BiggerPockets Real Estate Podcast - 571: Is This Deal Worth My Time? The 6 Crucial Steps to Vet a Multifamily Deal

Episode Date: February 15, 2022

Real estate underwriting isn’t a commonly used term within the residential world. If you’re used to dealing with single-family homes, duplexes, triplexes, or quadplexes, you’ve probably done real estate underwriting to some degree, but you’ve called it “real estate analysis”. In both scenarios, investors are looking at what they’ll make on a deal, how much they need to invest, and what exit strategies they have. But, in a hot housing market, like we’re in today, by the time you analyze a deal, a deal may already be gone. You need a way to quickly sort deals into the “pursue” or “dump” piles, and Andrew Cushman, expert multifamily investor, may have just the solution for you. Andrew has been on the BiggerPockets podcast before and manages over 2,600 units, so he definitely knows what he’s talking about! Today, Andrew showcases the phase one underwriting he uses to decide quickly on deals, as well as the four levers to look at before even getting into underwriting. His system can save you hours, or even days, if you’re a full-time investor, and it helps rookie investors quickly analyze deals so they can get into the game. Now, residential owners can transition into commercial real estate with better scale and bigger profits. In This Episode We Cover: How Andrew scaled from zero to 2,600 units in only ten years The basic screening process that allows you to triage your deals and waste less time Four levers every investor should look at when analyzing a new deal The six factors of phase one multifamily underwriting and using it to unlock “home runs”  Developing and nurturing broker relationships so you can get off-market deals before your competition  And So Much More! Links from the Show BiggerPockets Forums BiggerPockets Podcast 169: Using Hustle and Persistence to Build Wealth Through Real Estate with David Greene BiggerPockets Podcast 170: The Journey From Flipping Houses to Owning 1,470 Units with Andrew Cushman BiggerPockets Podcast 270: Turning Your Primary Residence Into 40 Units & Financial Independence with Amy Arata How to Find Overlooked Opportunities in a Hot Market with Andrew Cushman Hal Elrod's Website BiggerPockets Calculators Submit your Question for an upcoming Seeing Greene episode! CoStar ESRI LoopNet Invest with David Greene David's Instagram Check the full show notes here: https://www.biggerpockets.com/show571 Learn more about your ad choices. Visit megaphone.fm/adchoices

This is the Bigger Pockets podcast show 571. What that does is that takes the 10 deals sitting in your inbox on Monday morning and whittles it down to the two, then want to go to phase one underwriting on it, right? So that's helping you narrow your funnel and focus on this stuff that has the highest probability of working for you. What's up, everybody? It is your co-host, David Green, and welcome to the best real estate podcast on Earth. We have an awesome show today.

if you are interested in practical, tactical, detailed advice on how to invest in multifamily property. All right, welcome to the Bigger Pockus podcast, where it is our job to help you achieve financial freedom through real estate. We do that by bringing in experts in the field who have a lot of value to add in this space to teach you for free, how you can also use real estate to build your wealth as long as you take action and completely commit to the purpose that you have decided, which is financial freedom. You want it badly. So do I. Let's do it together. Now, today is a special guest, and he's special for several reasons. For one, he's one of my best friends. We have Bigger Pockets repeat guest, Andrew Cushman. He was on two episodes before this one, and we're sort of continuing in that theme. Now, he's kind of a special guest because we came into the podcast at almost the same time.

I was interviewed for the very first time on Bigger Pocket show, 169. Andrew was on 170. So that was pretty cool. Then he got into commercial investing and I got into single family investing and Andrew became the partner that I invest in when I do multifamily deals. So if you ever hear me talk about a multifamily apartment that I'm buying it or partnering it's all through Andrew. Now also, Andrew was a huge inspiration in the long distance real estate investing book. He's someone that I would go to to learn the screening criteria that he's using for multifamily and then I adopted it into my long-distance investing for single family. So a lot of the information I get about where people are moving to, where jobs are,

what I want the median income to be, the stuff that I teach in long-distance real estate investing, it was inspired and a lot of it came from Andrew Cushman. He's a very, very smart guy. It's why I partner with him on multifamily deals. And we get into the details today about what he looks for when he's screening a property. Now, basically, Andrew has a three-step system that we've helped develop and then help leverage out. We're going to talk about that too. But in the episode 270, we basically describe what the first phase was. In today's podcast, we're describing the second phase. And in a future podcast, we're going

to describe the third phase. So if you've ever wanted to start a syndication or invest in multifamily real estate yourself, or you're trying to figure out who's the right partner to put my money with, maybe you want to be in a syndication, but you want to be a limited partner. You don't want to be the one that has to build the whole system. This is probably the best episode that you will ever listen to. We get into what to look for, the specific, the six steps that Andrew uses to decide, is this property worth my time or should I move on to something else? We get into why these are important factors and then how to verify the information that you're collecting. So not only you're learning what do I need to collect, but you're also going to learn why that's important

and how to verify it. And then as a bonus, we get into the four levers. that make a property profitable. So if you've ever been exposed to multifamily real estate, you know that the internal rate of return is the metric that most syndicators use to describe if you invest with them, how much of a return on your money you can expect to get over, say, a five-year period or a six-year period. Well, Andrew describes the four things that move the needle on that IRR

more than anything else, as well as ways that you may be deceived by the syndicator who's putting the property together so that you can see right through that and you don't invest in the wrong deal. This is a fantastic episode. It's probably one you might want to listen to more than once because there's so much information and it's so many good, practical, tactical steps

that you don't want to miss anything. Now, before we get into that, let's get it today's quick tip. And that's going to be, get on the Bigger Pockets forums. Bigger Pockets has so much value to be offering you outside of just this podcast. They have a rent estimator tool.

They have an agent finder, so you can find agents in different areas that are used to working with investors than invest themselves. They have calculators that will help you analyze deals. They have forums where you can ask specific questions. Andrew actually talks in today's show about how he goes on the forums himself to look up answers to verify if he's been told something by a property manager or by a broker

by somebody bringing him a deal. You can do the same thing. So check out all that Bigger Pockets has to offer by going to the website and cruising around. Now, if you have any questions that you think I should have asked Andrew or just something you want more clarity on and you didn't. get it answered, go to biggerpockets.com slash David, where you can submit your video question or your written question for me to answer on a future episode of the Seeing Green podcast. Today is Tuesday. Tuesday is when we do the tactical information podcast where you get pure raw information to help

you on your journey. That's why we're interviewing Andrew. But if you need more clarity in any of that, please go to biggerpockets.com slash David. Do you ever notice how every passive investment somehow turns into a very active lifestyle. Active spreadsheets, active phone calls, active stress. Here's a better question. What if you could buy brand new construction homes, 10% below market value in the best markets across the country without making real estate your second job? That's exactly what rent-to-retirement does. They're a full-service, turnkey investment company handling everything for you. In some cases, investors get 50 to 75% of our down payment back at closing, plus interest rates as low as 3.75%. They've partnered with Bigger Pockets for over a decade, helping thousands invest smarter.

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That means less time on busy work and more time closing deals. Start your free trial and lock in 50% off your first month at re-simply.com slash bigger pockets. That's R-E-S-I-M-P-L-I dot com slash bigger pockets. There are two kinds of real estate investors, those who have reviewed their insurance, and those who think that they have. Most don't realize their coverage wasn't built for how they actually invest. Vacancy periods, rehabs, short-term rentals, or LLC-held properties.

These gaps surface only when filing claims. That's why investors work with N-Reg. They specialize exclusively in real estate investors, understanding portfolios, risk at scale, and cash flow protection. One claim can erase years of returns. If you own a rental property, don't assume you're covered. Have NREG review your insurance with someone who gets investing at NREG.com slash BP pod. That's N-R-E-I-G.com slash B-P pod. It is my pleasure to bring in my good friend and business partner, Andrew Cushman, the best multifamily investor that I know. Andrew Cushman, welcome back to the Bigger Pockets podcast.

