I wouldn’t rely on the lender a ton. At the end of the day, the lender’s looking out for their best interests. But it is another set of eyes and the underwriting guidelines have tightened up a lot. So if something doesn’t look right to the lender, they are going to ask you about it. So be prepared.
Jason Hartman: Okay. Is there a standard metric for how much it costs to maintain a property and maybe you want to talk about that in terms of the age of the property? Obviously, it’s brand new. We’ve got some apartments that we’re selling now that are brand spanking new, so there you don’t have too much maintenance concern. But then I’m looking at a deal from my own account that’s about 50 years old, which is the oldest property I’ve ever considered buying, but it does look like kind of a good deal, so I’m looking at it. I don’t know if I’ll do it.
Jon Swire: Well, you always want to budget for two line items. One is a maintenance and repair line item, where that’s going to be regular maintenance you have to do on the building just as a course of keeping it up, and it varies by locale, but typically, you’re going to want to budget anywhere between $250.00 and $500.00 per unit per year.
Now, obviously, if you’re in L.A. County, it’s more expensive to get a plumber to come out, so you’re going to be closer to the $500.00 per unit per year cost. If you’re in a place like Kansas City, maybe you’re closer to $250.00 per unit per year.
Jason Hartman: How about age of property?
Jon Swire: Again, age is going to be a huge factor. A brand new property built in 2008, not only is it going to be brand new, but it’s going to be copper plumbed, it’s going to be built to the most current code. The windows are going to be newer. Maybe they’re going to be insulated better.
Jason Hartman: Hopefully, they’ll be those new vinyl windows. I like those a lot.
Jon Swire: Those new vinyl windows and the low-E windows, exactly.
Jason Hartman: Right.
Jon Swire: A building built in the ’50s, expect more plumbing issues. You’ve probably gonna have to snake the main line once or twice a year, so expect to add that to a maintenance budget. And remember if it was built in the ’50s and it’s never been replumbed and the plumbing’s still original, you’re going to need to replace it sooner than later. So the next item you want to budget for is what’s called the reserve account. You want to make sure you put money aside every year for future capital expenditures.
Jason Hartman: And capital expenditures are large improvements to the property, like replumbing the whole building, for example.
Jon Swire: Exactly. Say you put a roof on the property and it lasts a full 20 years. Well, you put it on, you spend $20,000.00, you don’t have a roofing expense for the next 20 years. But what you want to do is every year set a little bit of money aside in a reserve account so in 20 years, when you have to reroof it, you have the money available, rather than having to write a check out of some other account. So you want to put aside what’s called a reserve account.
And the lenders, by the way, are going to budget in a reserve account when they underwrite your deal in the purchase and that’s going to factor in to how large a loan they’ll give you.
Jason Hartman: Okay. What else should we know about due diligence?
Jon Swire: You’ve gone through your books and records, which is the information on the rent roll and the expenses. You will go through a physical inspection. The other thing you want to make sure is you want to make sure the property being transferred to you has clean title. And this is something the agency representing you will help you with. You’ll be given what’s called the Title Report issued by one of the large title companies and basically, what you want to do is make sure that a) the person who’s selling you the property has legal right to sell it to you, and b) that when they are selling it to you, that if there are any liens or other unpaid taxes, etc against the property, that they’re taken care of before it transfers. And typically, the property cannot be transferred unless those liens and unpaid taxes are satisfied, but again, the title report is going to show you what’s been going on with chain of title to this property.
Jason Hartman: So in terms of the process of purchasing this apartment building, what is the typical length of that escrow period, or in some states, settlement period, depending on what you want to call it? What’s the length of the due diligence timeframe? Is there a different length for physical due diligence versus books and records due diligence?
Jon Swire: Well, typically, and it’s going to vary from state to state, but typically, your process is going to be as follows. You identify a property with your agent, you’ll make an offer, and then you go into contract. That will be called the acceptance date or the effective date. Then you’re going to have anywhere between 14 and 30 days to do your due diligence, where you go into the property, you kick the tires, you figure out if it’s the right property, if everything is as it’s been told to you as it is, and whether or not you can get it financed.
