Living in Contra Costa County

How Much Risk is Involved in Investing in Apartment Buildings in Contra Costa County?

First of all there is Risk in Everything; including Buying Apartment Buildings.   The real issue is a) How quantifiable is the risk and b) How manageable is the risk.

Generally speaking the Bigger the Risk the Bigger the Profit Potential.  That seems like an obvious statement.  But there is another consideration - The Bigger the Perceived Risk the more Opportunity for Big Profits. 

I want to pause here and suggest you read a post I wrote on How to Get the Best Deals.

By quantifiable risk I mean that there is some risk but it can generally be predicted relatively easily (The odds are you can rent out a certain house at a certain price in a certain amount of time is predictable.), it can be quantified (the cost of a new water heater installed is under $600.00 - if it should break).

By manageable risk I mean everything you can do to control risk - repairs can preserve and lengthen the life of property as well as keep liability claims from happening, good tenant screening and proper management can mean better tenant retention and stabler rents, Insurance can be purchased to cover larger loss that you cannot absorb.

Opprotunities come along for many reasons.  Frequently the most profitable come about because the seller cannot quantify or manage the risk.  Perhaps they feel overwhelmed by the situation and just want out of it.

I have an example I want to share with you.  I came across a commercial residential property for sale with a 15% Cap Rate.  (What is Cap Rate?)  At the end of 2010 the Average Cap Rate on East Bay Apartments was heading down from 10% towards 8%.  One report I looked at had Cap Rates at around 6-7% in Metro Areas and 9 to 10% on REO properties as of September 2011.

The property has been poorly managed and the records are poor.  The rental rolls and P&L statements are not very formal.  The only think we can get out of the Listing Agent is the Total Monthly rents.  I doubt there is any kind of budget or P&L statement.  Probably just some numbers in a check book.  Surprisingly we were provided inspection reports; no estimates of repair.  There are some problems, but nothing that cannot be quantified and delt with.

This property is below the Radar for a number of reasons.   The important thing is to get the property into contract.

I sent out the information on this property to 8 investors that tell me they want good deals.  Some of these investors have not gotten back to me.  A few others have asked to see the P&L statement, demanded a full rent roll, or want me to get detailed questions asked about the past management and history of the property.  In fact the list of things they have demanded could be right out of a "How to Invest in Apartment Building Book" sold on late night TV.  

One Investor has spoken to me and I have gone over the issues with him.  Did he ask the questions above?  Yes he did.  But he also listened to the advise I am going to share with you below.  He had more insightful questions about the zoning, possible future of the property, the properties around it, the cities long term master plan.  We noted new streets and developments that might go into the area.

Based on what we have now we think after improvements we can still manage a 15% cap rate or close to it.  We don't have enough information to figure out Rate or Return (or Return on Investment) but my rough estimate is that it might be close to 20%.  Furthermore, the long term potential for the property is excellent.  The Cap Rate will climb or the Property can be flipped for a fantastic profit.  

But what if there is a down side we don't see?  What if the Cap Rate and/or RoR is only 1/2 or 1/3 of what we expect.  What if 5 or 10 years down the line the property has not appreciated that much?  Well you can never tell for sure about anything; but the odds are there will still be profit and more profit than letting the money set in a bank vault.  With the state of today's banks it may be safer in property than in the bank.

But back to the purchase issue.  Are we giving up on getting an accurate Rent Roll or trying to piece together a P&L?  No we have not.  But what this buyer understands it the Real Estate Contract.  When you get into the contract you are not committed - it is like an engagement.  There are promises and obligations, but you can get out.  Part of the contract will be a commitment we will request from the seller for detailed rental information, detailed cost (as best as he can get together), and that he answer questions we have about the property.  We will also have more detailed inspection contingencies and time to get estimates of repairs and such.

But why get into contract before we get this information?  There are several reasons:

1. We want to lock up this property now and keep other buyers away.
   
   
   
2. The Seller is not likely to jump through all the hoops we want until he has some sort of a commitment from us; even if it is a contract full of contingencies.
   
   
   
3. Sellers (and Buyers) are often more motivated to cooperate and work on something (and compromise) once they are in contract.  When they get into contract they become more focused on closing.  
   
   

As it stands now I am going to have a buyer who gets one of those great deals everyone talks about and 7 buyers who are standing around wondering where all the deals are.