It is good to be here, man. Thank you for letting me join the rare group of just three Peters, right? Yes, you are in a rare and elite class of people, although you've been on Round Bigger Pockets for like, feels like forever. So three episodes really isn't that much considering your first one was on what, 170? Is that right? Way back in 2016, 170. One episode after you got on for the first time. and now you're the host of the whole thing.

So there's actually a clever backstory here. Andrew and I had a conversation together about being on the Bigger Pockets podcast before either of us were affiliated with the company. And it was Hal Elrod that we spoke to that made the connection to Brandon and Josh because he had just been on the show. And that's how I ended up getting interviewed and Andrew ended up getting interviewed. And now it's sort of morphed into this point where Andrew and I are partners now. And he is the guy that I partner with when I buy multifamily real estate or when we buy it,

I should say. And then I'm hosting the show and Andrew has gone on to build a team very similar to how I built the David Green team. So I built the real estate sales team and Andrew built a multi-family investing team. So why don't you tell us a little bit about sort of your biography, what you buy, how long you've been doing it and why you are the expert? Well, I took the traditional path into real estate and got a chemical engineering degree. But that was just a placeholder. I knew I wanted to do my own thing. I just figured I might as well have a good job until I figured.

it out. So I started working for a food company as an engineer and married my wife. She had the same mentality that I did of, hey, let's try to create our own thing. We discovered seven, after working as an engineer for seven and a half years, we discovered flipping and went and learned how to do that. And this was back in 2006. And, you know, as an engineer, I was not the best on the phone. I found this out later. My wife, when she was calling me when we were dating, she would make a list, a written list of topics. to keep the conversation going because I was so bad on the phone, right? So then what did I do is I went into flipping houses by cold calling people who were in pre-foreclosure. So not something that I was very good at, but I knew it worked.

So it took me 4,576 phone calls to get my first deal. But when I did, we made as much as I made all year of my engineering job. So I walked in, quit my engineering job. We became full-time house flippers here in Southern California for four years. had great years, particularly in 2009 and in 2010. But then we said, okay, number one, this feels like another job. It's super transactional. You're only good as your last flip.

You put the check in the bank. You got nothing after that. And then we said, this is starting to play out. Everyone else is coming in and becoming competition. What's the next big thing? And so we reasoned, well, we just had a huge recession. So that means we're probably going to have a big expansion. So that means job creation, household formation, all that.

And then we also reasoned, okay, well, half the planet just got foreclosed on, which means they can't buy a house, which means they're going to be renters. So put an expanding economy together with a growing renter pool, well, apartments should do well. So we went and found a guy who had done 800 units, hired him to be our mentor. He held our hand through our scary first deal. And 10 years later, we're at 2,600 units. And it's been great business. Multi-family, to me, is the Keanu Reefi. of the investment world. It's on a long winning streak, treats everyone well, and it's tough to find any legitimate reason to be a hater. As long as you don't make it communicate, right? Like, just keep it to the numbers. Yep, keep. Yep, exactly. It's funny you mentioned Kenna Reeves,

because I just saw the Matrix Resurrections yesterday, and I realize every time they make him talk, you start to lose it. And as long as Kenoreves not talking, the movie stays really good. And I feel like most multifamily investors, as long as you let them focus on numbers and projections and math, they do great. The second, like you said, they have to make a phone call. It takes 4,576 attempts to make it work. Exactly. That's why you're hosting a podcast and I'm focused on deals. That's funny.

All right. So how many properties have you bought and how long has your career been going on? I think we're on like 16 or 17 syndications. Like about 2,600. The last 12 months have been phenomenal. By February, we'll be at acquiring 670 units for about 108 million. But that puts us at a total about 2,600 since 2011, which is our first one. Okay.

So you're right around 10 years now, maybe a little bit longer you've been doing this. Yep. That's perfect. All right. And you were on episodes 170 and 279, if anybody wants to go kind of follow Andrews' trajectory to see why I picked him as my multifamily guy. I always like to say, I got a guy, right? Makes you sound cool.

I got a guy for that. Talk that way. I kind of just monitor what your career has done. We'll put those in the show notes for you. Now, what we're going to talk about today is the three-step process that we have that we use to decide should we write an offer on a property. Can you briefly explain what those, like how you've classified these phases of underwriting? Yeah. So, you know, the kind of the pre-phase is, you know, like Brendan talked about the funnel a whole lot, right?

So that's just getting all your leads and coming into your inbox. We're not going to really talk about that because we're assuming you figured that piece out or you're going to do that. The first main phase is actually the one we talked about in detail back on 279, and that's screening properties because there's so much opportunity out there. There's no way to look at it, everything. And so you want to whittle it down to the stuff that fits your perfect criteria. Or again, as Brandon would say, crystal clear criteria, right? Right. So just a quick recap of.

of those screening criteria. Again, the details are in episode 279. But number one is you're going to just do like a quick Google search, right? Pretend you're a person walking the neighborhood and look at the neighbors. What do the satellite photos look like? Does it look like a good neighborhood? All of that. Number two, you want to check the median income. And what you're looking for here is does the median income for that area support the rent that you want to get, right? It needs to be affordable. If the average family makes $20,000 and that neighbor, and you're looking to have $1,500 rents, you're going to have an issue, right? So that's what you're looking for there. Third one is population growth. You want to have at bare minimum. You want to have

positive population growth. Ideally, double the national average, right? That's what we're looking for. You stay away from areas that are losing population. Next one is flood zones. That one's a bit more of a just kind of a business and risk decision for us. We do not buy in flood zones. Again, we went through all, there's a handful of reasons for that, but we will not buy a property in a flood zone. If it pops up in a flood zone, we just say, sorry, we are out. Another one is crime. We will not buy in an area with high crime. And if you do it a couple of times, you eventually will not do that either, especially low income. You mean, low income and high crime go together about as well as microwaves and aluminum foil. It's not going to end well, and you just won't do it anymore.

And then the final is looping back to good old Google. You look for reviews, property reviews, but you're also looking for, you know, stuff that's in the news. Like if you're looking at Whispering Pines apartment, you Google, whispering pines shooting, whispering pines fire, whispering pines flood. And it's amazing the stuff that Google will tell you that the seller didn't, and that might affect your decision on whether or not you want to buy that property. And also, if you had a shooting or a fire, something that's going to affect your insurance numbers, which is something we'll talk about when we dive into underwriting. So that's kind of a really quick review of the screening process. But what that does is that takes the 10 deals sitting in your inbox on Monday morning and whittles

it down to the two, then want to go to phase one underwriting on. Right. So that's helping you narrow your funnel and focus on the stuff that has the highest probability of working for you. Wonderful. All right. So let's recap this. Number one is a Google search. Just if you were a person who was looking to rent this apartment, what would you find if you Googled it? What does it look like? what's the conditions. Number two is what's the median income in the area. Number three is population growth. Ideally, if you can find double the national average, you've got an ideal population growth. Number four is flood zones. Number five is what's the crime. And number six is online property reviews and was the property the subject of any news articles. Now, this is all the first step,

which you call screening, I believe. That's what. Yep. Yeah, we call it screening. And that's what was covered in episode 279. So if you want a more in-depth, detailed understanding of that very first phase, go check out episode 279. Now, today we're going to get into the second phase, which we call underwriting one, or underwriting stage one, phase one. How do you describe it, Andrew? We break it. We break the underwriting into phase one underwriting in phase two. There it is. Yep. And it's the same kind of overall idea of not only trying to weed it down to the properties that have the highest potential of being great deals, but also saving you time, right? So phase one underwriting is kind of like just a quick and dirty,

right? You're making assumptions that you're not necessarily going to go verify, because the idea is if you do a quick underwriting on a property and you make favorable assumptions and it still doesn't look good, there's no point in spending any more time on it, right? So if you make favorable assumptions and you do a quick underwriting based on that and it looks good, now you go Abraham Lincoln on it and trust by, no, sorry, Ronald Reagan, trust but verify, right? I don't know why. Honest Dave, well, he wrote everything on the internet, so maybe that's why. So that's when you said, okay, I assumed a $100 rent increase. Can I actually get that? That's phase two, right? All right. So in phase one, we're going to talk about that today. We're going to actually