Once you remove those contingencies and you remove your physical contingency and your books and records contingency, now you’re going to spend the rest of your time during your escrow period focusing on getting that loan funded. Lenders today are running anywhere between 65 and 90 days.
Jason Hartman: Wow, it’s getting slow, huh? They’re really cautious.
Jon Swire: It’s getting really slow. In fact, in the multi-family market out here in Los Angeles, a lot of the major lenders have pulled out of the market right now, so there’s only a few left. So you’re really bound by how much time they want to take. If they want to take 90 days, they’re going to take 90 days and they don’t care if you need to get it done sooner. So make sure that when you go into contract on the property, one of the things you want to write in there is that you have the ability to extend the escrow period, at no cost to you, if required by the lender because at the end of the day, you don’t control the lender.
So if the lender needs more time, the lender needs more time. The seller may not want to give you more time, but it’s not your fault. You haven’t been the one dragging your feet, so make sure your agent’s looking out for you, and they’ve put a provision in there to cover that.
Jason Hartman: In terms of the financing, Jon, talk to us about the different loan sources. There’s conduit lenders. There are different types of lenders and a lot of new terms that a residential investor who maybe owns ten single-family homes and wants to move up to the multi-family world. What are they going to hear? What are some of these terms they’re going to hear and what do they mean?
Jon Swire: Well, the easiest and quickest way to go get a loan is to go down to your local savings and loan or Wells Fargo or Washington Mutual and apply for a loan. And those are what are called conventional lenders, okay? And they may like your deal and they may not. If it’s a plain vanilla deal, a lot of times it will be fine. And if it’s under a $3 million loan amount, it’s probably also fine.
Typically, when you get over $3 million loan amount, you may dabble into what’s called the conduit market or the CMBS loans, Commercial Mortgage Backed Securitized Loans. Those are the Wall Street loans that we’ve all heard about and those are typically reserved for larger properties, $3 – 5 million loan amounts. They usually want a well located asset, so they want it in what’s considered an A or B area, versus a C or D area, so they’re only going to loan on well located assets and they want quality assets.
So if it’s a multi-family building, they’re going to want a newer asset in a solid location because they don’t want to take any risk with that property. Once they originate that loan, it’s going to be parsed up and resold in pieces on Wall Street to a secondary lender, so it’s really important to them that they’re getting a quality asset, that they know the income stream is going to be protected on.
Jason Hartman: So they like higher end properties then is what you’re saying?
Jon Swire: They prefer higher end properties, higher end multi-family. They like retail and commercial properties. A lot of the big shopping center loans and the office building loans lately have been with the conduit lenders on Wall Street.
The biggest difference between your conventional and the conduit financing is going to be – and this has changed a little bit lately, but it was the difference in rate that you might get. About 12 months ago, before we had the subprime meltdown in late ’07, a conduit lender might have a ten-year fixed at 6 percent, whereas a conventional lender like Wells Fargo might have had a ten-year fixed at 6.75 percent.
Jason Hartman: So a conduit loan is cheaper.
Jon Swire: The conduit loan was cheaper until –
Jason Hartman: Was cheaper.
Jon Swire: Was cheaper in terms of an interest rate, however, there are a lot of upfront points and fees associated with originating the loan.
Jason Hartman: More than with a conventional loan.
Jon Swire: Far more than with the conventional loan.
Jason Hartman: Do you have a sort of rule of thumb for the upfront fees? Like, in residential, we say plan on about 3.5 percent total closing cost. So if you’re putting 10 percent down, another 3.5 percent, plus we say have a 4 percent reserve to cover vacancy and any negative cash flow.
Jon Swire: I would say that on a conventional loan for a multi-family property, you might be looking a 2.5 percent in terms of closing costs.
Jason Hartman: But those are just loan fees or all closing costs?
Jon Swire: Those are loan fees, title, escrow, city, county taxes, any other junk fees that might be thrown in there.
