When I made the jump to multifamily investing, I was unsure of the steps I needed to take to get into my first deal. I was very familiar with buying single-family homes, but fear and doubt was building inside me just at the thought of buying a multifamily property. The objective of this article is to create a roadmap for you to follow on your first multifamily deal. I would like for you to read the 7 Steps To Success In Real Estate. This article focuses on the actions all real estate investors need to take in order to become successful. This article will drill down into multifamily investing and present a framework for you to follow.
Let me outline the steps and then describe each step in more detail:
- Choose market/begin research
- Contact brokers
- Start to build a team
- Begin analyzing deals
- 100-10-1. Analyze 100 properties – Bid on 10 – Acquire 1.
- Write Letter of Intent
- Negotiate and begin to acquire financing
- Create purchase and sale agreement (Contract)
- Perform due diligence
- Renegotiate – address any needed repairs/issues
Choose a market
The majority of investors who are new to multifamily investing focus on the deal, and pay very little attention to the market. My focus is to first zero in on markets that have job growth, household and population growth and favorable demographics. Read our article on analyzing markets to learn how to invest in an emerging market. I would rather invest my time and money in a market that is exhibiting signs of positive growth. You can reap the gain of appreciation as well as cash flow if you invest in a market that is beginning to emerge.
Once you have committed to a market, the next step is to contact real estate brokers. You should have a basic knowledge of the market’s demographics. A broker is a key resource to learn more about the market. A real estate broker is a key team member, and the majority of our deals have come through networking with them.
Where do you find brokers that specialize in multifamily? We will jump on Loopnet and find out who the brokers are in a specific market. We look for brokers that are listing multiple deals, and we contact these brokers and begin to create a relationship. Don’t expect a broker to throw you an amazing deal in the beginning of the relationship. Try to build rapport, let the broker know what your business plan is, and try to become more knowledgeable about the market. Once the broker becomes comfortable with you and your business plan, he will start to send you deals.
If your intention at this point is to continue with this market, your next step is to start building a team. Your real estate broker should be able to help you with this step. Ask the broker if he has any recommendations for an attorney, an accountant, a property management company, a banker and a title company for starters. It is always ideal to have a team in place before you start putting in offers. On our first deal, we only had an attorney on our team. We were ill equipped to continue along the due diligence phase and almost made a few costly mistakes. The lack of a team definitely slowed us down and could have cost us a lot of money. We were scrambling to find a multifamily property inspector to perform the inspection, and a contractor to give us estimates for the repairs that were needed on the property.
On our next deal, we were confident because in the letter of intent, we were able to convey to the seller what bank we were using for financing and we had a team member to perform the property inspection. The level of stress dropped dramatically, along with the time needed to close the deal. Having a team in place made it a lot easier to close the second deal, and it gave us the credibility with the broker and seller that we could close on the deal.
Begin to analyze deals
Now comes the fun part. You need to set certain parameters for your buying criteria. We look at three criteria when analyzing a deal: Cash on Cash, Cap Rate and Debt Coverage Ratio. We call it the “Buy Right” portion of our framework. As I mentioned earlier, don’t expect the first few deals to be home-runs. The broker is testing your knowledge of underwriting a deal, and wants to know if you are a serious buyer. If the deal he sends over does not fit your parameters, thank him and let him know why the deal doesn’t work for you. Do not make him wait for a response. Get it over ASAP.
We believe in the 100-10-1 principal, especially for beginners. 100 is the amount of properties you’ll have to analyze to find 10 that might be worth while, and you’ll only close on 1 of those deals. Now you may be saying to yourself “How am I going to analyze 100 deals?” You will need to analyze the numbers first, and if the deal makes sense, then you dive deeper into your analysis. There is no need for you to jump into your car and look at one hundred deals. What you need is the experience in analyzing numbers, looking for value and spotting a deal.
That takes time when you first begin. Unfortunately most beginners quit at this early stage because they can’t “find” any deals. They’re out there. You just need to know what and how to look for them. The only ways is with practice and constant repetition.