walk you everyone here through the detailed steps that Andrew and I go through when we're going to be buying multifamily apartments. But before we get to that, we're going to talk about four levers to look at that are not necessarily specific to the asset itself, but you found that they're very, very important. Can you walk us through what those are? Yeah. And those who are, especially those engineering types like myself, it's really easy to get focused on the property and, okay, if I, you know, spend this much money on a new countertop, I'll get this much rent increase. And all of that stuff is important. However, these four things, if you get these wrong, you can be the world's best underwriter on all that property-related

stuff, but you get this wrong and the rest won't matter. Those four things are, number one, your market rent growth assumptions, number two, your cap rate assumptions, three, your time of sale, meaning, am I going to sell this in three years or am I going to sell it in five, and then for your leverage. And so I'll go, you know, kind of I'll step through kind of really quickly what I mean by each of those four. What I did is, and I've been wanting to do this myself just to see how it comes out, we closed the deal in this October where our pro forma internal rate of return was 14.4%. And I went in and slightly changed each one of these four levers, and we'll walk through just how much it changed the projections for that deal. And mind again, the actual deal did not

change one iota. So rent growth assumptions. That is, well, well, how much is the market rent going to increase over time? And market rent, that's not your property's rent. That's just saying, okay, the overall market in the last 12 months, let's say you're in Savannah, you know, and rents were, you know, $1,000 at the beginning of the year. And at the end of the year, they're $1,030. Well, that market rent increased across the whole market 3%, right? $30 is 3% of 1,000.

So when you're underwriting a deal, you have to assume, make some kind of assumption of how the market's going to move. And if you overdo that, if you say, okay, well, I think rent growth is going to be at 3% every year. All right. Well, okay, what if I just say 4%. It's only 1%. Doesn't make that big of a difference. So that's what it would seem like. So I'll give an example that on that property that we closed, we assumed 2.5% rent growth for five years. And that led to a 14.4% IRA. When you go in and move that to just 3%, so only a half a percent difference, it bumped the IRA all the way up to 16.4 percent, 2 percent increase just by making a slightly different assumption on rent growth. And when we get to phase two,

that's where we'll really dive into like, well, how do you figure out what that right number is? But again, your rent growth assumptions are a huge lever. And whether you're underwriting your own deals or investing in other people's, these four levers are the four most important things to look into, right? Let me jump in real fast. What is an eye? And then how do these levers affect that? So, IRR is actually one of my least favorite metrics. However, it's just, it's like the one that just about everybody uses. So that's why my favorite is cash on cash, but everybody uses IRA.

So it stands for internal rate of return. And what that means is it factors in not only the amount of money that you're making, but the timing of that money, right? Because if you make, you know, $100,000 today, that $100,000, $1,000 is more valuable today than if you make the same amount of money five years from now, right? What internal rate of return does is it discounts or in a way cheapens that future money by accounting for the fact that money today is more important to you than money in the future. It also, it deals with more than just the cash on cash return.

So every investor understands their return, their ROI, right? The return on the investment. If I put in X amount of money, how much will I get back as far as cash flow goes? but real estate makes you money in more ways than just cash flow. You also make money as you pay down your loan. You also make money as the property appreciates. You also can make some money through saving and taxes. So the IRA takes all of that into account, correct? Yes, it does. Exactly. So you're looking at all the ways that this property will make money and then you're looking at over how much time, if I hold it for five years or eight years or ten years, what can I expect at the end when we actually sell the property for the return on my money to be? Is that more or less? Accurate. Yeah, IRR is kind of like the all-encompassing. The intention is it just, it factors in everything, the amounts, the timing, all of those things. And it kind of boils it down to one number. And the reason it's so popular is because someone can look at a self-storage deal or in a part and compare the two, right? Otherwise, it's hard to compare. That's why IR is so popular. But it's

also one of the most dangerous because as you'll see as we walk through these, it's the most easy to manipulate, either intentionally or unintentionally. And these levers we're talking about are ways that you can manipulate either honestly or dishonestly the internal rate of return to make your investment look either better than it is or maybe measure it accurately but improve its performance, more or less, correct? Yeah, IRR is the easiest way to do financial engineering on a spreadsheet. Okay, perfect. So one way that you can do that is through rent growth assumptions. Now, you do need to make some form of assumption of what rent is going to do because it's probably not going to be the same in year one as it would be in year eight. So it's not honest when you just assume rent will always be the same. A lot of people make that assumption. But really assuming rent won't go up is no different than assuming it won't go down.

I mean, maybe statistically it's more likely to go up than down. But just to say, well, we're going to assume rents are never going to go up is just not accurate because statistically rents do go up over time. So that's one way that you can affect the IRA of something. What is number two? So number two is cap rate assumption. And we probably don't have time to dive into what cap rates are and how to calculate them and all that. And a lot of this stuff is also, Brian Burke did a really good job in his hands-off investor

book. And he did a great job of explaining why he hit, you know, cap rate. People get way too focused on that. However, you do need to know what cap rate is and how to estimate it because that's how you determine what your exit price is. Let's say you're doing a deal for five years. You take your projected net operating income, NOI, in year five, and divide it by the market cap rate, I love Brian's definition. The way to look at market cap rate is market sentiment, right? It's how the investment world is valuing an income stream. So in order to calculate your sales price,

you have to make an assumption about what cap rates are going to be in the future. And so the short version of how to do that is figure out what today's cap rate would be for that asset and say, okay, well, if I think this cap rate is going to be higher or lower in the future, and then you plug that number in to calculate your sales price. So generally what we do is we say, okay, if today's cap rates of four and a quarter, every year that we hold it, we're going to increase that cap rate by 0.1%. So five years from now, an exit cap rate would be 4.75%. Now, okay, Andrew, why does that matter? You know, does it really change everything that much? So on that deal that we did, we had a 0.5% cap rate expansion. If we take that out, the IRR now goes up to 21.1.1%. percent, right? It increased by 4.7 percent. So all of a sudden, a deal that was at 14.4, if you make a slight increase in your rent growth assumptions and then you remove the cap rate expansion, boom, your IRA goes from 144 to 21-1. And did the deal get any better? No, it hasn't,

nothing's changed. You changed from very sensitive levers on your underwriting. All right. Now, 10% of our audience thinks that this is genius, what you're saying. The other 90% is embarrassed to admit. They don't actually know what we're saying. So, Let's take a step back and explain what we're talking about. How would you define what a cap rate is? Cap rate, it stands for capitalization, right? And kind of the short version is, you know, how quickly does that investment return what you put into it, right? Okay.

So if you bought a property for a million dollars and it returns 100,000 a year, first of all, send it to me because I'm looking for that stuff. But if you bought that, right, every year you get 100,000 of that million or 10 percent. So in 10 years, you've got all your money back. that property has a cap rate of 10%, right? Also being said, if you bought it for cash, that's what the ROI would be. Yes, that's actually, that's another good, really good way to say it. So when you hear people say it's a five cap, what that means is if you paid full cash for that property, you did not use any kind of debt at all to leverage it, that is the return

that you could expect for your money. And the reason that we use the cap rate that way is because just like what you said, anytime you hear us talking about metrics, the reason metrics like this were created are so you can compare one investment to another. It's all a way of trying to turn apples to apples. That's what ROI is. Well, should I put my money in the bank or should I buy a house with it? Well, you need to understand what the return on your investment is to compare it to decide which would be better. So the cap rate is the way that the metric that we use to decide what is like a multifamily or commercial property worth. Well, if I get a 5% return on my money, if I pay cash, that's a 5 cap.

