FULL TRANSCRIPT
Eric Cantor (00:00)
Welcome officially to breaking down a multifam real estate deal. Pretty exciting topic, a lot of interest in real estate in the last few months, coming off a few challenging years. We are here to dig into that, answer audience questions and do some exciting engagement on a real live multifam deal. Let me do quick introductions first. My name is Eric Cantor, I'm the CEO of Vincent.
At Vincent, we help investors navigate private markets and a number of asset classes. Real estate is one of them that's been surging lately. We also cover venture capital. You've probably seen our pre IPO updates, crypto and a number of other assets. You can find us at www.withvincent.com. I'm joined today by my partner, Adam.
Hi, Adams are a real estate investor in his own right manages a number of properties has also done a lot of these deals like what we're talking about various SPVs and syndicates and has a lot of knowledge in the space. I'm excited to learn with him and with all of you. So with that, let's find out who's in our audience today. It looks like this is based on the survey coming in looks like mostly accredited investors.
beginner to intermediate, we'll tailor the remarks accordingly, make sure we define all our terms and definitions. And it looks like we're split on whether it's a good time to invest in real estate. So perfect attitude to bring into a session on talking about what's happening in this asset class within real estate. Before we start, just a reminder, everything we're talking about is not financial advice. This is for your information, for education, for entertainment.
When you're doing any moves involving your portfolio, you have to look at your situation, talk to your advisor and such. So nothing here is warrantied. Great. So with that in mind, let me talk about what we'll cover for the next 45 minutes or so. We're going to start with an overview of some of the terms, definitions, metrics, things you want to be just aware of in general in this asset class. We will then move to an overview of the market. What is multifam? How has it been performing? What role is it?
you know, filling in people's portfolios. And then we're going to tear down an actual deal. That's kind of the meat of this discussion. We're to look at the terms being offered on a specific deal that we pulled from Lightstone and take your questions on it. Really, really ask the hard questions and think about how do we look at a deal like this with this deal serving as an example. So without further ado, let's jump on into our discussion. Let's start with our key definitions, Adam. You want to walk us through what are the
terms and metrics I need to understand to be acting in the multifamily space.
Adam Katz (02:32)
Sure. These are the basic ones. There are obviously a lot more when you dig in further. But the thing that the way that most people evaluate a multifamily building is going to be based on the net operating income, which is just the income minus the expenses and not including any debt payments, any leverage, stuff like that.
And then there's the cap rate, which takes that net operating income and compares it to the property value. So for example, if you are making $350,000 and the property is listed for $7 million, that's a 5 % cap rate, which is essentially represents your like unlevered return. So that's not necessarily your return on investment because most properties are acquired with, you know, large loans, but
this is a way to compare buildings with each other. So generally, a building is going to be more attractive with a higher cap rate, so like a 7 % cap rate or an 8 % cap rate. But there are trade-offs. If it's in a worse neighborhood, investors might demand higher cap rates. So cap rate is a good way of comparing buildings to each other. It's not necessarily the only way to evaluate a single investment on its own.
because you don't know what the leverage is, you don't know what the property is. We'll get into all that in a little bit. And then...
Eric Cantor (03:58)
is a if I can just know is cap rate particular to multifamily as an S class or is this cutting across all real estate types and is it cross rated multifam the same
Adam Katz (04:12)
It's across investment properties. You're not going to look at your primary residence at cap rate, but anything that's generating income. So yeah, it works for retail, industrial, any kind of commercial building, or even a duplex that you're buying as a rental property. And yeah, so ⁓ across asset classes. And then sort of the way that
That most people evaluate the individual investments is based on the internal rate of return, which is a way of looking at your return on investment with the time value of money. So because real estate is a cash flowing asset, you know, a dollar today is worth more than a dollar in 10 years. So it takes those cash flows and kind of bakes it all into one number. And then cash on cash return is just the distribution, not including
any potential appreciation, any principal pay down of a loan. It's just how much are you making before paying taxes versus the amount you originally invested? Because again, remember, the amount you originally invested is not necessarily the price of the property because you're going to be almost always taking out a loan. So those are the main ways that we are going to evaluate a multifamily real estate investment, as Eric pointed out, most commercial properties.
or investment properties.
Eric Cantor (05:33)
Great. So I mean, guess just zooming out a little bit so people can think about how they're positioning this in there with alongside other real estate pieces and alongside other investments. Why multifamily? Why is this an asset class to concern yourself with?
Adam Katz (05:49)
Well, we'll start by talking about the multifamily market currently. Over the last few years, there's been fairly flat rent growth across the country on average. But as you can see from this graphic and just kind of since the pandemic, there have been very different results in different parts of the country.
The Midwest has performed significantly better than the rest of the country. The Northeast has been fine. And then places that became really hot during the pandemic, generally like the South and the Sun Belt, where you're talking about Texas, Florida, there was kind of an oversupply in those markets that has now led to rent declines in places like Austin, Tampa, Florida, places like that. So while there was a surge
in multifamily supply. can see in that second graph, sort of 2022, there were a ton of multifamily starts, which is the beginning of construction, which obviously leads to new multifamily buildings, new apartment buildings. So nationwide, there was a bit of an oversupply that is now turning into an undersupply. Like it is really low. And that's going to eventually like
because there are fewer multifamily starts right now, that will eventually turn into lower supply down the road in the next couple of years. And again, that is unevenly distributed. So there was a ton of new supply in Sunbelt regions to kind of catch up to the demand of people moving there during the pandemic. And now people are moving away. Now there's more supply. So rent is going down there.