Jason Hartman: Here’s one thing – I don’t want to get you off your train of thought, but I just want to bring this up real quickly. One thing that surprises some of our investors is the cost of an appraisal for a larger deal, a multi-family deal, and the cost of inspections for them. They’re much higher, so you’ve got to be prepared for this. Is there a certain rule of thumb there?
Jon Swire: I would say typically on a $1.5 million to $3 million multi-family purchase, the appraisal could run anywhere between $2,500.00 on the low end and $4,000.00 on the high end.
Jason Hartman: So $2,500.00 – $4,000.00 just for the appraisal. How about an inspection?
Jon Swire: Just for the appraisal. Now the inspection, again, it’s going to depend on the company that you hire, but in L.A. County, if you brought out a company like LaRocca, they might charge you $100.00 a unit. So if you bought a 12-unit building that you were looking to inspect, it might be $1,200.00. And if you wanted to bring out your plumber or your HVAC guy or your roofer, that would be on a per agreed basis. For instance, I’m in contract right now on a piece of property in the Valley and my roofer came out and did a quick inspection for me for free because of all the work I’ve given him.
So if you have relationships with existing vendors, take advantage of those when you’re in contract to purchase a property. They don’t have an incentive to lie to you and they’re going to be honest, and that’s really what you’re looking for at the end of the day. You want somebody on your side, who’s making sure that you’re getting into the best deal possible.
Jason Hartman: Okay, what else were you going to say about closing costs, I guess?
Jon Swire: Oh, closing costs, again, conventionally versus conduit loans. The closing costs on a conventional may be anywhere between 2.5 percent to maybe three on the high end. You can figure another point to a point and a half, so 1 – 1.5 percent more for conduit loans.
Jason Hartman: One of the things I love about single family and duplexes and four-plexes is that you can get these great 30-year fixed-rate loans and in my opinion, that is going to become just a huge asset moving forward, not only because of what we talked about before about inflation-induced debt destruction, but also because those interest rates are so historically low that maybe they’ll blip down from time-to-time, but overall, I think the trend has to be higher rates.
What happens, you know, on multi-family, you just can’t get these long 30-year fixed. You can get maybe five or ten-year fixed, seven-year fixed, and then they become adjustable. Tell us about some of the terms that are available in terms of financing.
Jon Swire: Well, Jason, you’re right. The 30-year fixed on residential is a fantastic loan product that’s not available on commercial. Typically, you’re going to get anywhere between a three, five, seven, or ten-year fixed product. There are one-year adjustables available and I would tell people only take a one-year adjustable if you’re going into a property that you’re either buying to flip or you’re going to reposition and do a cash-out refi pretty quickly.
Otherwise, you’re better off taking a three, five, seven, or ten-year fixed. You want to try and match the length of the loan term with your anticipated hold period. So if you’re going to hold the property for three years, don’t take a ten-year fixed because the rate on the ten-year fixed may be 6.5 percent and on the three-year, it might be 6 percent.
If you are going to hold the property for five, seven, or ten years, take the longer rate, especially right now. Interest rates are still close to historic lows. It’s a great time to get cheap debt on properties.
Jason Hartman: I couldn’t agree more. That’s just a huge benefit. Can you kind of give us some idea what the rates are today? You talked about a year ago when the credit bubble burst, but what are we looking at today?
Jon Swire: Well, on the property that I’m in contract in the Valley, I’m talking to a lender right now. We’re looking at a five-year fixed on a multi-family deal and the rate is around 6.15 percent.
Jason Hartman: That’s fantastic. But it’s not very long. It’s only five years. What if you wanted that to be ten years?
Jon Swire: The ten-year rate right now is probably about 6.7 percent.
Jason Hartman: Still very good.
Jon Swire: Very good. The yields aren’t as good on the long-term money right now as they are on the shorter term, on the five years as they are on the ten. The five-year money is priced a little better right now, but if you’re going to be in the property for a while, you’ve really got to take a long hard look at that because it’s hard for me to tell you that when you go to refinance, when that five-year comes due in five years, you have three options when a loan comes due. You can either let the rate adjust. You can sell the property and pay off the loan, or you can refinance the loan. If you need to refinance –
Jason Hartman: Well, wait a sec. You could just go into foreclosure. That’s what everybody seems to be doing nowadays.