This number will drop drastically as you gain experience in the market. As you become more experienced, you will be able to focus on certain areas of a city, certain size of a property, certain value-add characteristics, etc. You will be able to eliminate many deals even before you waste any time analyzing them. And you will have brokers bringing you deals because they will know what type of deals you are looking at. When a mom and pop comes on the market, we have brokers contacting us because they know we are the mom and pop kings.
It has become increasingly difficult for investors to find deals. Cap rates have been compressing the past couple of years, and money continues to flow into the multifamily sector. It is vital to create and maintain relationships with brokers in your market.
Letter of intent (LOI):
Once you have located that elusive deal, it is time to write a letter to the broker conveying your intention to purchase the property. Here is a sample letter of intent that we use:
RE: Letter of Intent to Purchase Apartments
I would like to make an offer to purchase the apartment complex known as Apartments located in __________. Please see the terms below regarding the purchase of the property:
1. Property: Apartments located at ______________________
Buyer: ABC LLC
Price: $ 6,400,000
Earnest Money: $100,000 at Execution of Purchase & Sale Agreement.
Due Diligence: 30 Days
Financing: 30 Days; Interest Rate 4.25%, 25 yr amort, 20% down payment; Financing through bank
Closing: 30 Days following expiration of Due Diligence Period
Other Terms: Seller and Buyer shall each pay for half the cost of the Title Insurance Policy and the Transfer Taxes. Purchase and Sale Agreement shall be negotiated and entered into upon Execution of this Letter of Intent. Property shall be delivered Free and Clear of any existing Liens from Previous Ownership.
Jake & Gino
A letter of intent outlines the basic terms of a deal between the two parties. The job of the letter is to outline the basic terms before negotiations begin and to offer a roadmap. The letter can be either binding or non-binding. Our letter of intent is non-binding (having no legal or binding force), and we try to include all of the important provisions that are to going to be negotiated in the deal.
Negotiate and begin to acquire financing
Once the seller receives the LOI, he has two options. He can either accept the terms or counter with his own terms. There is usually a back and forth between the two parties before the buyer accepts the terms. When I send an LOI to the buyer, I usually put a deadline for a response. I do not want the buyer to go and shop around my offer. I am looking for a quick response so I can counter and come to terms as quickly as possible.
If you have the luxury of having a banker on your team, now is the time to show him the deal and ask to see if he can finance the deal. I recommend seeking out at least three sources to finance the deal. They include local banks, credit unions, regional banks and mortgage brokers. I prefer to use local banks because they have a better understanding of the local market and are much easier to work with, especially on your first deal.
Create a purchase and sale agreement
The day has finally come. The seller has accepted the terms and it is time to draw up a contract. Send over the LOI to your attorney and have him draw up the contract. I prefer to draw up a contract because I want to control the wording in the contract. The contract should reflect all of the points discussed throughout the negotiation and include all the terms in the LOI.
Perform due diligence
Once the contract is signed, the due diligence clock starts. The buyer has a specified time frame to perform due diligence. Click here to read our Three Step Due Diligence Framework. We try to schedule thirty days for due diligence and an additional thirty days to secure financing. During this crucial step, it is vital to trust but verify everything the seller has told you. Now is the time to uncover any problems and discuss them with the seller.
If the due diligence has not uncovered any problems, then it’s time to close the deal. On the other hand, if the financials are incorrect or if the inspection uncovered problems with the property, now is the time to handle them. Real estate professionals use the term “re-trade” when a buyer goes back to the seller and asks for a concession. For example, if the buyer has uncovered a roof that needs replacing, now is the time to ask the seller to either replace it himself or provide a credit at closing for the repair.
Only ask for concessions that are reasonable and fair. You don’t want to be branded as a re-trader in your market. Brokers will not take you seriously and will not want to do business with you.
The day has finally arrived. A sense of fear overwhelms you, and feelings of doubt start creeping in. That’s how I felt during our first closing. Jake confessed to me that he lay sleepless the night before our first four deals. All that is left is to sign the contract and take over the property. NOW, the hard work is just beginning.
Written by: Gino Barbaro