That is not the case in the Midwest and Northeast. And then if you zoom into specific markets, the New York cities of the world, that's not going to be the case in specific markets. And then across the
Eric Cantor (07:42)
I'm on that a little bit. Like, if there's a pendulum, it's like a pendulum, right? Like you build a little too much and then it softens and then all the people come in and buy that and then there's not enough and then they go to build more, but they build too. It's sort of
Adam Katz (07:55)
realist is
cyclical. mean, this is a cliche, but it's true, you know, because there it you can't just build a apartment building in a day, it takes time. So there are these market forces that you react to. And, you know, so if you're seeing a bunch of people come in, you're like, we need to build more apartment buildings, but that takes years. And then by the
Eric Cantor (08:16)
I'm
wondering about a market like Austin, All I hear is people want to move to Austin. So maybe did they build too many apartments in 2022? Like maybe, but won't that then catch up? Or are you saying like that's still not even a good place to be playing because there's just going to be an overhang and like maybe they can't, there's not capacity for more people or something.
Adam Katz (08:39)
there's always going to be difference between evaluating something in the short term, medium term and long term. over the last couple of years, Austin has seen rents decline 20, 30 % on average because of all of the oversupply and because it was a hot place to move to during the pandemic. now it's seeing people actually start leaving, like their net migration numbers are not great. so yes, eventually if this construction completely slows, you'll expect
that demand will eventually catch up to supply, but you don't know when that's going to happen. And the key in all real estate investing, and this is also a cliche, but it's like you make a lot of your money when you purchase the property, because are you getting it below market value? And then you need to kind of project over your whole time, like what's the market going to look like? So if you think that Austin is going to come back in the next three to four years as an individual investor, you can make that play.
trend, trend wise over the last couple of years. And again, you know, past performance doesn't guarantee future results, but trend rise right now. It's the Midwest cities, it's the Northeast cities that have been seeing the most sustained rental growth. And if you, know, we're looking nationwide, rental demand has been slowly rising. Buying has become, well, it's not become, but buying has been.
unaffordable over the last few years, mortgage rates shot up from the threes, the sixes, to the sevens, making it much more expensive to buy. We're talking about people who might otherwise buy if mortgage rates are down in the threes are still renting. And so you have more renters and rental demand is growing. And particularly in expensive markets, in markets that have demand,
⁓ For housing, you're talking about New York, San Francisco, places like this, and then Chicago. A lot of the big Midwestern cities have seen home price growth go up. So it's becoming more unaffordable to buy in those places, which leads to more renters, which leads to more rental demand, which leads to rental growth. I wanted to talk specifically about class B properties, the way that we define kind of multifamily and most commercial properties.
is by kind of talking about the class A, class B, class C neighborhoods, and also types of buildings. So class A is sort of your luxury apartment buildings. Class B is your normal workforce housing. Class C is going to be the sort of cheaper, lower class housing in probably less desirable neighborhoods. And
Over the last couple of years, Class B has actually been outperforming Class A and Class C. have a lot of that supply that came online in the last few years was Class A, was luxury apartments, because developers, it's easier, well, not necessarily easier, but the numbers are projected to be better a lot. If you're building a building, the cost of a Class A building does not scale to the same versus the cost of a class.
B versus what you can get in rents. If you put luxury finishes in there, you're going to get a lot higher rents, but the cost of that refrigerator is maybe not that different than the cost of the refrigerator in the class B building. And so a lot of that supply was class A. So a lot of these markets are seeing a glut of luxury housing. Class C, there's vacancy issues. There's rental payment issues.
So the kind of middle ground here is the class B buildings, which can generally be acquired at a discount to replacement costs, which means that if you were to build that building from scratch, it's going to cost you more than what you can buy it for right now. And that gives it kind of this value-add potential where you can do cosmetic changes. You don't need to do these massive renovations, but you can put on new paint. can update the gym. You can, you know,
upgrade the laundry room, these things that are not going to be full renovations, but that add a lot of value to the property.
Eric Cantor (12:44)
Got it. So like, why multifam? Like, what is this asset class? I mean, this has been a good overview of like, what's been happening in the asset class, but just as an investor, like, why do I want to engage with this at all?
Adam Katz (12:58)
Yeah. So there's two ways of kind of talking about this, which is like why in general and then why now. So why in general? I mean, like with all real estate, you have the opportunity for cash flow from the rents. So every month you're getting paid rent. And ideally, that is more than is going out the door on expenses. And by either monthly or quarterly or yearly, you're hoping to get these cash distributions.
