Real Estate Investing; How This All Happened $118
Reflecting on a few interesting reads and listens over the past week
Real Estate Investing
Like many other assets, we tend to find a lot of great content on 'how to invest' when asset prices are going up. This section will focus on Real Estate Simpleton - who manages a Substack that focuses multifamily real estate. I've found his posts to be quite practical for those interested in understanding how these investments work and the process of underwriting the investment.
Three posts that I'd highlight are:
As I've mentioned in the past, real estate investing is incredibly different from buying mature software companies in the sense that you're focusing on the same characteristics (underlying contracts, their respective stickiness, ability to grow prices over time and etc).
Here are a couple of highlights/notes I'd take away from the posts referenced above.
Keeping the Screening Process Simple
In an ideal world, you want to have a very specific purchase criteria along with 2-3 data points that allow you to make a decision as to whether a property/deal is worth a deeper dive.
The post on screening properties focuses on the following criteria and data points:
Criteria:
In a market I know well (i.e. I know what market rents are without researching)
Large enough for non-recourse lending (typically loan value greater than $1 million)
Doesn’t require a ton of day 1 capital expense (I’m at the stage of my real estate career where I want to minimize risk)
Some forced appreciation possible (net operating income (NOI) increase I can “control”)
Data Points (to calculate an intrinsic value of the property):
Unit breakdown of the property
Market rents
Ballpark market cap rate for the property
Now if you don't do real estate investments on a day-to-day basis, I'd argue that you should have a more stringent criteria and play the long game. This could mean picking a specific market, having a specific 'day 1 capital expense' that you can afford and perhaps limiting your forced appreciation (e.g. value-added renovations).
You can also perhaps add a buffer into your market cap rate so that you're focused on getting exceptional deals vs. ones at market value. Too often, people have appeared to look like great investors by focusing on deploying capital as soon as possible - with market value growth creating the mirage of great returns. Unless you're an active investor, the goal should typically be to find deals that are great on its own merit with any potential market growth becoming a bonus.
Doing Your Due Diligence
Many investors I know have lived through a frothy real estate market for 5+ years and have consequently had a stronger focus on getting the deal done vs. completing diligence. It's hard to understand the value that can be had by doing a proper diligence, identifying potential challenges/opportunities and adjusting the price accordingly.
Here's the data checklist that's referenced in the diligence post above.
P&L reports: Last 3 years
Trailing 12 month (T-12) P&L
Rent roll: Name, Unit, Rent $, Security Deposit $, Lease Start, Lease End
All leases
Insurance policy & premium
Radon test reports
Mold test reports
Tenants in arrears: Name, $ amount
Insurance loss reports: Last 5 years
Fuel bills: Last 24 months; I ask for 2 years because fuel usage can vary significantly from year to year.
Electric bills: Last 12 months
Water & sewer bills: Last 12 months
Plowing bills: Last 24 months; I ask for 2 years because snowfall can vary significantly from year to year.
Landscaping bills: Last 12 months
Trash removal bills: Last 12 months
Balance sheet: Last 3 years
Service contracts
Original applications of current residents: I want to assess the quality of in-place residents.
Equipment & building warranties
Maintenance schedules & logs
Property survey
Notice of any litigation or violations
Environmental reports
I'm quite convinced that most investors (especially ones in Canada) don't go through the entire checklist above. While this level of data may not exist for smaller properties, it's important to ask many of the underlying questions behind this checklist as you can often uncover problems/hidden costs that will give you the leverage to either adjust the purchase price or add more value to the deal sooner than later.
How This All Happened
Similar to his other posts (along with his book - The Psychology of Money), this essay is a great level set into how we got into the situation we're in today. It takes us from WW2 to our current predicament (good and bad) and gives us a slightly better perspective on why things are the way they are.
Take a read-through as I don't think it will be in your best interest to read a summarized version.
I’d specifically pay attention to the underlying events (e.g. focus on the ‘American household’ and the expectations it set for future generations).