Jon Swire: That’s option No. 4.
Jason Hartman: That’s a bad joke.
Jon Swire: But realistically, if you’re going to hold that property for a while, you’d probably try to get the ten-year right now because you don’t want to – you’re basically rolling the dice. The question is in your mind if in five years rates are going to be lower or higher.
Jason Hartman: And again, our philosophy is just buy and hold. Don’t sell these things. We just think just keep them.
Jon Swire: So if you’re going to buy and hold for sure, take that ten-year fixed right now.
Jason Hartman: What happens after the ten years? What kind of an adjustable? I mean what’s it indexed to? What are the margins and the spreads and so forth?
Jon Swire: Well, look. It depends on the terms of your note. Most conduit loans in ten years are what’s called “due and payable.” They don’t adjust, they don’t extend; they’re due and payable. The bank wants their money back. So at the point, you have three options. You either sell the property and take the proceeds to pay off the lender. You refinance the loan with another lender and use the proceeds from the refinance to pay it off. Or you come up with fresh capital from somewhere else. So, on a conduit loan, they’re due and payable.
Now, on a conventional loan, typically what happens is they’ll adjust and there will be some rate and some margin. The index they’re tied to may be the LIBOR or the COFI or the MAT-12 or the ten-year Treasury. And then you’re going to have some margin, maybe 2.25, 2.75 percent, whatever it is.
And what will happen is when the adjustment period comes, let’s say on the primary today is 4 percent and when we go to adjust, it becomes 6 percent. At that point, your rate is going to move up 2 percent. However, your loan docs are going to govern how much your rate can move in any period of time. Typically, there’s a floor and a ceiling and there’s an annual maximum and minimum increase to the rate.
So carefully read your loan docs when you’re signing them. It’s really important. I know when you’re signing your loan docs, nobody’s thinking about what’s going to happen in five years when the rate adjusts, but it typically will.
Jason Hartman: Obviously, over the last few years, people should have been reading their loan docs because then we wouldn’t have the mortgage meltdown we’re in now, right?
Jon Swire: Very true.
Jason Hartman: Yeah, good point. Okay, so talk to us, Jon, a little bit about markets. I want to talk about markets, deal sizes, and classes of properties. So you brought with you some paperwork on some different markets that you wanted to highlight with our listeners. Tell us about them.
Jon Swire: I think in any market that you’re going into, first of all, you want to look at a few economic indicators, before you even decide to make an investment in that market. Job growth is a great economic indicator. Are jobs coming into the area? Let’s say 3M is bringing 3,000 new employees into a manufacturing facility. Typically, that’s going to create anywhere between two to four service support jobs for those 3,000 jobs. So the 3,000 jobs that 3M is bringing in could bring 10,000 new people to the area and those people all need someplace to live. So that’s a great thing. That means all of a sudden, you have an increased demand for the existing housing supply.
Jason Hartman: That’s a lot of sticky notes.
Jon Swire: It’s a lot of sticky notes. It’s a lot of sticky notes, my friend.
Jason Hartman: By the way, listeners, I’m just being goofy here. 3M obviously invented the post-it note.
Jon Swire: So you want to look at job growth. You only want to invest, in my opinion, in areas that have positive job growth outlooks. You also want to look at what the forecasts are for vacancy and the rental rates. Are vacancy rates going up or are they going down? If you’re going into an area where vacancy rates are slowly increasing, you need to be prepared for the fact that you may buy an apartment or a multi-family complex or a single-family house that is forecast at a 9 percent vacancy rate, but it may be projected to grow to ten or 11.
Jason Hartman: Now, here’s the thing about that and maybe we can get into now the class issue, and what I mean there is that people – I find investors are constantly making mistakes, Jon, because they look at macro indicators and they don’t parse them up and they don’t do market segmentation. So for example, you might have a market like Dallas, where I’ve been reading that they’re building a lot of new really, really high-end, Class A product, and so they’re going to drop a lot of supply on the market here in the new term. But if you have Class C or B product in Dallas, which is more affordable, maybe the vacancy is better or worse. I’m not saying what it is. I’m just saying make sure that the buyer segments how the vacancy allocates to different markets and different prices.