All the while, the value of the underlying property is appreciating. And in multifamily, that's generally going to appreciate with the amount that the net operating income is going up. And so it's one of the few assets where you can get both cashflow and appreciation. Multifamily itself generally does well during volatile times. People need places to live. Doesn't matter what's happening, right? And, you know, kind of counterintuitively when
there are times of of economic uncertainty, you're going to see more renters because people aren't going to buy. And so you're going to have actually more demand for apartments across the spectrum. And in times of inflation, generally, you can still see rents rising with the inflation, like rents go up with inflation, because again, like it's a core necessity for people.
So when things get more expensive, people still have to pay their rent. Maybe they're going to cut back on going out to eat or going to movies or whatever, but they have to pay their rent. So that tends to scale up with inflation. inflation, the measures of inflation generally measure housing costs. So that is a measure of how much housing costs are going up. And then we can talk about why now? Why multifamily now?
⁓ you're, talked briefly about the supply and demand dynamics and how there's been this oversupply that's led to undersupply. So in the next like two or three years, you're gonna have way fewer apartment building completions coming online, which leads to less supply compared to demand that is slightly rising. That's going to lead to rental growth, which it's, you know, it's a one, two, three, four thing, right. And it's going to lead to rental growth.
which is going to lead to better property values. then right now, I believe that now and in the next probably year and a half is a really good time to get in because we are hoping for interest rates to go down. you know, there are geopolitical factors that have maybe delayed this a little bit, but we're expecting, you know, a few more interest rate cuts. And as interest rates get cut,
Mortgage rates go down and historically cap rates, what people demand for cap rates go down with the interest rates because you can't get as much from say private credit or whatever. it's a, cap rate is a measure of what people are willing to get as a return for the building. And so if your cap rate is, when you buy it is 6 % and then you can sell it at 5%, it's a huge difference in the property value.
And so that I would expect over the course of holding a building where you want to hold it for three, four five years, at least we're going to see interest rates come down, which is going to cause cap rate compression, which is going to cause property values to go up. then there are also, sorry, there are also tax benefits, which, you know, talk to your accountant. I'm not an expert in that.
Eric Cantor (16:39)
would expect to get those if I'm dabbling. ⁓ So okay, let's just say I'm on the call. I'm like, okay, I bought it. That sounds great. Like, what do I look for? I don't I mean, there's a million of these that come into my inbox every day. Like, how do I? What do I look for in terms of evaluating whether this is a good one? Yeah.
Adam Katz (16:41)
Yes.
So and this is kind of like a rubric that we can use for most real estate investments, not just multifamily and not just a 400 unit multifamily complex, but it's also something you can use for two units, three units, four units, whatever. You always want to look obviously at the actual building.
how many units does it have? What is the income? is, know, just where is it located? The specific building, you know, because real estate is not just a market by market thing. It's a neighborhood by neighborhood. It's a block by block, you know. It's extremely, extremely important to look at the specific asset that you are looking to acquire and what class is it? Where is it located? All these kinds of things. Now, in this case, when we're talking about something where you're not going to be doing it as an individual, you're going be doing it through a syndicator.
The next thing you want to look at is who is that sponsor? Who is managing the building? Who is buying the building? What is their track record? What is their experience? Both nationally and in the market you're looking at. Have they bought in that market? Have they operated in that market? The difference between a sponsor that has been around for decades and has been
active in this specific market is very different than somebody who's doing it for the first time. mean, that's fairly straightforward. And then you want to look at their fees. What kind of cut are they taking? There's a lot of different ways that sponsors get paid, which is the same for a lot of syndications, whether it's in real estate or venture or whatever. You want to look at the fees because you don't want to get surprised at the end when
You think that this asset's doing really well, and a lot of that gets eaten up by fees. Then you want to look at the dig into the numbers. You want to look at the income and expenses of that property. If the projected numbers pass the smell test, are these projections too rosy? Because anybody can say, oh, we're going to buy this building, and we're get a 25 % return. We're to a 20 % return.
But if you dig in and you look at their projected tax costs, or 10 % of what the actual taxes are, you know that those numbers aren't going to be accurate. So you want to look at rental comparables in the area. Are they projecting rents that make sense? Are the current rents, is this an area where a one bedroom rents for $1,000 and they're projecting $1,500? Or are they projecting $800? Are they being conservative?
Are they being liberal with their projections? Then you want to look at recent sales comps to make sure that you are not, or they are not overpaying for the property at purchase, right? If a very similar building or complex went for 10 million and you're paying 9 million, that's great. If you're paying 12 million, maybe that's not as great. And then you want to look into the location, which is both the city, metro area. You know, is this a place that is, you know, ascending?
Is there job growth? What's the economy looking like? Are people moving in? Or is it in decline? What's been the historical trend in that market? And then within that market, what is the neighborhood that this building is in? Because anybody on this call knows that in their city, there are good places and bad places to live, where people want to live and people don't want to live, and good and bad places to invest.
You know, there there development coming? Is there, you know, is this the best building or best house on a bad block? You know, so you want to you really got to dig into the specific location. I mean, it's it's the oldest thing in the book with real estate, but it's all about location. And then when you are doing this on your own. You can assume that in a syndication, the sponsor is doing this, but when you're doing this on your own, you obviously want to look at the building inspection. You got to look at the appraisal. You got to get, you know,
lawyers to look through the title. Just make sure that everything is buttoned up.
