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The Investment Journey
Volume 30 Number 8 August 2006
By Jeanine Gajewski
When it comes to the best way to invest, not all paths lead to prosperity.
Last year, Black & Decker sold more than 365,000 drills, but not one person who
bought one wanted the drill, they wanted the hole. When you buy an apartment
building, you don't necessarily want the building itself, you really want what's down the road, said Jeff Hawks, a Denver-based partner with
Apartment Realty Advisors. Hawks, who spoke in June at the 2006 NAA Education
Conference & Exposition in Denver, said the Black & Decker Rule of Life holds true for independent owners who have the vision and patience to make the
right kinds of investments for maximum returns.
Timing is Everything
In constantly fluctuating market conditions, Hawks said even the most savvy
investors from the largest companies can't always accurately predict a market. If you think you know where the cycle is, I would say you're probably wrong, said Hawks, a 33-year industry veteran. For example, he said that in
2001, experts forecasted that Denver would be an A market, but in one year,
vacancy went from 4 percent to 11 percent, plummeting Denver to a C-minus.
It doesn't come down to all luck or all skill, but to a combination of both, Hawks said. Some of the smartest and most accomplished apartment
investors that I know have lost everythingand some of the dumbest investors
to walk the earth have become wealthy.
Hawks said in 1988 he met an investor who was clueless. The investor had owned
several smaller properties in California, had held his properties while the
market soared and then had sold them to purchase two 100-unit buildings in metro
Denver.
He made terrible management decisions and failed to maintain his properties
in a manner that would hold their value, Hawks said. But in 1993, Hawks said,
the investor sold his properties for more than two times what he had paid for
them, returning eight times the equity that he had placed just four years
earlier.
Sometimes, bad luck can ruin a smart owner's best-laid plans. Hawks related
the story of one of his clients who began investing in smaller properties in the
1970s, and by the early 1980s, had built a portfolio of seven apartment
communities, each with 40 to 120 units.
He was one of the best apartment owners and managers I have ever met,
Hawks said. He and his wife had ridden the market up, had managed the
properties well and had kept them in very good shape.
Sensing the market was at its peak, the investors sold all of their properties,
carrying back some financing on different properties, but removing most of their
money from real estate and putting it in the bank. In 1986, the market
collapsed.
As the buildings decreased in value, the clients were presented a dilemma,
Hawks said. Their income from the money they had loaned to the purchaser was
going to disappear if they lost the building in foreclosure, so they had an
opportunity to repurchase these properties at approximately 80 percent of the
price they had sold them at three years earlier. Knowing that they had almost $1
million in cash in the bank and knowing that they had real estate expertise,
they took over these properties and purchased more properties to take advantage
of a down market and ride the market back up like they had done in the early
1980s.”
What they had not counted on was that the market would continue to fall. Most
properties in 1987 and 1988 dropped to a value of about 50 percent of what they
had been in 1984,” Hawks said. These investors tried to hang on, used up
all of their money and eventually lost everything, including their home and all
of their investment properties.
When to Invest
Misfortune aside, Hawks said there are some key indicators that can help rental
owners decide when to invest in a market.
When to invest is a very difficult question, Hawks said. The easiest
answer is to invest whenever you want but to make sure that you have staying
power in case the market reverses quickly after you have invested.
Although trying to judge a market and its future is a full-time job, Hawks said
the basic barometers for most apartment investors are supply and demand, job
growth and demographics.
Supply and demand is fairly straightforward, Hawks said. Take a look at
future growth when dealing with supply. How many apartment units are currently
under construction? How many permits were pulled for how many units and in which
areas of town? Hawks said that the number of condo conversions within a
submarket also affects supply.
Hawks said that while the second half of the equation often is more difficult to
determine, demand depends on several factors, including changes in job growth
and employment. In boom towns, such as Las Vegas and Phoenix, construction
workers make up a large percentage of the workers demand for apartments,
Hawks said. When the work stops, there will be an out migration from those
markets of laborers who will move to other markets following the jobs.
To determine demand, investors should consider birth rate, high school
graduation rate, in-migration and family formations. An example in metro
Denver is that the average household size is increasing and the average age of
women giving birth is decreasing, Hawks said. This is a result of an
increase in the Hispanic population and will be a contributing factor to a
tightening of the apartment market for many years to come.
Moving Up to Buy New
Hawks said that apartment investors often ask him whether it is better to
purchase established properties or to buy new. However, he said, investing in
old properties or new ones often is not a choice available to the investor.
In most markets, new properties meaning properties that are less than 20
years old are usually larger properties, he said. In many markets, land
that was available for development after 1980 was slated for 200-plus unit
communities, resulting in almost no smaller properties being built after 1980,
according to Hawks.
Because of the higher number of units and the price per unit which is
usually up to twice as much per unit as an older property moving from an older
property into a new property is not financially feasible because of the increase
in the purchase price of that newer property, Hawks said.
Hawks used the Denver metropolitan area as an example. If an owner had a
60-unit building built in 1974 and wanted to purchase a new property, he would
be selling the 60-unit building for approximately $3.5 million but would have to
replace it with a 200-unit building built in the past 20 years with an average
of $100,000 per unit, thus making his new purchase price $20 million, Hawks
said. It is very difficult to exchange a $3.5 million property for a $20
million property.
Hawks said that what an owner must do is move from a 60-unit built in 1974 to a
100- or 150-unit built in 1974. However, Hawks said, if the owner owns
a 200- to 300-unit building built in 1974, the choice would be, upon sale, Do
I buy an older property or a new property, which are both in my price range.
In my experience, purchasing a newer property has more potential for increased
return than an older property.