Now, the other time that cap rate becomes very important, like you said, is when you're exiting. Because the way that apartments are basically valued is that you take the net operating income, also known as the profit you make in a year, and you divide that by the cap rate, and whatever number you get is how that property is pretty much valued. Is that more or less accurate? Right on. Okay. So here's the thing to understand about this.

If you want to make an apartment worth more, there's two levers that you pull. The first is you increase the NOI. meaning if you can get your rent that you collect to go up or your expenses to go down or some combination of the two, your net operating income will go up. You made the property worth more. The other way and the bigger lever in this is the cap rate. If you get the cap rate to go down, meaning there's a higher demand for that property. So if everybody says, man, I really want that thing. It's got a five cap. I could get a 5% return if I bought it cash. And then one person says, well, I'll actually take it at a 4% return because I want it that bad.

now it's trading at a floor cap because there's more demand. Like you said, Brian Burke's definition, the sentiment in the market is, I want that type of income stream. And right now, apartments are a very, very, very popular income stream for many of the reasons that we're going to be talking about on the show today. So when you get into a market and the cap rate goes down, if you compare that to residential real estate, that's kind of like if the cops are going up, right? If the neighbors are willing to pay more for the house, all the other houses in the

neighborhood are worth more. If the cap rates are going down on apartments, all the other apartment complexes are also going to be worth more. Yep, exactly. All right. So cap rate is a huge lever that if the cap rates are going down where you buy, you can make your property worth more. And what you're saying is when you underwrite, you're actually assuming cap rates will go up a little bit every year. It's just another way to be conservative to protect yourself so that if you raise money and then have to sell the apartment complex, you're not assuming that cap rates are going to go down, even though they have been going down. Is that more or less accurate?

Yeah. In one way, if you like, we've been wrong for the last 10 years. Every deal we've done, we've factored in cap rate expansion and it's gone the other way. But however, especially if you're bringing in outside money, you would rather have it work out that direction than assume it's going to go down and it goes up because not even going to be to get your equity back out. There you go. It's just a conservative way that you work into your underwriting to make sure that the investors are protected. Exactly. Yep.

Okay. Lever number three. Lever number three is hold time. And this is one where there is not really a right or wrong. It's just a matter of transparency and understanding how big of an effect it has. We had that discussion on IRR, and one of the things that factors in is the timing of cash flows. Well, most apartment complexes, especially in the last 10 years, there's been a nice profit when you sell. And so if you move that profit from sale upward closer to the time of purchase, That IRA goes up because that cash flow is getting closer and closer to today, right?

So if you are driven by IRA and that's what you're trying to hit, then what you'll see is you'll see people will move that sale closer maybe two years or three years because the IRA goes up. And it can dramatically change that internal rate of return. And it can actually make you miss deals that are otherwise fantastic deals, right? some of the richest people have ever met are people who bought an apartment complex or built it and held it for 20 or 30 years. Well, if you put that in a spreadsheet, your IRA is going to look like crap. But because of just how that's calculated, but otherwise, it's a great property. So you have to be really careful of not letting this lever drive the investment. So again, as an

example, that property that we bought in Savannah in October, we had a 14.4 IRA. That was on a five-year whole time. If we move that from five years to three years, that increased the IRA 5%. It adds now five full points to it. So again, and did nothing change in the property? Especially if you're looking at passively investing or you're looking at trying to bring investors on, it's really important to educate yourself and whoever you're working with how much of an effect that can have. It can make a bad deal look great and it can make a fantastic deal look bad and you can pass on a deal you shouldn't or do a deal that you shouldn't if you get that hold time wrong. So that's one where you need to do a sensitivity analysis. How does it look at your three, four, five, six, seven, eight, nine, ten?

And then also realize that that really shouldn't necessarily be the driving factor. You know, is it going back to the screening process and some of these other levers, just be careful that a hold time that you plugged in isn't covering. up something else that maybe is incorrect or missed. Now, if you get a better internal rate of return selling in year three instead of year five, why doesn't everyone just sell in year three? Because not everyone is focused on the velocity of money. Again, there's nothing wrong with selling in year three. If you're looking to get in, make some money, move it to another project or something like that, then selling in year three is fine. If you're looking to build

longer term wealth, most of the work is really in the first couple of years. So if you're, you know, if you just want to do that work and get in, get out, then three years can make more sense. But if you're looking for a little bit longer term appreciation, especially cash flow, then that's where years five onward make a little more sense. I think also in many cases, a three-year turnaround time just isn't reasonable to do, especially if it's a big value at project. It just might take longer than three years to be ready to exit. So if the syndicator is telling you, well, we're going to sell in three years,

they know that makes their IRA look good and then people chase it because the return is great, but that doesn't mean that they can actually accomplish that. And also with a three-year time frame, you increase the probability of getting caught by a bad market turn. Three years is a pretty short period of time. But if you've got five years or longer, you have some more flexibility there. And you always can sell after three years if you want

and get your investors a better return, right? But it's not good to assume we're going to be able to do it in three years. And then when it goes wrong, now the IRA is dropping from the really enticing when they gave you to the more reasonable one that would be a five-year term. Exactly. And again, I don't want to give it.

everyone, the message that you're saying three years is wrong, that definitely not. Just be aware of how much of an effect that has when you are doing that in your underwriting. And then the final one is just leverage. This has basically been covered in other podcasts as well, but you'll see a lot of deals, especially lately coming out at, you know, 80% leverage. So if you go from even 75% to 80% leverage, meaning you're getting a loan for 75% of the purchase price versus getting a loan for 80% of the purchase price. doesn't sound like a whole lot of a difference, right?

Well, typically that loan is cheap money because it's coming from Fannie Mae or maybe a bridge lender or something like that. So by increasing that leverage, at least on a spreadsheet, it increases the rate of return to whatever your equity is, whether it's coming out of your own pocket or investors, right? So again, just give an example of how that affects everything, that deal that we purchased in Savannah, we went in with 75% leverage. if we had increased that to 80%, it would have added another 3% to the IRA. So you go from 14-4 to 17-4 or 17-3 just by going that extra 5%.

Is it a better deal? Again, property didn't change. The market didn't change. We just increased our leverage. So the returns go up, but so does your risk because you're a higher levered. So, again, just something to be aware of and just how sensitive your underwriting is to that, especially again, as our engineer types, it's really easy to dive into rent comps and lost the lease and all these things that are easy to tie down a set of data.

But these are the big four that actually have the biggest effect. So if you do on that deal that we did, that was a 14.4, if you slightly change these four levers combined, it takes the deal from a 14-4 to a 29. And I can guarantee you that deal will not be a 29. And that's the purpose of going through this is, you know, that 29, you know, that 29, percent IRA deal. That's a deal based on hopium, right? Everything has to go just right for that to work. And, you know, these days sponsors and deal underwriters saying that they underwrite conservatively, that's about as trendy as meatless hamburgers, right? I mean, just everybody said, but no one says what

that means. Underwriting conservatively, at least to me, is being aware of these four levers and plugging in values, especially for these four, to have a very high probability of happening, right? conservative underwriting is realistic underwriting, meaning that it's your base case and it has a high probability of happening without everything having to fall perfectly into place. And now I think this is brilliant. I would like everyone just to go back and listen to the four levers. They are rent growth assumptions, cap rate assumptions, holding period or time of sale, and then leverage.