Eric Cantor (21:09)
Right. And so just, just recapping, I we always want to be cognitive, like what's the downside, what's the risk. So what are the risks of multifam? Just broadly speaking, we should be accounting for them. do this analysis.
Adam Katz (21:21)
So there are a few different kinds of risks. One is sort of on a macroeconomic environmental level, right? I talked about how I expect interest rates to go down, but we didn't expect necessarily there to be a war in Iran. And so now we're talking about potentially there might be rate hikes, or maybe we're just going to be in this high interest rate environment for another five years. So that's something that you've
You can't control, I can't control. That's something you're just gonna have to bake into your diligence. Like what is this property gonna look like if interest rates stay high? What is this property gonna look like if interest rates go up? What is the property gonna look like if interest rates go down? And you kind of wanna look at all of those things and see if it's worth it in each scenario. What's the upside? What's the downside? Nationwide rent growth could slow. This is again something that you have a little bit of control over with your.
your actual building because you can make things nicer to kind of force rents to go up, you know, you're going to to get better tenants so that they don't leave. So your vacancy rates are low. But there are a lot of factors that you can't control. Right. And if rent growth in your market or the country slows down because of, know, you can't control how much construction there is, you can't control how much supplies coming in.
You can look at the trends and you can see there's probably going to be less supply coming in the next two or three years. But if in the next year there's a ton of multifamily starts across the country, that's not something you can control. And so that goes along with the market risks, like what's going to happen in that specific city. That supply could rise. And it could also rise in your neighborhood. You cannot control how much is being built next door or two blocks away or in that city. You also can't control.
you know how that local economy is going to do. A lot of that's going to be maybe based on local employers, local politics. You just have to take an educated guess on how stable that market is and whether or not, you know, the last few years is going to carry over to the next few years. And then obviously there's always risks from that specific property, right? You know, there could be higher vacancies. You know, people are leaving because maybe the property manager is not doing well.
or they're not putting in the right tenants. And that's another bullet point there is unreliable property management. If you're gonna self-manage, that's one thing. If you're gonna outsource this to a third party, you have to pick the right one and somebody you're gonna trust. And so you hear all sorts of poor stories about poor property managers who just put in tenants without screening them, that leads to all sorts of risks. And that can also lead to...
You know, you've got higher maintenance costs, you know, a roof breaks, appliances break, a water heater breaks and good sponsors and good investors underwrite for that. They project higher maintenance costs, higher capex costs. Anytime I'm looking at a building, I always project higher maintenance costs than I actually expect just to make sure that the numbers still, still work because you don't want to be in a position where one big fix.
ruins your cashflow for the year. And then property taxes, in certain markets that's capped, how much it can rise, but in other markets, you might get reassessed at your purchase price. These are things that you can look out for, but you're never gonna be able to 100 % guess what the assessor is gonna come back with.
Eric Cantor (24:56)
Got it. So plenty of things to look at. So let's dig into the actual opportunity. And we pulled one here. We pulled a really interesting multifam deal from our partner, Lightstone. Those of you who don't know, Lightstone Direct provides investors in multifamily and industrial opportunities alongside their own 12 billion dollar institutional real estate portfolio. So they've done all the deals, taken all the risk and built up this institution. And now you can invest alongside via Lightstone Direct.
This deal that we're looking at is actually on Lightstone Direct right now. We can drop a link to it in the chat. Before we dig into it, just a couple, I see a bunch of questions popping up, which is great. Keep asking questions. Will the slide decks and webinar be available? Yes, we will distribute that. The other questions we're gonna keep an eye on is working to our discussion, but keep submitting as we have a bunch. Let's dig into Hidden Lake. So this is a garden apartment.
property in Grand Rapids, Michigan. I'm assuming it's Class B, but we'll find out. ⁓ Adam tells about this property. Let's walk through that same heuristic and just apply it here.
Adam Katz (25:53)
Yeah. so like I said, we want to look at this specific property. you're correct is a class B multifamily property. It's 384 units. So it's, it's a big complex, the big apartment complex. It's in Grand Rapids, Michigan. It is being acquired at a 12 % discount to sales comps. It's also being acquired at a 40 % discount to replacement costs. So
The amount it would cost to rebuild this building is 40 % higher than what is being bought for. Current rents are at a 6 to 7 % discount to rental comps. So there's room for growth. And it also shows that they're not overcharging. so this is going to come into play later when we look at the specific numbers.
So I think the next thing that we're looking at is the actual sponsor of this offering. Because most people, even generally when 400 unit buildings change hands, it's not one person buying it. And even when you're talking about a 12 unit, 20 unit, usually it's not going to be one person. These things are not priced in a way that individuals can just go out and buy them.
And so in order to get access, you're usually going to have to be doing this through a syndication of some sort or an investment platform, which means people are pooling their money together. Somebody's managing it and they're buying the property. And so it's super important to look at who is doing the purchasing, who is going to be managing the building. And in this case, it's Lightstone Direct, which is a new offshoot of Lightstone, which is a real estate fund, one of the biggest private real estate funds in the country.
