Part 1 - Goals & Objectives - Preparing For The Transaction (For Buyers)
Monday, February 25th, 2008WHAT TO EXPECT WHEN YOU’RE INVESTING PART 1
Goals & Objectives - Preparing For The Transaction (For Buyers)
Planning ahead is always important in life and purchasing a piece of investment real estate is no different. For many investors their livelihood and sometimes life savings or retirement are tied up in their properties so failure is not an option. For an investor looking to purchase a new piece of investment property there are several factors that should be taken into consideration in order to make each individual property a successful part of their portfolio. We’ll consider 5 major areas that each person should make a part of their decision making process. Those areas are; Property Type,Personal Circumstances, Management, Cash and Market Trends.
1. Property Type: There are many factors that change as you look at investing in different property types. Let’s consider some factors that change over different property types. Retail property is less management intensive than other subtypes as most often retail leases are Triple Net (NNN) meaning all costs, maintenance, and day to day operations are responsibility of the tenants not the owner. Also consideration should be given to the difference between retail tenants and other tenant types. Retail tenants are typically on longer term leases and lease larger amounts of space meaning when a vacancy arises, a large portion of your income can be lost while filling that vacant space. The same holds true for Office tenants as well though they should be given special consideration as well. Office tenants normally have Tenant Improvement or TI costs for making a certain space meet the needs of their particular business. This cost can be worked into the lease amount or made a separate cost and can be paid either by the Tenant or Landlord or a portion for both. This can increase the time that a particular space stays vacant while being augmented to fit the needs of different businesses. Office properties typically have large common areas as well, which depending on the language in your leases, can increase the costs and management of the owner. Multifamily properties can be the most management intensive and require a large portion of time if not properly cared for. However vacancies for multifamily properties do not impact your net income as much as the number of units you own rises. For example, a single vacancy in a 10 unit building will severely impact your bottom line as you are now 10% vacant. A similar single vacancy in a 50 unit property has less impact as you are now only 2% vacant. The same holds true for Office and Retail properties and should be considered when choosing a property type. Multifamily properties do offer a certain advantage that retail and office cannot, that of a shorter time to maximize your revenue. As apartments typically turn over every one or two years on average you are afforded an opportunity to raise your market rents each time thus increasing your income every few months as new vacancies open up. Conversely on Office and Retail properties longer lease terms mean you are locked in to a rate that may be well below market for several years, thus losing opportunities to make the most money as the market dictates.
2. Personal Circumstances: Each individual investor has a unique set of circumstances that should be considered before purchasing investment property. Time is a major factor and can be critical to the success of your investment. A good course of action is to analyze your current situation and take factors into consideration such as secular employment, family, recreation, and travel and notice how much each of these areas demands time from you that might be needed to manage or oversee your investment. For example, a father of 4 with a busy secular job and family needs may not be able to make it every weekend to inspect the property or to repair a leaky faucet or clogged toilet or meet prospective tenants for leasing. On the other hand a retired individual may have the time to do these things, but simply just does not wish to spend time away from the golf course so a property that manages itself would be more desirable. Location is also a factor in your purchase decisions as sometimes the best market is not in your backyard. Ownership out of state can be extremely difficult and worrisome especially if you do not have reliable management on the property itself. Again property type factors in as well as an out of state owner for a retail property will not be nearly as disadvantaged as an out of state multifamily owner.
3. Management: Management is probably the single most important area to be considered before purchasing a property. The best investments on paper can be destroyed by mismanagement and leave you with a property under valued and unattractive to a future purchaser. Self management is always preferred for a few reasons. First, no one will take care of your investment better than you as each dollar spent is a dollar out of your pocket and hits home the hardest. Second, you will be much more motivated to lease spaces, perform repairs, and keep the property clean as it represents you as an owner. Management companies sometimes take a lackadaisical approach to your properties as it can get lost when a company manages multiple properties in the same area. That being said there are reliable management companies to be found, but each potential manager must be scrutinized on past performance, leasing criteria and advertising, ability to handle repairs and maintenance timely and so forth. Also differing levels of management do exist and should be explored from a full service agreement where all bills and accounting will be taken care of by the management company to limited management where leasing and rent collection are the only responsibilities of the manager.
4. Cash: Many times a day I am asked the question “How much will I need down to purchase this property?” The answer is never the same to the last dollar but each market has its own normal levels. In our current market the short answer to that question is at least 20% of the purchase price plus closing costs which are typically around 2% of the purchase price. Most all of the lenders, banks, private equity funds and other financing sources I speak with on a day to day basis agree that the days of purchasing a property with 10% down are gone. Lenders are tighter with their restrictions on both the borrower and the property and want to make sure equity exists from minute one in case of a foreclosure. This is a major factor in your purchase and should be considered first and foremost before anything else. At times creative financing exists and should be taken advantage of such as assumable mortgages and seller financing but each investor should still base the size and dollar cost of the property they are considering purchasing on the above 22% rule.
5. Market Trends: In late 2005 an investor approached me with the desire to buy an apartment property with the intent to convert it to condominiums. At that time the market was saturated with conversions and the market collapse was looming and was evident to those educated enough to see the signs. I advised him against it and he instead purchased an office property which is performing exceptionally well. Another investor did purchase that property and convert it into condos and to this day still has not sold a single unit. Each market is unique but all real estate markets follow somewhat predictable real estate cycles that can be identified to those trained properly. Working with a CCIM can be an extreme advantage as they are not only recognized as the most successful in their practice but the most knowledgeable on the inner workings of the economic cycles of real estate and the driving factors behind each market. For example, a smart broker will analyze an office property and take into consideration not only the number of other similar properties in the area, vacancy rates and lease rates but the economic factors that drive that market. A capable broker will analyze the number of new jobs being introduced into the market and the impact that they will have on demand for that particular type of office space and any newly constructed supply that may be planned for construction near the subject property. There are too many factors to list in this short blog of incidentals that can affect your investment and that is the main reason to work with a professional who will make sure you know all you need to know to be successful in your investments.
Next week we will discuss the goals and objectives as they relate to the Seller’s side of the real estate transaction. For more information on any of the information discussed above feel free to post a comment or to email me directly at pbarnett@jabarnettrealty.com to discuss your individual situation. I look forward to speaking with many of you in the future.
Peter J Barnett, CCIM