So before you address that question, do you want to tell us what Class A, Class B, and Class C are? How do you define those things?
Jon Swire: Sure. If you think about it on a spectrum, typically, Class A would be the nicest buildings in the nicest areas, so Beverly Hills, for example. You go down from there. You go A, B, C, and D, where D might be a more depressed economic area with a lower credit tenant profile, which means you may be banging on doors on the fifth of every month to get your rent checks.
Jason Hartman: With your sidearm strapped onto you.
Jon Swire: With your sidearm strapped on, as opposed to the rent checks from your Beverly Hills tenants, who probably postmark two days before the first and then they arrive on the first.
Jason Hartman: And if you have to collect your rent in Beverly Hills, you got to deal with their lawyers, so it’s all something different.
Jon Swire: Exactly. It’s a different problem, but it can still be a problem.
Jason Hartman: Right.
Jon Swire: Now, you can actually parse assets up into A, B, and C as well, where you can have two buildings in Beverly Hills, which is an A area, and one could be a C property and one an A property. The A property might have been built in 2007. It’s brand new and fully amenitized. And the C property was built in 1950. It’s got carport parking and smaller bedrooms and older windows.
Jason Hartman: I’m finding it difficult and I appreciate everything you’re saying. I’m just finding it difficult to exactly categorize between, for example, B and C. Is that a perception or is there a real hard rule of this is C and that’s B?
Jon Swire: It’s definitely somewhat subjective for sure, although I will tell you this. If you have some component of government-subsidized housing in your property, you are for sure buying in a C or D area.
Jason Hartman: Okay, that’s a good rule to know. All right, so it’s Section 8 type?
Jon Swire: Section 8 type, HUD housing, typically, that’s going to be a C or D area. The one anomaly might be Santa Monica has some areas where they have some government-subsidized housing, but for the most part, around the country, any area that you invest in with government subsidized.
Jason Hartman: Okay, good rule. So segmenting the vacancy. I don’t know if you’re ready to go back to that.
Jon Swire: Sure, yeah. So segmenting the vacancy. You really want to be careful and understand where you’re buying and what the asset is that you’re buying, and Jason made a good point. Most investors don’t fully understand this and, typically and unfortunately, they’re represented by brokers, who either don’t understand it or don’t care. They just want to close the deal.
You want to do as much market research as you can because, once you make that investment, your money is stuck in there. Go around. I tell my clients all the time that one of the best things they can do is a rent survey. Pose as a renter. See what’s available in the area. Get a feel for what the actual vacancy is. Understand what concessions are being made.
There’s two components to vacancy. There’s a physical vacancy, which is how long that unit sits vacant. But there’s also what’s called an economic vacancy. If you had to give one month’s rent free every time you rented a unit, that’s an 8.3 vacancy to start. It’s one month out of 12 gone. So if that unit sat vacant for a month and then when you finally found the tenant, you gave up another month, you now have over 16 percent effective vacancy. And a lot of times, people –
Jason Hartman: So one month was real vacancy and one month was economic vacancy, due to a rent incentive.
Jon Swire: Yes.
Jason Hartman: That’s what you’re saying.
Jon Swire: And most markets outside of some of the very tight markets, like New York, California, and San Francisco, most rental markets have rent concessions and they’re not written into the lease agreement. So to circle back to your due diligence period here, when you’re doing your due diligence and you’re looking at some units – say you’re looking in Memphis – and all the leases are written for 12 months. What you don’t realize is that when that tenant moved in, they may have gotten a rent concession that doesn’t show up in the lease, and typically, it doesn’t. They may have gotten a move-in special, even though the lease was written at a different rental rate.
So you want to go do a rent survey. Talk to some tenants if you can and find out if there really is some economic vacancy going on that you aren’t accounting for.