They've been around for four decades. have $12 billion of assets under management. They own 25,000 multifamily units across the country, which is just crazy amount. They're also an industrial and commercial. They've done dozens and dozens of these investments. Historically, their net IRR on exit investments is 27%, 27.6%. And the
multiple on the equity multiple investment is 2.5 x, which means that you put in $1 you're getting $2 and 50 cents back, which is a pretty impressive return. And this is their first multifamily offering they last year offered an industrial project. But this is their first multifamily.
Eric Cantor (28:21)
So tell us about the structure of this deal and what it costs to get into it and whatnot. Yeah. There's a question about that. Please explain the fees that are charged in detail.
Adam Katz (28:32)
Here we go. So we'll talk about the terms and the fees here briefly. It's for acccredited only. They are estimated to hold the building for four years. The minimum investment is 100k. They're targeting monthly distribution. So you'd be getting cash every month. And then in terms of taxes, you get a K one, which is the standard thing in this. And so it's a pass through thing. So the income of the
Building that you get paid passes through to your taxes. There are going to be tax benefits because you also get the depreciation to pass through. It totally depends on your individual tax situation. Fees, there's going to be a 1.5 % acquisition fee, which is totally standard. And then a 1 % annual management fee, which is actually
pretty good because the standard in venture syndications is a 2%, like 2 and 20. So 1 % is half of that, which is a pretty substantial difference. You have construction fee. then at the end, there's a 20 % is the 20 % carry, which is pretty standard in all sorts of syndications. But that only comes into effect above 8%. So once the investor gets 8 % so if this returns 8%, you're getting all of it.
and then above 8 % it's split 80-20. So if it returns 20 % then that's gonna be 12 % above the hurdle and the mandatory gets 20 % of that, you get 80 % of that. Does that make sense?
Eric Cantor (30:05)
Yeah, but if we talk on net, mean, a lot of those construction fees are kind of behind the scenes because they're sponsored as well as the investment manager. From my perspective, I put in one hundred thousand dollars. I'm getting eight thousand a year before anybody's getting any fees off of that, right? Like now return to me, maybe not each year, but cumulatively. And then you're saying the 20 percent share starts out in the next percent. So nine percent to 15 percent.
Adam Katz (30:29)
Exactly.
Eric Cantor (30:29)
doing the 80-20 and that's un-gapped like it's even if I make 80 % it's still
Adam Katz (30:36)
believe so. 80 20. Generally that's the case.
Eric Cantor (30:40)
And so the net IR that's listed here, there was a target on the deal like that. Takes into account that that investment management fee. Yes, that's a net of fee.
Adam Katz (30:49)
That's net of fees
Eric Cantor (30:51)
Okay, I think we dug into this enough. Let's look at some comps, like where this property is and what's around it.
Adam Katz (30:58)
Yeah, so like I said before, their acquisition price is 12 % below recent sales comps, 13 % per square foot, which is actually the better metric because you're not necessarily going to find an exact 384 unit building, right? So if you look at these comps, it's between 182 and 924 units. I think this goes down in terms of the closest to the furthest away. So you're looking at.
things that have sold, in the last few years, that top one is not actually been sold. It's just marketed. So, you want to look at the most recent sales are going to be the most kind of robust comps. And this is, you know, there's a little bit of art to this because you want to look at the most recent sold, but also the closest types of buildings, which is unit count. Average unit square foot, you know, because if, if this is a building with huge.
units, you don't want to comp that to a building with smaller units, right? You want to look at also class B, you don't want to comp this class A, you don't want to comp this class C. So you're looking at per unit costs per square foot costs. And then they added 3 % for inflation for buildings that were bought or sold, you know, a couple of years ago. And so when you put this all together, their analysis has it at about 12 or 13 % below
recent sales comps.
Eric Cantor (32:25)
in terms of rent.
Adam Katz (32:27)
And then you look at rental comps because you want to make sure that they're not projecting rents that are too high, that they're not charging rents that are too high. And so they look at, there are one bedroom and two bedroom units in this building. And so you're looking at what the average rents are for comparable one beds and comparable two beds in the area. And this is all stuff. If you want to do it yourself, you go on to Zillow.
in New York, you go on the street easy and you see what things are renting for what they're asking for and what they're actually renting for it. You know, this is generally public information, like you can you can track this information down. And so when they look through this, it their average rents are about six or 7 % below the rental comps, which leaves room for some upside, especially as you sort of refurbish these units and do light renovations on them.
Eric Cantor (33:21)
Got it. So, I mean, you factor all this in, like, what is the, let's look at the projections and what your take is on what they point towards in terms of performance.
Adam Katz (33:31)
Yeah, so like I said, they're expecting to hold it for four years. In that time, you're gonna see units that go vacant. You can then kind of upgrade those units and end up charging more rent. That's the clearest path to kind of force appreciation in the building. So they are projecting a 7.4 % annual cash on cash over the course of it. In year one, it's 6.9.
up to 8.3 by year four. So that would be how much you are being paid distribution each year. And I believe they pay monthly. So you'll be getting like a little bit paid to you every month. The net IRR. So that's again, net of fees that they're projecting is 12.3%. And the net equity multiple is 1.5. So if you put in 100K, they're expecting you'll get 150,000 back in four years.