Those four things make a huge impact on the internal rate of return of a deal. And if you're going to invest in someone else's deal, you want to know. know how they're using those levers to make it look better or accurate for how it could be someone like Andrew, when we do, we always just kind of take a worst case scenario. So we look at these four things and we say, hey, if they all go poorly, will it still make sense? And if so, those are the deals that we move forward on. People love to call real estate passive income, which is interesting because most of the investors I know are very busy. Busy finding deals, busy managing teams, busy worrying they pick the wrong market. Rent to retirement flips that model. They

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this, how do you make the deal work better? The next part is much more practical. We're going to get into our phase one underwriting. And these are the six things that we look at. Once we've identified a property and we've gotten through that initial screening process that we talked about to start the show. Yep. So you want me just kind of hit what the six are and then we can dive in? Well, let's start with what like basically this is the does this property deserve by time, right? that's what we're looking at. Yeah, that's what you've done. So, so you did the screening process and you found out that, okay, this property checks every box in terms of those things that we talked about. And you weeded it down from 10 to 2. And you're like, okay, in phase one underwriting, like you said,

David, you're trying to figure out, does this property deserve any more of my time? And we're going to walk through the six things that we do to answer that question. And kind of the high level is you're making the hopium assumptions, right? I can get this rent growth, this renovation, all of this, and plugging it in. And if it doesn't look good in that situation, ditch it, right? Because the reality is going to be something less. So that's kind of what you're doing here. So we're saying, hey, if everything works out hunky dory, that's a funny phrase. I haven't said that in a long time. I haven't heard it. If anything looks good, it is worth digging in deeper to verify that our assumptions in phase one were accurate. Yeah, exactly. So the first is purchase parameters,

and we'll get in these is second's revenue third operating expenses fourth renovation budget fifth is loan terms and equity extraction again we'll define that when we get there and then six is just kind of your pro forma what does it all come together and look like at the end right so purchase parameters that's different than your property parameters right your property parameters or i want to buy stuff that's built in 1990 or newer you know stuff like that purchase parameters are simple things like price, right? If the seller is asking for 10 million and what you want to do is you want to plug 10 or 9 million into your underwriting and with that price that they're asking for, if it comes out at a negative 3 IRR, you know that it's really probably not worth your time,

right? But if they're asking for 10 million and you plug in 9 and the deal basically looks like it works, that checks that box, right? So kind of, again, it's just coming down to saving time and weeding it down to deals that can work, right? You don't want to deal with sellers that either have crazy high expectations or where a property is likely to trade at a price that doesn't meet your criteria, right? Which happens a lot in today's market. Maybe the seller's not crazy. Maybe it is going to trade at 10 million, but it only works for you at 7. You don't want to spend any more time on that. You want to call the broker back and say, hey, this is a great asset. Unfortunately, it doesn't work for us because of this, this, this and this. And I'm not going to be close on pricing.

So thanks for showing it to me, but, you know, this one's a pass. That's what purchase parameters are. This kind of the overall terms, the pricing, they say you have to close in 30 days. Well, if you know you can't perform that way, then trash this deal. Those are purchase parameters. So before we head to revenue, anything you want to touch on or expand on that, David? I just want to highlight to everybody that if you're getting into this space and you're trying to do what Andrew and I do, or maybe you're just trying to invest with somebody else, it's important to recognize no experienced investors run all the way through an entire deal once they come across something that they know won't work. And so conserving your time, but more so your energy, like, you've only got it in you

to do this so many times. You only have so many phone calls in you in a day. So many rounds of taking data from one place and sticking it into another and thinking through how it would work. And I think people assume they've got all the time in the world. And maybe they do, but they don't have all the energy in the world. And so what we're talking about are these are the big disqualifiers that experience has shown from all the deals that Andrew's done and all the deals that he's analyzed. If I see this doesn't work, I'm just not even to waste my time. I'm going to move on to the next one.

Yeah. And really what you're doing is you are looking for reasons to say no. There you go. Like get this thing out of my inbox as quick as possible. Say no, say no. And then every once in a while you're like, oh, man, this thing's perfect. I've got to spend time analyzing it now. That's a great way to put it.

You get to that point, right? Here's the reality is we are, in this past year, we're averaging and looking at, at least going through screening, 200-something deals to make 20 to 30 offers to buy one, right? You don't want to spend eight hours analyzing 200, like, it's just, you'll be brain dead. So that's part of what this, you're saying no and then just running through and then trying to confirm that so you can get rid of it. And every once in a while, you're going to be wrong. and be like, oh, this could be a good deal. Let's take a deeper look. That's a great point.

You're looking to say no, not looking to say yes. And when you really want a deal, you start to get tempted to overlook problems and try to find a way to make it work. And that's where it becomes dangerous. Exactly. Yeah, you start tweaking one of those four levers and it's like, oh, this will be okay. You know. Yep, there you go. So the second part of phase one underwriting is revenue.

And all this applies, whether you're looking at 10 units or 200, right? The principles are all the same. Okay, there's revenue today, but then where are you going to be able to take the revenue in year one, two, three, four, and five? And again, with phase one, it's kind of quick and dirty. So what we found to be the most effective is we look at the T12, which stands for trailing 12, right? It's the historic, the last 12 months of operations at the property. And we use that as our baseline. Let's call it, we call it year zero.

Like here's where it is, boom, today at the beginning. And then what you're going to do when you plug things like market rent growth assumptions and renovation and rehab budget and then how much of a rent increase you're going to get from that, over time as you hopefully increase rents, your revenue is going to increase. But one of the key things to keep in mind is to compare it back to where it is today. Now, most properties are strongly trending up today. And so in today's market, what we found the most effective thing to do is look at the last three months. and then annualize that, right?

So take the last three months and multiply it times four. That gives you what the annual revenue is if the property just stays right where it is. One of the biggest, I'd say probably one of the most common mistakes that I see is super tempting to do is to assume a big revenue increase in year one. It's really difficult to make that happen because for whatever reason, whenever you purchase a property, people get, you know, oh, the new owner is going to screw me. I'm out of here, right?

And people move out. People think, oh, you know, it's just kind of like when the substitute teacher comes in, everyone thinks they can get away with not turning in their homework. Well, oh, hey, rent's optional. This is a new owner. I don't have to pay, right? You got to, you know, there's delinquency tends to go up. And I'm not saying you can't increase revenue the first year. In fact, most cases you will be able to. But when you're doing a phase one of revenue, you want to say, okay, well, here's where it is today. And I'm going to improve it this, you know, 3%, whatever your number is, every year, I'm going to improve it by this amount. but you always want to look back to the starting point to make sure that you're not assuming too big of a jump, especially in those early years, right? So it's kind of your reference point. And again, in phase two,

we really dive into the details of this. But phase one of underwriting and say, hey, if I get a $100 rent increases, my underwriting says my revenue is going to go up 4%. Is that reasonable? And you just kind of answer that question, yes or no, based on all the other factors. That's what you're doing in phase one. You're making basically a favorable assumption, plugging it in and saying, okay, is this deal still a no? When I look back at the deals we've done together, I think almost every one of them, we assume rents were not going to go up much in year one. But in like, by the time we hit year three, four, five, they were way more than what we had projected. They were actually going to go up. So I think in general, this is a principle that I really like when investing is I give myself a longer

runway. Yes. Don't assume you're just going to start it off and boom, the plane's going to take off right off the bat. Year one, anything I buy, single family, multifamily, anything, I assume will at best break even. So if I buy a single family house and I'm going to rent it out, I just assume there's something that was missed in the inspection.

The tenants are not going to like what happened. There's something I could not have foreseen that will pop up in year one. It always does. And then year two is actually like, okay, now we're actually having some expectations of what I want. Is that similar? I mean, obviously with multifamily, there's a little more detail that goes into it. But overall, do you agree that that's a better approach?

Yeah, it is. And not only does it give you more runway, it also gives you a higher probability of beating expectations. So, you know, we got a deal under contract last December, which was COVID winter. And a few months later, things got a lot better. But at that point, December 2020, the market was really uncertain. So on that deal, we actually underwrote a revenue decrease for the first year. And turns out the market. went completely the other way, and revenues are way up because the market shifted in a way that

none of us foresaw, and now it's fantastic because we're just so far ahead, right? So it increases the odds of you beating expectations. There's nothing worse than getting behind from day one. It's not fun for you. It's not fun for your investors. So resist the siren call of giant increases in revenue for the first year. All right. Awesome. What is the third thing that we look for it in phase one? Third one is your operating expenses, right? And again, this is phase one. It's quick and dirty. You're just kind of coming up with an estimate. This is going to vary a lot, depending on the markets you're in. So we operate in the Southeast U.S. and operating expenses might be anywhere from $4,000 to $6,000 a unit, depending on the type of property in the submarket.