Jason Hartman: Why does that not show up in the lease, though? Wouldn’t the tenant, if the first month rent is free, wouldn’t the tenant expect that to be in writing, I mean as part of the deal?
Jon Swire: Well, two reasons. One, you have a lot of unscrupulous owners. But two, let me give you a better example. Typically, when you get one month’s rent free, they’ll give you the 13th month free because they want you to –
Jason Hartman: Oh, so it’s the end. It’s just like the health club. My health club does that.
Jon Swire: Just like the health club. Exactly. So again, it’s all about doing your due diligence, moving slowly, venting all the information that you’re being given, and doing the best job you can to make sure that everything’s above board.
Jason Hartman: Very good advice. Okay, back to markets. Tell us about markets. I know we kind of got off on a tangent there.
Jon Swire: Right, so some of the markets that I like right now for reasons that they’ve got good job growth, tightening vacancy, and tightening rental markets, the Dallas-Fort Worth area and the Austin area and the Indianapolis area. Those are three markets right now where you’ve got a lot of positive things going on and if you’re going into a market as an investor for the long haul – and that’s what we’re talking about right now. We’re not talking about going in and flipping units. We’re talking about buy and hold strategy.
You want to make sure you’re in a place where you’ve got jobs coming in, you’ve got a tightening rental market, and you’ve got climbing rents because over time, that rental income is going to grow and as that rental income grows, when you go to refinance the property, it’s going to be able to service more debt and give you more capital out that you can spend.
So Jason, just to touch a little bit further on each of these three markets that I brought up, the Dallas-Fort Worth market, that’s projected to have about 50,000 new jobs coming in, in the next year, which is, again, a fantastic thing. Remember everybody who comes into the market needs a place to live, so it’s going to suck up a lot of the available housing product.
So as a landlord, right, and remember investors, you’re landlords at the end of the day, that’s a great thing if you’re a landlord because all of these people come in, they need a place to live. They’re going to suck up the vacancies, which is going to drive up rents.
So to piggyback off of that, we have job growth coming and, of course, we have a projected increase of 3.4 percent in 2009 for Dallas, which should make sense. Basic supply and demand dictates you have an increased demand; supply doesn’t increase quickly enough to meet that demand. Rents are going to go up.
You’ve got the same thing going on in the Austin market. The Austin market is projected to bring in about 10,000 new jobs this year. They brought in about 100,000 jobs in the last three years. So the Austin market is growing like hotcakes right now. Anybody who’s been out to Austin knows this. They’ve got great barbeque and a great quality of life. Again, the rents in Austin are projected to grow about 3.3 percent in 2009. You’ve got more people moving in and these are high earners, so they’re going to want a nice place to live and it’s going to suck up a lot of the vacancy that’s in the local market.
And the final market is the Indianapolis market. Again, same as the other two Texas markets. You’ve got more job growth coming in. What you have there is also vacancy is projected to fall, which means the available number of units in the housing market for rent is going to fall, which is going to push rents up. In this case, you’ve got increased demand, but you’ve also got a decreased supply.
Jason Hartman: Indianapolis is really on the residential side, but a surprisingly good market for us. Our clients have had very good experiences there and that one kind of surprised me because most of our interest, Jon, is in the Southeastern U.S., in the Sunbelt sort of states, and in the mid-Atlantic, like the Carolinas. And so we have a few that are out of our primary areas of focus, but Indi’s been really quite good.
Jon Swire: Well, you know the beautiful thing, Jason, about a market like Indianapolis is it gives your investors an opportunity to geographically diversify their portfolio.
Jason Hartman: Very good point.
Jon Swire: Don’t have all your eggs in one basket. Put a little bit of your investment money in somewhere other than the Sunbelt or the Southwest, and this is a great place to do it.
Jason Hartman: Jon, finally in closing, I’d just like to ask you to address the issue of deal size. In every market, we look at this in the residential market, there’s sort of an optimal deal size. Does someone want to get an $800,000.00 six or ten-unit building or 16-unit building or do they want to get 120 units for $2.6 million? Where’s sort of the optimum deal size there or do they want to get – if they can afford or they have a partner – do they want to get a much larger complex that’s $16 million? Where’s the right size?
