For today’s episode, we will be discussing the different business models available in the broad term of real estate, New Build, Yield Player, Value Add, and Distressed Asset.
We will go over starting with the end in mind, and understanding what your investing parameters are.
What can we do from knowing your risk profile?
We will talk about these things…and more in another episode of Multifamily Investing Made Simple in under 10 minutes.
Tweetable Quotes:
“So you're adding tremendous value to that neighborhood, to that community. So theoretically, you stand to be rewarded very handsomely if everything goes to plan.” – Anthony Vicino
“We get paychecks via the cash flow while we're executing that business model.” – Dan Krueger
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Multifamily Business Models In Under 10 Minutes
Anthony Vicino: [00:00:14] Hello and welcome to multifamily investing made simple in under 10 minutes. This is the podcast where we take the complexity out of real estate investments so you can get started today. And we're going to do that in under 10 minutes. And we're going to take a concept today and break it down. This is actually our second try at this podcast episode. It was so tricky. I got tripped up midway through that we just had to scrap it and start all over. So bear with us as we go through this one again. But you don't know any of that because you're listening to the perfect version.
Dan Kreuger: [00:00:44] It's Hollywood magic right here. Yep.
Anthony Vicino: [00:00:46] So today we always like to talk about starting with the end in mind. And as an investor looking to get into multifamily syndications, you have to understand what your investment parameters are. What type of investor are you? What's your risk profile? What type of returns are you looking for? Once you have that, then it's a matter of going out and finding the right operators that are executing the correct business plan. So what we're going to talk about today are those business plans that those operators could be executing sedan from a high level. What are some of the ways and business models that an operator might be executing?
Dan Kreuger: [00:01:17] Yes, there are a few of them. And it's really important to go through this mental exercise, especially if you're newer because one might think that they want to get into real estate and think that, OK, all these real estate opportunities are essentially the same when in reality real estate's a very broad term. And within the multifamily class real estate, there's a few at least, you know, for we've got identified here different business models that one could be following, one of which is a new development. So just buying vacant land or maybe land with something weird on it that's going to get bulldozed down in a brand new structure is erected and leased up. Another one might be a yield play, which might also be called a turnkey operation. That's something where there isn't really a big value add component. As soon as the investor takes it over, it's producing cash flow and it's just generating cash flow. And that's pretty much it. There's not a huge equity upside component of it. The next option would be a value add type we really like to do. And it's a step between the yield player, the turnkey option, and what's coming next. So value adds business plan will be one where you buy an asset that is performing currently but could be performing better. It could be increasing the income or decreasing the expenses or both. But there's some way that the operator can force some appreciation. And then last but not least, or maybe at least is the distressed asset class. So if you are an operator that's looking for war zone properties, for dirt cheap prices and you don't mind the headache and the time and the risk of getting into those types of deals, you can buy something for really, really cheap and do a ton of work and up a ton of capital into it and end up with a lot of equity appreciation.
Anthony Vicino: [00:03:01] All right, so let's take these and break them down from lowest risk, lowest returns, and build up to the big boys that offer the biggest pop, those big, big returns. But in exchange, there's also a lot more risk. So at the very bottom of this pyramid, we'll call it is the turnkey or the yield plays. And so these are typically very nice, high-end buildings, like classy apartment buildings, luxury that when you're driving around town, you see those really nice plush apartments. These are those and these are a nice safe play because they're already at the top of the market in terms of the amount of rent that they're demanding. So there's not an opportunity to go in there and drive additional value. So these are great for really risk-averse investors like institutions or just an individual who wants a steady hedge against inflation and they want solid cash flow may be in that five to six percent range, but there's not going to be a ton of appreciation. So when you go to sell these properties, they're more or less worth what they're currently at. And so there might be a little bit of a pop, but it's not going to be very big by comparison to if you were in a Value-Add deal. So you kind of already alluded to what value add is. But let's go into that a little bit more in-depth.