New buildings have several advantages, according to Hawks. The first is
supply and demand, he said. There will always be more buyers for newer
properties than there are buyers for older properties. Along with this demand
comes an ability to liquidate this asset whenever the property owner chooses.
The next plus is capital improvements. Most owners of older properties
understand that there are constant issues with 30-year-old boilers, 30-year-old
roofs and 30-year-old structures, Hawks said.
The other important factor is financing. A newer property has more avenues
for loans and usually lower interest rates, he said. Also, some buyers of
new properties purchase these properties with all cash and with no financing. In
a time of higher interest rates, newer properties are less interest-rate
sensitive because owners can sell to all-cash buyers.
Don't Believe Your Eyes
Hawks said one of the biggest mistakes owners make when investing in a new
market is having preconceived ideas based on the areas from which they came.
When you investigate a new market, the kiss of death is to assume that
a submarket that looks like a submarket from your last city will react the same
way as that submarket did, he said.
When entering a new investment market, Hawks said that while owners should bring
with them proven management strategies, they should start with a clean slate
regarding underwriting and their understanding of local submarkets.
Many new investors believe that they have found a unique investment at an
undervalued price, Hawks said. They then proceed to quietly acquire the
property, not wanting to mention to too many people what they are doing.
This is the opposite of what their business plan should be, Hawks said. When
going into a new market, it is very appropriate and imperative that you seek
advice from knowledgeable local members of the apartment industry, he said. This
should result in many local facts, ideas or concepts that you were not aware of
coming new into this market.
Industry resources include apartment management companies, appraisers, lenders
and apartment brokers. Getting multiple sets of feedback on assets that you
are considering may alert you to any issues that would not be apparent to a new
investor from out of state, yet are obvious to the local investors, he said.
Aspects that are difficult to discover are the transitioning areas, resident
profiles, city and county restrictions or newly enacted policies and trends in
local job growth.
When the Grass Isn't Greener
If a property looks too good to be true, it probably is. The grass is always
greener because someone has been applying fertilizer, Hawks said.
When looking for properties in a new market, it is very important not to be
taken in by opportunities that look too good. It is safe to say that if
there was a great opportunity, some local investor who had been in this market
for his entire career would have snapped it up, he said.
Investors wanting to move to a new market do not always do so to get the best
deal on the market, Hawks said. The opportunity to move to a new market
should be one in which the market timing is better in the new market than it is
in the market you are exiting, he said.
For example, Hawks said one of the biggest moves during the past five years has
been apartment investors in California taking advantage of the local upturn in
pricing and cashing out on what they believe to be an overheated market. They
are moving into markets, such as Las Vegas, Phoenix, Albuquerque and Denver,
where the markets appear to be more on the downside than the upside of the
curve, Hawks said.
The other opportunity in changing markets is for owners to upgrade the quality
of their assets. Investors in Denver can sell 1970s product and move into
1980s product in a market such as Phoenix, Hawks said. Investors from
California can sell a 10-unit building and potentially purchase a 60- to
100-unit building in markets such as Dallas and Denver.
Hawks said these strategic moves can assist apartment owners in accomplishing
their investment strategies.
Jeanine Gajewski is NAA's Manager of Communications. She can be reached at jeanine@naahq.org or 703/518-6141 Ext. 141.
Sidebar:
Buying in Bulk
For smaller investors coming out of $1 million to $3 million in equity, Jeff
Hawks, a Denver-based partner with Apartment Realty Advisors, suggested the
option of buying a block of condominiums as rentals.
By approaching a condominium builder or converter, buyers should be able to
negotiate a discount off of the retail value of the condos when they buy
multiple units, he said. This discount should be negotiated with the
owner, and the buyer should avoid larger commissions, closing costs and
upgrades. By buying in bulk, the buyer should be able to purchase between 10
percent and 20 percent below the current retail price.
Hawks said that one of the physical advantages of buying condos is that an
investor can buy them all in the same building or diversify and purchase condos
in different areas and price ranges. The management duties for condominium
owners are less than apartment ownership because the homeowners association
usually takes care of building maintenance, exterior maintenance, landscaping
and any amenities, Hawks said. The buyer is left with the leasing duties
and little more.
Another advantage to rental condominiums is that they can be sold off as one
investment group or exchange them one by one to spread the sales out and pay
taxes in multiple tax years.
Renting individual condos poses a disadvantage in that the value of the condo is
usually greater than the same unit would be as a rental. The value of a
1,000-square-foot apartment unit is usually less than the value of a
1,000-square-foot condo unit. The returns should be less on a cash-on-cash
basis, but may equal out because of the discount received upon purchase and
potential value increase, Hawks said. J.G.
An A-to-Z Guide to Apartments
Making a smart investment in rental property is only the beginning. Managing an
apartment or apartment community requires an owner to possess unique qualities
and skills--and a certain amount of luck. Following is a quick, A-to-Z look at
what it takes to be successful in real estate, according to Jeff Hawks, a
Denver-based partner with Apartment Realty Advisors:
A Apartments; Analysis; Accounting
B Budget; Building Departments; Boilers
C Consistency
D Determination
E Energy; Exit Strategy
F Fun; Financial Analysis
G Guts
H Help (from your team of specialists)
I Insight; Innovation; Ingenuity
J Justice
K Knowledge
L Lender; Legal Advice; Leaks
M Management; Mortgage; Marriage Counselor; Meth Labs; Mold
N NOI
O Optimism; Occupancy
P Planning; Patience; People Skills; Plumbing
Q Questions (always ask)
R Reserves; Roofs; RUBS; Return
S Strategy; Skips
T Tenants; Timetable; Tax
U Utility Player
V Vision; Vacancy
W Wisdom
X Xeriscape
Y Yelling; Yes
Z Zeus (because sometimes you will need help from the gods)
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