But basically what you want to do is you want to take a quick look at the historical operating expenses. What is it been costing for utilities and wages and repairs and all that? Make any adjustments that you think you can make. For example, let's say their wages are really high. You're like, you know what? I've got two great people I can bring in and this is how much I'm going to pay them. I can reduce wages, right? Or when I buy it, the tax assessment's going to double. So I need to factor that in. Right. And so the source of that information is twofold. The seller should, should provide you with at least a year's worth of historical data. So you can see, this is how much they paid in utilities for the last 12 months. This is how much they paid for repairs. This is how much

the cable contract costs, right? All of those things you'll get from the seller. You take that as a starting point and then you adjust for your business, right? And you say, well, okay, Andrew, that's great because if I don't have a business yet in front of getting started and buying my first 10 unit, well, how you come up with the future data is a number of ways. Number one, find a good management company and ask them, okay, the properties that you manage in this market that are similar to this, what are reasonable ranges for these five expenses, right? Whatever the ones that you don't know are, say, where would you expect a property like this to operate expense-wise and get that information from them? A lot of times brokers will give you pro forma expenses. Be a little

careful with that because pro forma is Latin for pretend, but it at least gives you a baseline, right, of something that seems reasonable. That you can then compare to the information you got from someone else that might be exactly. Right. And thank you, David, because that's really what you want to get the data from multiple sources and then compare and contrast. And if it lines up across the board, you know you probably have a good assumption. If there's huge differences, you want to dig into that. So the broker is another source. And then also, I would go on bigger pockets and the forums. You'd be like, hey, I'm buying 10 units in Kansas City. I know a ton of you guys already owned stuff in Kansas City. What have you guys been paying for utilities? How much are you having to pay management companies?

How much are you having to pay staff? So networking, right? And again, I can't think of a better place in the bigger pockets forums to do that. Those are the three ways that we get that data. Now, you can also, at a higher level, you can pay for services like CoStar, Esri, and all this other stuff. But if you're not at that point yet, those first three that I mentioned will take you 90% of the way there. I just want to highlight the temptation is always go to the seller and say what's your numbers and then you get mad when they end up not being what they provided, which is kind of silly because everyone is going to do what's in their own best interest. So you can't expect a seller to give you accurate information if you have no relationship. I mean, it'd be nice if we lived in a world

that worked that way, but we don't. And then many of those people, they get mad when that happens would probably do the same thing if they were in the seller's shoes, to be honest, when they go to sell. They put makeup on their numbers too. So if you go to a property manager and say, hey, you manage a lot of properties in this area, what are you finding? That's much more reliable objective information. Isn't biased by the person who actually has an interest in getting more money for that deal. Yep. Exactly. All right. So what's number four? So number four is renovation budget. And again, keep in mind, we're not buying deals off of this. This is just phase one. You're trying to say no. This is where we say, you know what, based

on the pictures that we've seen, we think it's going to cost $6,000 a unit to renovate this, or maybe $10 or $12,000 or whatever that number is. And, all right, this is 10 units. It's going to cost $10,000 a unit. Okay, my renovation budget is $100,000. Boom, plug it in. And then, okay, well, what kind of rent increase can I get from that? Well, if I'm looking around, there's these other properties advertising, all right, I should be able to get $100 rent increase. That's literally you should do on phase one. Number one, contractors are super busy, right? You're not going to call them for every deal that you're looking at. Like, hey, can you run over there or anything like that?

And even if you don't feel like you have a good grasp of how much stuff costs, again, this is where Bigger Pockets Community, brokers, and even management companies can help you with this too. Say, hey, email your property manager three pictures of from inside a unit. Say, hey, I'm thinking I can spend $8,000 to renovate this and get $100 increased. You know, what do you think? And if they respond back, yeah, you know what, that might cost you $10,000 and you're going to get $80. Okay, cool. Plug it in, right?

That's what you do if you feel like you just have no idea and you're trying to learn the market or the cost. Once you've analyzed a few of these, you'll pretty quickly get a feel for what that is. And again, at this phase, you just plug it in. You know what? I can do this for $6,000. I'm going to get $80 rent increases.

And you're looking for a reason to say no. If you plug in the best case assumption of, I only got to spend $6,000 to get $80 rent increases and the deal doesn't work, you're like, cool, I don't have to spend any more time on this, right? If it does, and you're like, well, okay, spending six grand and getting $8 rent increases, this looks like a great deal, you're going to continue on. It's that simple.

Just a quick guess. Six grand. I think what I love about how this system is built is that it's getting 80% of the problem taking care of before you dive in and put a lot of time into it. So you don't know until you actually look at an inspection report and walk it with the general contractor what it's going to be. But you can get a pretty good idea. And if it's like, oh, my God, it's going to.

cost $75,000 a unit to get these up to market rent or to bump rent a little bit. You can quickly plug that in and realize the ROI and that is going to be terrible. It just doesn't make sense to do it. Versus, if you're like, you just said, wow, it only got to spend six grand spruce them up a little bit. We can bump rents by $80 or $100. Then it's worth verifying. So this is just so simple. If you just follow these steps, it takes all the mystery out of what am I supposed to do? What should the renovation budget be? Yeah. And again, this is one where you can take the broker's number and plug it in. And, you know, because the real reality is probably not much better than what the

brokers perform is. So if the broker says spend $8,000, okay, cool. Does that work? And if it doesn't, you know it's not worth your time. There you go. All right. What's number five? Number five, loan terms and equity extraction.

And so what I mean by equity extraction is basically that's the BIR method, right? Pulling money or equity out of a deal via supplemental or refinance. Those are two main methods. And again, if you're negotiating an LOI and you're best and final or you're close to a deal, you're going to want to be talking with your lenders so that you can narrow down terms. At this point, you don't want to spend your time doing that or their time. So, you know, again, if it's your first time analyzing a deal, okay, maybe you want to make a few phone calls and get a sense of the market. But once you've done a few of these, you're just going to be like, well, okay, if I'm buying a 50 unit apartment complex,

in Dallas, and I'm going to get agency debt, and I want a 10-year term. Yeah, interest rate on that's probably going to be, you know, I don't know, 3.5% or whatever it is. And you just plug that in. How you get that data is just call a few loan brokers and lenders and say, hey, can you put me on your mailing list? Most of them will send a weekly or monthly update on what market rents are for all the various loans that you can get on multifamily. And what I do is I just save those to a folder. And when I'm doing a quick, dirty underwriting, I say, okay, I need a $20 million loan.

I'm probably going to go Fannie Mae. Okay, so this week, where are those trading? Right. Oh, that's going to be a 3.4%. All right, I'll throw in 3.5 just to be safe. Does this work? Right. That's all you're doing at this point.

Again, you're making a somewhat favorable assumption and hoping the answer is no. And so you can throw this thing away and move. on to the next one. You put this favorable assumption in and it looks good. Okay, I'm going to move to the next step. But when I get to phase two, I'm going to go verify that these loan terms really do work. Yes, that comes up a lot. As you know, anyone who's done a lot of loans realizes that loan officers will frequently tell you, oh, I can do it 3.4. Yeah, you got it. And then you dig into it. Andrew's laughing because he's seen this happen so many times. And then that 3.4 was actually for the person with perfect everything, right?

And everyone knows credit score, but a lot of people don't realize your debt's income ratio, how many properties you might already own, the purpose of what you're going to use the property for, all affect interest rate. Sometimes it's just a high balance loan. So, like, this is more for the single family space, but if the loan balance that you can borrow in an area is 800,000 and you're trying to borrow $780,000, just the fact that you're close to the limit will make your interest rate higher. There's all these tiny little things that will accumulate.