Dan Kreuger: [00:04:18] Yeah, and I'd even push back on the cash, on cash, on the yield player, on the turnkey's stuff a little bit, because, you know, if you're looking at class stuff, the type of stuff that institutional investors are looking at, I think those guys are really satisfied with maybe three to five something in there. I mean, it's really just can we get at least inflation or maybe a smidge more? So it's a place to dump money in a hedge against inflation, really? So, yeah, low risk, but returns are not the most exciting. So the next one up would be the value add business model. So that's what we really love. You get that existing asset that's already producing cash flow from day one, but you have the ability to go in there and force appreciation, either increasing the income of the property or decreasing expenses or both. We love that because we get that equity appreciation component in a way that it is in our control where we go in and we do the work and we're not hoping that the market's just going to get better and we get paid. We get paychecks via the cash flow while we're executing that business model. So it's cash flow from day one. Cash flow gets better and better as we execute that business model and we get nice equity that gives us the ability to do a cash-out. I pull some of that equity out if we like. So it's a really great kind of Goldilocks zone type of deal, in my opinion, between, you know, class A turnkey. And we'll get into shortly here, which is the more distressing types of assets.
Anthony Vicino: [00:05:45] And on the Value-Add side, you're going to be looking at returns anywhere between maybe eight to 10 percent cash on cash and an IRR around 15 to 20 percent. So these are really good returns and we like them because they're already performing assets. By comparison, we have destressed deals and distressed is a lot like value add. But on steroids, we're going into these buildings that require a lot of heavy lifting that might have
Dan Kreuger: [00:06:09] Crack instead of steroids. Really?
Anthony Vicino: [00:06:11] That's kind of what you get. Yeah, yeah. Like there's something going on here. And what that means is we might need to get rid of all the tenants, might be a foreclosed build or like a forbidden building or a condemned building rather. And we might need to go in there and do some plumbing, some foundation work that is probably going to be upgraded. These might be really old buildings. There's a lot going on. There's a lot wrong with these and but the thing is, where there are problems, there's usually an opportunity. And so if you can go in there and make these upgrades and improve the building, bring it up to market standard, there might be a massive pop at the end. But in the meantime, there's probably no cash flow in the meantime. And so that means that there's a lot of risks associated with these assets. But if you're not a very risk-averse investor, if you're playing on a long timeframe, you want those big returns. This might be a really good fit for you. Now, one step up from that. I don't know if it's even if it's riskier or better returns, I'd say it's kind of comparable in some ways as a distressed deal. We have our development deals. And so this is where we're going and we're taking a plot of land or we're ripping down an old building. Maybe it was a distressed building. We rip it down and we build something new there. So, Dan, why is this associated with risk, but also pretty good returns?
Dan Kreuger: [00:07:23] Yeah, so I think the risk component comes from really the timeline on these deals. When you're starting to put together the business plan for something like this, you're looking out for it depending on the size of the project. You're looking at at least six to 12 months, maybe more than that. So maybe a year and a half even to when you're actually going to be done building it and starting to lease it up. And a lot can change in that time period. So say, for example, you started plans to build a building in a really popular urban downtown area around midnight, you know, early twenty-nine. And your plan was to build this property and start leasing it up in spring of 2020, you can see where I'm going with that. A lot can change where you're already fully in this deal, you're dumping money into it. There's construction going on by the time 2020 hits and you realize that the paradigm has changed drastically and this might not be the best place to build a building and lease it up. Right now. You're already into it, so you can't really pivot. Whereas if you're buying an existing asset with like a forced depreciation model, you know, you could pivot at the last minute. Something changes. But by the time basically the long timeline, I think presents a lot of risks because you don't know what's going to happen in the next couple of years if something changes. You might be halfway through a business plan that might not be the most appropriate.
Anthony Vicino: [00:08:44] And it's time that you have to, like, project out multiple years and survive until this asset can start producing cash flow and start justifying its existence. There's going to be a little bit more risk. But the plus side is you're going in to add complete value to something where there was no value before. It's a blank plot of land or an old building. You're ripping it down. So you're adding tremendous value to that neighborhood, to that community. So theoretically, you stand to be rewarded very handsomely if everything goes to plan. So those are from a high level, just four of the most common ways that people are investing in multifamily real estate. They're very different. They're not for every investor. Then again, they could be you might have a place in your portfolio. Just diversify and have a little bit in development, a little bit in value, add a little bit distressed like there is no wrong. So you can mix and match and play with them all. But that's going to do it for us today, guys. I think we did it. We made it through the entire episode without me flubbing.
Dan Kreuger: [00:09:43] So only two takes only three.
Anthony Vicino: [00:09:46] So we'll catch you guys next week. I appreciate you guys