Eric Cantor (34:25)
That's total gross return after four years, effectively.
Adam Katz (34:29)
Yes, exactly.
Eric Cantor (34:31)
And then pro forma. Yeah.
Boom.
Adam Katz (34:34)
So we're not going to dig into every line item here, but you can get the deck and look at it yourself. But they're looking at the rents, which you can project pretty well because you know what rents you're getting right now. They're projecting the vacancy, is relatively. So what you want to see is conservative projections here. So they're projecting a relatively high vacancy rate, higher than the current vacancy rate, higher than their
historical vacancy rate of their properties. They're projecting about an 11 % vacancy rate in year one and then declining down to about a 7 and 1 half vacancy rate on year four. You look at the expenses. The property manager fees only 3%, which is pretty good. And then that gets you to a net operating income. It gets you to the cash flow. And then you're comparing that to the purchase price, which gets you a cap rate, which I believe on the first
slide was about 6.3%. And they're projecting that when they exit, it's going to be a 5.75 % cap rate. So there'll be some cap rate compression. So they're hoping for a couple of interest rate cuts, but not an extreme amount.
Eric Cantor (35:49)
and a bunch of questions are popping up as a fun one. This looks great. Why would somebody want to sell this building at a discount? Seems like you should sell it at premium. And you may not know the actual circumstances around this sale, but maybe talk about why a property like this would even come to market.
Adam Katz (36:07)
So in this particular case, think that this property has been held by the same person since like the 80s. So I think they're just trying to get out. And when you're talking about properties of this size, there's not a huge market of buyers. It's going to be because you have to put together a syndication in order to purchase this. And so you know.
One thing that I'm asked in my own deals a lot is like, how are you getting this? Like if this is such a great deal, like why are you getting it? And a lot of times it's just because you're doing the diligence. You're the one putting in the work and finding the properties and making sure they pencil out and doing the research and looking at the income, looking at the expenses and not everybody's willing to do that stuff. And there's not like
Eric Cantor (36:37)
Bye.
Adam Katz (36:58)
It's not always a lot of competition, even in my deals in Brooklyn and New York City. You would be surprised. clearly, this has been on the market. This has been the best offer. And so the way that most multifamily operators make money is by improving the rents. You can see inefficiencies. can see that if you're going to, some of these units might be not in disrepair, but
in need of a cosmetic upgrade. You put in some new appliances, you put some paint, and you're going to be able to get much higher rents. just even $100 here, $100 there on rent makes a big difference in how much that property is worth when you're looking at a 5 or 6 % cap rate.
Eric Cantor (37:43)
Yeah, I mean, I would just chime in like I've seen a lot of this in different, different businesses, whether it's real estate or plumbing business or small company, like usually there's a person behind it that's been putting all the effort in and at some point that person, especially if he's at 80 years old or something like is ready to trade all that effort and the benefits for like a flat fee windfall and then to stop having the headaches. And there's a lot of that out generationally right now out there.
Maybe just piggybacking on the point you were making, another question that came up in the chat is in the Q &A is, you're giving us like a formula here. Does this same formula work on smaller properties like the buildings that you've been dealing with that have two to 10 apartments? is there some scale difference where that approach kind of has challenges?
Adam Katz (38:33)
There's definitely a scale difference. It's much different to buy a two-unit building and even a 12-unit building versus a 400-unit building. But the general rubric, this is the way that I look at the deals that I've done. And I've done three-unit, four-unit, six-unit, eight-unit buildings in New York City. I've never bought a 400-unit building. But it's the same kind of thing.
It boils down to what kind of rents can you get? What's the rent growth going to be? What's your enter rate? What cap rate are you entering in? What cap rate do you think you can exit at? For bigger buildings, you have a much bigger margin for error. In a four unit, if one of your units is vacant, that's going to hurt you a lot more than in a 384 unit building when one of your units is vacant. So this is actually, in some ways, easier.
to project because there's so many units. It's unlikely that one water heater or one roof leak or whatever is going to really affect your projections monumentally in a way that in a lower unit building you. That's why when I underwrite these four unit or six unit, you really want to go conservative on the maintenance costs. You want to think, OK, if we need a new boiler, we need a new water heater, is this going to really break this?
It's probably not going to be the same once you get to massive apartment complexes, which also are going to have maintenance issues all the time, but you can kind of underwrite that in a way that in a more accurate way than you may be able to with smaller buildings.
Eric Cantor (40:10)
Why would you want to buy six doors instead of 60 or six?
Adam Katz (40:14)
Because 660 are more expensive. you might not be able to raise the money. You may not be able to raise the money for that. Also, there's not a lot of 600 unit buildings in Brooklyn that are for sale.
Eric Cantor (40:29)
Let's look at a couple more areas before we finish this. Metro area, what do we know about, we haven't talked that much about Grand Rapids, tell us a little more about where we're buying.