If you're planning on barely making that thing work with the 3.5 and they come back with the 3.7, you don't want to just have spent 15 hours of time that gets blown up because of something that the loan officer then tells you later. So it's very smart to just make these assumptions and see, am I close? Does it work before you go all the way in? Yeah. And also it's good to keep in mind that the loan officer who's trying to get you to fill out an application, his purpose in life is almost the opposite of the loan underwriter that is trying to, dig up everything that might cause an issue, right? So just put everything you can think of out

up front, save you both time, right? The other important piece of the phase one loan assumptions is your leverage, right? Because going back to what we talked about before, this is one of the huge levers. Ideally, you start off with a little bit lower leverage than where you hope to end up, right? So let's say you're going to say, all right, I'd like to buy this at 75% loan to value. Let's start, let's plug it in at 70%. Does it work? Oh, well, well, all right, a little thin. All right. If I go to 75 is that good. We'll even look at 65, right? Because if you plug in initial numbers at 65 percent and it works, that means you've got some margin to work with, and that deal really probably is worth your time. You're playing around with your assumptions on your

interest rate, how many years of interest only payments you have. The term of the loan is the amortizing over 10, 20, 30 years. And also just, you know, can you refinance it down the road and pull money out? All of those things, you make an assumption that, again, you're not verifying until phase two. Make a middle of the line to slightly positive assumption. And if it doesn't work, there's no point to spend any more time on it. All right. Cool. And what is the sixth step? The sixth is just pulling all of these pieces together. And that's what creates your pro forma. Whether it's four units or, again, 400, your pro forma is your project. for how this investment is going to perform over the next three, 10, 20 years or whatever that is.

So what you'll do is you'll put in these first five things and then go look at your performance. So let's say you're a cash on cash investor or maybe your investors that work with you are focused on cash on cash. And your minimum target 7%. So you go ahead, you make five quick assumptions on those first five steps. you plug it in and then you go look at how what your pro forma is. And if your cash on cash is two and a half percent, well, that's an easy no. We're out of here, right?

But if you're looking to make a minimum, let's say, 7% cash on cash, you made those first five assumptions and you look at your pro forma and it comes out at 8.5. Huh. Okay. Well, what if we only get, what if we drop that leverage a little bit? What if operating expenses are a little bit higher? Oh, this still looks like it could be a good deal. those are the ones you kick to phase two is when you make five assumptions here,

then you go to step six, look at your pro forma, which is the projections that all of those assumptions create. Most cases, it's not going to work. You're going to kick it out. But on the ones that do, that's when you move it to phase two. And keep in mind, a pro forma, it's not an exact science, right? As much as it drives us engineer types crazy, a pro forma, a performer is kind of like the center of a toilet, right? It's just something to aim for. But except in this case, you want to exceed it, right? You are never, ever going to exactly hit performer. You're always going to be below or above, and you want to underwrite in a way that gives you a high probability of being above. So that's what, again, we're predicting the future

three or five or ten years out. No one can accurately do that. So that's what you're doing. You're making five assumptions that you quickly put in and says, okay, let's say five years out, if these happen, here are my numbers. If that's acceptable, you move to phase two. If not, you kick it out. Wonderful. I love it. So, and can you just give a brief definition of what a perform it is, if anyone hasn't heard of it? It's a prediction of how a property is going to perform over a given time period. So let's say you are looking at something for three years. right? And you have a three-year performer that says in year one, it'll produce this much cash flow, and then in year two and year three. And then when in year three, we sell it, it's going to make this

month, we think it'll make this much profit. And then when you factor all those things in, the cash on cash returns will be this much. The internal rate of return will be this much. And it just breaks down the property performance based on the assumptions that you put in. So a good pro forma will show those assumptions. It'll say, hey, based on this rent growth, these expenses, these taxes, et cetera, here's the projected returns. All right, awesome. We've got a treat for the audience because we are going to move on to the next segment

of the show, the deal deep dive. And we are going to dive into a deal that Andrew and I have actually bought together and work through the specifics of that deal. So you can kind of get an idea for what this looks like when it works out good. Andrew, you got the information handy for the deal you have in mind. I do. All right. Awesome. Question number one. What kind of property is it? This was a 252 unit apartment complex in the Florida Panhandle. Average year construction is about 2010, so it was a B plus and we're taking it to an A minus. All right. And how did you find this deal?

This deal was brought to us by a broker who we've known for years and who knows exactly what type of properties we like to buy and what we like to do with them. And he saw that this was a really good fit for us. And for the sake of context, how many hours would you estimate you've spent building relationships with various brokers to bring you these kinds of deals? Many, many, many hours. There's brokers now that have known for 10 years. And that really is the key to the business, it's relationship. In relationships, you're like showering. You have to keep doing it for it to be effective, right? You can't do it once and be like, okay, cool, now they're going to send me a deal. People always work with people that they know like and trust, and that's

just across the board. So you didn't just grab this thing off LoopNet and say, ah, let's just run it through. What do you know? It worked out. No, exactly. No, he called us because he knew we had a reputation for being easy to work with. We would close. And it's what the kind of asset we were looking for. Beautiful. Okay. And how much was this deal? We ended up purchasing it for, 49.8 million. 49.8. Okay. How did you negotiate that price? That was a four and a half month process. This was purchased from a developer that built these properties for his own family portfolio. And many months of back and forth,

several in-person meals together with him and his family. And after four and a half months. I ended up getting final agreement on a three-way conference call as I was boarding a plane back home. We had spent two days on site meeting with him and looking at the family. And it was off-market. However, these days, off-market doesn't mean that no one's looking at it. There were still a handful of other offers. And so he actually had another offer that was $1.2 million higher than ours. However, we had taken the time to build relationships and get to know each other in person, even during COVID. time. And not only that, we negotiated some special factors that helped us win the deal, right? And number one is we saved him about $2 million in taxes by letting him take a large equity

position in the property. So the seller himself put about a third of his proceeds back into the deal as preferred equity, which NOM gave him, again, a couple million in tax savings. And he's going to get depreciation because he's a limited partner. Also, not surprisingly, a handful of family members were working at the property. That was their livelihood. So we agreed for a minimum of 60 days that we would keep them on as staff. And of course, interestingly enough, they have done a phenomenal job. We've kept them on permanently. We've increased their wages. And let me tell you, have your property manager be the guy who literally built the property from the ground up and knows every single nook and cranny of it,

that negotiation piece that was intended to help us win the deal actually ended up being huge win for us. Because given the right systems and tools that we brought in with professional asset management, they've excelled, like, beyond our highest expectations. They're happy. We're thrilled and it worked out. It worked out amazing. Okay, great. Next question. How did you fund it? We got a Fannie Mae agency loan, it's a 12-year loan, which gives us a ton of flexibility on the exit, kind of getting back to underwriting and making sure you have flexible exits. We did Fannie Mae, and then the equity was, again, a large, excuse me, a large chunk of it was the seller himself.

And then the rest of it was just from our investor pool. We syndicated the deal 506B and sold out the equity in a matter of hours, and that was it. That's awesome. And what did you do with it? once you bought it. We immediately started renovations. We've only owned this. That was March 1st is when we closed on it. We've owned it nine months. We have rents up on average $408 a month per unit. Revenue is up, geez, about $60,000 a month. And if we were to sell it today, it would trade for about $72 or $73 million versus the $49.8 we paid for it in March. So it's been pretty

good. So Mr. Engineer, how much profit is that on this deal? If you put in 100 grand in March, today, that's worth 256. Pretty good return. Not counting the cash flows. Now, that is, I do want to give the standard disclaimer of when you're looking at deals, don't look for just the home runs like that because you won't end up doing a whole lot of deals. The reason that was that deal ends up like that is going back to the underwriting parameters that we talked about and making realistic assumptions, but then also going back to the screening that we talked about in episode 279, what that screening does is it puts you in properties and markets where you have a tailwind that increases the odds of this kind of thing happening, right?