Jon Swire: Well, Jason, there’s no right answer. I would say the first thing that’s going to dictate the deal size is going to be the amount of equity an investor has available. Sit down; figure out how much money you have to comfortably invest in your next purchase. Once you do that, pinpoint the market you want to be in and see what that will buy you. I will say this. For a lot of smaller investors who have been focused on single-family residences, the first multi-family property they buy probably should be somewhere between eight and 20 units, maybe 25 on the high end.
Jason Hartman: And what do you think that’s going to cost them in terms of money?
Jon Swire: Well, if we were to go into the Texas market and spend anywhere between $30,000.00 – $40,000.00 per unit, you might look anywhere between $800,000.00 and $1.1 million. And if you had to put 20 percent down –
Jason Hartman: That’s pretty comfortable for most investors, yeah.
Jon Swire: Yeah, it really is. I will tell you this. For you investors out there who have $500,000.00 – $600,000.00, maybe $1 million to invest, that can buy you a lot of units in Texas. Maybe as many as 60 or 70. I don’t know that that’s the best investment for you for the first time out of the gate if all of your experience is with single family.
Jason Hartman: And I’d like them to diversify it, so if they get one building that’s an apartment building in one of the Texas cities that we recommend for them, plus another one in another city in Indianapolis or the Carolinas or whatever, or maybe sprinkle it with one apartment building and then several single-family homes diversified into different markets. So you can do it a lot of way.
Jon Swire: Yeah, I think that’s good advice. Also, from a management standpoint, the reality of it is, again, we want to be investors. We don’t want to be landlords, okay? We’re going to hire third party property managers to manage these assets for us. But a 60 – 70 unit property is a different management situation than an 8 – 10 unit. So cut your teeth on the smaller property. Get comfortable with finding the right property managers for you and diversify your money.
Jason Hartman: One of the things I have heard, just to comment on that, Jon, is that some brokers have told me that when you get up to about 70 – 75 units, it’s kind of nice because then you can afford onsite management and the building just sort of works out better with a good onsite manager. What is your take on that?
Jon Swire: There’s a lot of truth to that. I would say that, typically, once you have about 40 – 45 units, you’re going to have some sort of onsite management. I would even say that typically under anything over about 12 units, you’re going to have an onsite manager, but that may be a tenant who you’re giving a rent concession to, so it’s not a true onsite manager dedicated to making that building run. Anything over 40 – 45 units you’ll probably have a full time onsite manager and it’s going to make a huge difference. You’ve got somebody there five days a week, eight hours a day, whose job is to make sure the building stays leased and the tenants stay happy.
Jason Hartman: And they don’t live there. They’re a professional.
Jon Swire: They’re professional. They could live there if you wanted to have them live there. Some buildings do, some don’t.
Jason Hartman: So, Jon, how much do you pay that onsite manager?
Jon Swire: The onsite manager is going to vary from area to area. In a place like L.A., in a 50-unit building, you might pay them $2,000.00 – $2,500.00 a month. Typically, it’s in relation to the percentage of the gross collected rental income of the property. It may be anywhere between 2 – 3 percent of that gross collected rent.
Jason Hartman: Oh, okay. That’s a good metric. Excellent. Well, Jon Swire, this has been just a wonderful show and thank you so much for sharing your wisdom with us. I’d encourage all of our listeners to go out and get a copy of your book, There’s No Free Lunch in Real Estate: Simple Tools for Creating Life-changing Wealth. And where can they get the book?
Jon Swire: You guys can pick up the book either by visiting my website at www.jonswire.com or you can go to www.lulu.com, and for anybody out there who’s interested, I will be teaching again this quarter at UCLA Extension starting Thursday, September 25, in the evenings for 12 weeks. The class is titled “Investment in Real Estate Analysis.”
Jason Hartman: So if you’re local in the Southern California area, check that out as well, and Jon, thanks so much for being on the show.
Jon Swire: Thank you, Jason.
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Duration: 44 minutes