Adam Katz (40:39)
And I mean, this is important. Like we said, like the specific metro area and the specific neighborhood is super important. We talked briefly at the beginning here about how the Midwest has sort of been the most stable region for rental growth over the last few years and for home price growth, which are related within that region. Grand Rapids has actually been one of the stronger performers. It has led the Midwest in the rate of population growth.
It has led the Midwest in the rate of economic growth in the past decade. You can see it's got all these rankings and stuff. A lot of people don't think about Grand Rapids. And that goes back to sort of the question of why do we think that this can be acquired under comps? know, Grand Rapids is not a sexy market. It's not Chicago. It's not New York. It's not San Francisco. But a lot of times those markets can be the best for these things.
⁓ because they're overlooked and this is a place where
Eric Cantor (41:36)
Those markets meaning Grand Rapids, not Chicago.
Adam Katz (41:40)
Yeah, the Grand Rapids of the world, the smaller but mid-sized cities. You've got a tech sector that's upcoming. There's this big biomedical center. It's called Medical Mile. You have local college kids that are sticking around. It is a lot more affordable to live there, rent, et cetera.
⁓ than a Chicago then you know coastal cities, but it is still because it is has become a nicer place to live and there's jobs and the economy is doing well. It's actually still significantly more expensive to own than rent there, which means that there's going to be more renters, especially when you're talking about recent college grads and things like that. They're not going to be ready to buy both from a life perspective, but also because you know it's
Mortgage rates are high. Property values are still high. It's difficult to buy. So you have this kind built-in rental base. If you look at that graph, there's very, very little supply coming in. You can see there's a bunch of supply that came in a couple of years ago. But in the last year and a half, and then projected over the next year and a half, very little additional supply. And there's only one new construction project near this particular neighborhood.
⁓ and it's primarily for affordable housing. So it's not a class B. So you're not gonna have a lot of competition. There's not gonna be a lot of new supply coming in, ⁓ which is going to be good for rent growth, which is gonna be good for the growth of the value of the property.
Eric Cantor (43:12)
mean, you're with such a small market, like Grand Rapids, like 200,000 or something. Is there any concern of like ceiling? Like, you know, five big buildings could change the market. Whereas like if you're in Chicago, that's endless demand, probably.
Adam Katz (43:23)
That's
That's definitely a risk. But even when you're looking at Chicago, it's a neighborhood, right? If you get five new multifamily buildings in the three blocks around you, that's going to affect things in a way that, you know, I mean, everything, everything in real estate, as I said earlier, is, is micro, right? It's not just the market. It's not just the neighborhood. It's, it's block by block by block. and so, you know,
Is there going to be the same kind of rental demand in Grand Rapids as in Chicago? Probably not. But there's a lot less supply in Grand Rapids, you know, on a on a overall level. And then if you zoom in, there's a lot, there's not much supply coming on in this particular metro coming in the next couple of years.
Eric Cantor (44:09)
Gotcha. So just clicking to an investor question that came in around these same issues. We are evaluating small multifamily opportunities with at least five units. If you were starting today, which states or cities would you prioritize? What minimum return metrics would you require and what red flags would make you walk away from a deal? So think there's a I would take this question to be like, are the what are the locations that you like right now, other than Grand Rapids, maybe including Grand Rapids? And what would make you walk from a deal? And if you want to throw it in there?
what's the minimum return you think is exciting.
Adam Katz (44:44)
Okay, one at a time markets, you know, overall, I'm always partial to New York City, because that's where we live. And that's where I've invested. And historically, know, in New York real estate has done very, very well. And specifically, you know, it's gonna be different if you're talking about, you know,
Brooklyn and even downtown Brooklyn versus East Brooklyn. So, you you have to really zoom into these neighborhoods. But you anytime I'm looking at stuff, you want to look at neighborhoods that have shown population growth, rental growth, but haven't quite popped yet. Right. You want to get that that thing that's in the middle, like it has started to take off. It hasn't completely taken off in terms of markets. You know, San Francisco, I think, is coming back in a big way.
with the AI boom. The Midwest has definitely been super solid over the last few years. I mean, there are arguments to be made that there are going to be opportunities in Texas and Florida in the long term because things have gone down. I personally am a little worried in Florida about the kind of the weather risk, the insurance stuff. So I probably would stay away. again, if you were doing this on your own, like this question said, they're looking at five unit multifamilies.
You want to go to markets where you have expertise. So usually that's where you live or where you're from or where your family like you don't want to go into a market by yourself that you don't know that well. And so when you're talking about a sponsor, This sponsor has 10,000 units already in Michigan. So they know the Michigan market.
their in-house property management company is based in Michigan. So that, you know, there are a lot of efficiencies there. You can look at their multifamily performance here. It has exceeded the averages in the Midwest and also in the U S you can see that they're in the Midwest, Chicago, Detroit, Columbus versus the Sunbelt markets that have gone down over the last year in, terms of rent change. So
You want to like this. I'm trying to tie this into the question, but you want to make sure when you're looking at a sponsor, maybe you don't know Grand Rapids. Maybe you don't know Michigan, but if the sponsor does and you trust the sponsor, then that is going to be as good as you having the expertise.
⁓ Red flags, they asked about red flags.