Remember, I said you will never hit a pro forma. We screwed up. Our pro forma was way off. We are so far ahead of that pro forma that in one sense, we failed. Like we got it all wrong. But by doing, walking through the steps that we've been through in these last two episodes, increases the odds that that's going to be the result. Yeah, I like that you mentioned the momentum aspect of it.

So that deal would never have been someone's first deal. That deal was a result of all the other deals you did that were base hits. It accumulated into being a very good baseball player that then can hit a home run because they recognize the pitch that somebody else might not. And it's even opening more doors, right? Because we won't get into it a ton, but you and I are actually looking at another deal in that same area very close to it, that we would be able to use the same management to now run that deal. So we would be able to operate that thing much cheaper than somebody else who bought the

same property. Exactly. Yep. Okay. Next question. What was the outcome? I guess you kind of just described it, went up about 20 million, maybe a little bit more than that. Yep. And that's something, you know, we planned to hold that for our whole time and that was six years for a variety of reasons. So, yep. Okay. So what lessons did you learn from this deal? Creative financing and dealmaking scales up really, really well. It's a lot of times that's kind of portrayed as something you just do in the single family world or, you know, small properties. That is absolutely not true. We won that deal. We were not the highest priced. We won the deal because of the seller financing aspect, because we were willing to say, yeah, you know what, we'll keep the family members on.

That creative structure. And actually, this is the second, I'd say a second thing that we learned is, you know, keep pushing. When you're told no, verify that the answer is no. We were told that we could not do that structure with Fannie, right? Because seller equity, they see it as basically a recapitalization and you can't do that, whatever. We've finally found the right people that said, no, we can get this through because I know a guy who knows a guy and he likes this. We'll get it approved, right? And they did. They got it done. So don't take no for an answer, especially if getting to yes has a huge win to it. When we bought that in March, that was the largest deal that we had ever done. We had not ever tried to raise $18 million in equity. And going into it, told you the results sold out in hours, but going into it,

I wasn't sure like, oh, man, can we really raise $18 million? Today in today's market, finding a great deal is everything. A great deal is like a homing pigeon, right? If you have a homing pigeon and you send it out and it doesn't come back, you did not lose a homing pigeon. You lost a regular pigeon, right? So if you've got a great deal and you put it out there to either your investors or the bigger pockets community or your network and you can't get funding, you don't have a great deal. You just have a deal, right? And it means you didn't do the underwriting properly. So in today's market, great deals will get funded. So, you know, I know for a lot of people, it is super discouraging how hard it is to find great deals right now. And it is.

There's no question about it. But the good news is, if you get it, you can get it funded. Either by partnering with somebody or networking or anything like that. So just persist and go out and find that great deal. And again, and this property that we were just talking about, that was bought this year, 2021, hottest time of the market, right? You can still do it. Okay. One thing we learned from this deal that we're talking about is that they go quick, right?

So there's a lot of investors that were like, hey, I want to get into the deal and they just weren't able to get in because it sold out in hours. So now there's a new system sort of set up where people that want to invest with us, they can kind of raise their hand and say, hey, can you keep me in mind so that the email can go out. what, Andrew, first off, what do you recommend that people should look into when they're trying to figure out what the right deal to invest in is? And then where would you recommend people go if they want to get sort of on a list where they can be told, hey, there's a deal coming down the pipeline. If you like and trust David as much as I do, go to invest with Davidgreen.com, right? Yeah, yeah, invest with Davidgreen.com.

And that's definitely a good place to start. And I believe we'll be talking about some additional pieces of this stuff down the line, right? Yeah, so there's a lot of people that I know are wondering after they hear about this. Well, what comes next, right? Like you've done the stage one underwriting, then there's stage two underwriting, and then you're actually going to write an offer. So Andrew has graciously agreed to do some more education on the topic. So I would, what's the best place people can follow you on social media?

Do you have social media, actually? I don't know that I've ever seen you on there. No, I'm what, you know, I'm old school. We just focused on the real estate. I don't think I've ever made an Instagram post in my life. That's funny. You know, we'll get to social media eventually. I do plan, one of my goals for this year is to communicate a whole lot more in LinkedIn.

Try to put out a lot more original content and commentary on there. So I'd say go to LinkedIn, but to connect with us. Let's do this. Follow me at David Green 24. And then I will post when we're going to do like a webinar or some topic where we're going to like, hey, this is how you write an offer. This is kind of the more intricacies of what you do here. Because if you're on bigger pockets, you want to learn this stuff and we want to be able

to teach you. Of course, that will all be for free as it should be. So we're getting close to wrap it up. Is there anything, Andrew, that you think we should highlight or you'd like to leave people with before we wrap up here and then we're going to get into stage two on a different show? Yeah, I would trust the process, especially at this point in the market cycle, and just go into it knowing that, you know, the best way to spot a really great deal is to look at a thousand bad ones first and have that relentless persistence to just keep at it,

whether it's building the relationships, whether it's, I got to look at a thousand and deals. Don't get me wrong. I mean, there are many times when I look at something in my inbox, it's like, oh, I got to look at another property, right? You know, fortunately, and, of course, at this point, we have an acquisitions team and, you know, things have changed. But, you know, when it was just me, I'm like, oh, my gosh, I've got all these deals to look at. And that's part of where this process came from. You know, how do we effectively whittle it down? So have that persistence. Yes, it can still be done. Yes, there are great deals out there. I can't think of a better business than real estate for the average person to jump into

and really have the potential to become quite successful and quite wealthy. All right. So check out BiggerPockets podcast episodes 170 and 279 to hear more of Andrew. Check out my website, invest with David Greene.com. If you'd like to invest with us in one of the next deals that we're doing, message Andrew on the Bigger Pockets website. A lot of people don't realize we do check those. inboxes. And so when you're trying to get a hold of a guest or one of us, that's a great place

to go to. And then make sure you follow me on social media because I will be sharing when we're going to do a webinar where we basically break into a detailed analysis just like this of explaining what we do once we've identified a property, how we write an offer, how we present it to the seller. As you've seen, Andrew is a relationship ninja. He's very, very good at being authentic and building relationships of these people and sort of getting ahead of all the other investors that we're looked at it more from just the financial side. Yep. And also I wanted through out there, so for all of you who are still listening to this and your eyes haven't glazed over as we talked about all these numbers and technical stuff,

this is definitely not your motivational podcast, right? If you're still listening and this stuff got you excited, we are looking to hire an analyst at the beginning of 2022. So please reach out. If you think that might be you, just go to vPACQ.com, short for vantage point acquisitions. There'll be a tab on that website. Let us know that, hey, I'd like to work with you guys and be an analyst. And we'll be in touch soon thereafter. And looking forward to hopefully meeting a bunch of awesome bigger pockets members. That's very cool.

What's the ideal person or personality or skill set that you think identifies if someone is a analyst? somebody who, you know, if you go to the disc profile is high C, which is just a very analytical person, where, you know, a lot of people, the idea of running numbers and diving into data just, you know, we can't, couldn't, can't stand doing that. We're looking for the person who would love to do that all day, who gets excited by the prospect of finding that one in a thousand that is true gold and go through the rent comps and look at a T12 and say, oh, this, there's opportunity here. no one's going to see this. And loves Excel, lives and breathes Excel. Yes, that is a prerequisite.

It's like if you want to be super into fitness, you got to like going to a gym or being outside. You got to like Excel if you're going to be analyzing properties. That's a great point. All right. Well, thank you very much, Andrew, for being on here and sharing your wisdom as always. I really appreciated this. And I think you gave a lot of value.

I'm going to get you out of here. This is David Green for Andrew BP3P. Pete Cushman, signing off. Thank you all for listening. listening to the Bigger Pockets Real Estate podcast. Make sure you get all our new episodes by subscribing on YouTube, Apple, Spotify, or any other podcast platform. Our new episodes come out Monday, Wednesday, and Friday. I'm the host and executive producer of the show, Dave Meyer. The show is produced by Ian K. Copywriting is by Calicoe content, and editing is by Exodus Media. If you'd like

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