I'll tie it into the question about return. You know, I think that it's a red flag if something is offering a return that seems too good to be true. you see this a lot where they're like, Oh, we're going to have a 40 % IRR 50 % IRR And you're like, that's, it's not realistic. Um, it's not to say that you can't achieve those returns, but
Generally, that means that people are going to be projecting an optimistic situation, which is not going to happen. And the sunnier the projections, the sunnier the returns, the more that you, the individual, need to dig in and do the research and make sure that those things make sense. So that's a red flag for sure. Again, the difference, if I'm an individual looking through a building, you want to look at kind of
who the renters are, how long have they been there? What's the condition of the building? You know, how old are the the mechanicals, things like that. There are a million reasons to walk away. Especially I mean, in in a market like New York, there's a lot of buildings for sale, you know, you want to find the perfect one. And so you start to kind of see things, whether it's the way that things have been maintained, the the
reliability of the renters in terms of the payments and stuff like that. know, if I mean, something that I will 100 % in my experience walk away from is if there's a non-paying tenant, you do not want to deal with that. In the case of a 384 unit building, that's going to be probably a little bit different than a six unit building. But that's something for me where I do not want that headache.
Eric Cantor (48:27)
Got it. A couple of financial questions here. One is what's the bear case? we walk this, this investment looks really good. You kind of sold me like what could go really wrong here? ⁓ And you can include like micro things like, somebody clogged a toilet or, you know, geopolitical. ⁓
Adam Katz (48:46)
Yeah, mean, one of the reasons I like multifamily because the risks are, you know, the risk return ratio is generally pretty good, right? It's not as risky as venture, right? This is not going to go to zero. the value of this building, you know, and well, here's another, here's a risk and a red flag is also if a building is over leveraged, right? If you're taking out a loan that's
90 % or whatever, like you're more likely to go underwater if property values decline. But if this is underwritten well, and your loan to value is in a reasonable place, and you're in a market that's seeing rent growth, multifamily is, in my opinion, very difficult to lose money in. You might not see the returns that are projected, or you might see flat rent growth or whatever, but it's very difficult to lose money.
if you are doing this correctly. And if you look at this specific sponsor, they have a very long track record of doing it correctly. so risk-wise, I think for this project, for my own stuff, it's really macroeconomic, right? And so it's like, are interest rates gonna come down in the next four or five years? Are they gonna go up? Where are we at with that?
That's the thing that's most out of your control. And that's going to be the thing that kind of affects the returns the most, in my opinion, right? If we get three rate cuts and the cap rates go down by 75 basis points, that's going to be huge. If it stays flat, the difference in the return profile there, it doesn't sound like it's going be a lot, but it really is. And just a way to.
about you to kind of illustrate this, right? Let's say that you have a property, I'm going to do some mental math here. And hopefully everybody can follow along. But if you have a property that is generating $100,000 in net operating income at a 6 % cap rate, that's worth 1.6 something million. At a 5 % cap rate, that's worth 2 million. That's a substantial difference. And especially when you're talking about stuff that's levered.
So while a 50%, 75 % basis point cut in cap rate doesn't sound like a lot, it can be substantial in your return profile over four five years. So I think that's going to be the biggest factor that's going to determine the success of multifamily projects right now.
Eric Cantor (51:01)
I just want to say a quick word about sponsor and then one more question and we're gonna sign off all in two minutes. So again, this deals on Lightstone Direct. You can find more information there. They provide accredited investors with a new path forward in private market real estate investing. This is like a 10, $12 billion sponsor who does project with their own capital. Now you can invest in the same multifamily and industrial deals that they do for each offering. Lightstone itself co-invests at least 20%. So you're really side by side.
And obviously they've got the four decade track record of strong risk adjusted returns in various market cycles. There's no middleman here since they're the sponsor. They're a lot more aligned and a lot more institutional than the crowdfunding platforms of the last decade. Last question, I think you answered this, but just to be confirmed, is it better to see the cost to rent higher than owning like Grand Rapids or owning higher than renting San Francisco a market you may have some knowledge of?
Adam Katz (51:59)
For a multifamily investor, you want to see the cost to buy higher than the cost to rent because you want more renters. You want more rental demand. And we're seeing this across the country. And in Grand Rapids, is significantly more expensive to buy now than to rent. so, you know, I mean, this is kind of the
debate around the country for a lot of people is, you know, can I afford to buy right now or should I wait and just rent a little bit longer? And generally people are renting and generally that's going to be good for multifamily investors.
Eric Cantor (52:33)
Any last word on San Francisco market before we jump?
Adam Katz (52:36)
I love San Francisco as a market and it's been popping over the last year thanks in large part to the AI stuff. If you can invest in San Francisco with caveat of being in the right neighborhoods, I think you're going to do very well.
Eric Cantor (52:52)
Amazing. This was great. We learned a lot. Any follow up questions, feel free to ping us or go directly to the deal sponsor. Thanks everyone for your time. Thanks Adam for your candid thoughts and we'll look forward to seeing you on our next briefing. Have a great day. Cheers.
Adam Katz (53:05)
Thanks, Eric.
