When we first started investing in multifamily syndications, we didn’t know what to look for and we didn’t have a checklist to help us more objectively analyze deal opportunities. As we learned about the industry and invested in more deals, we discovered that several key factors underlie the success or failure of most syndications. Although multiple variables affect the deal’s operations and the investor returns, here are the FIRST five things we analyze before investing in apartment syndication:
1. The GP team and track record
The general partner team is the FIRST thing we look at when considering a deal, and although it is more of an art than a science, here are several things we evaluate:
- Experience and Track Record: Look for partners with a strong track record of successful multifamily apartment syndications. Ask about the number of deals they’ve closed, the size of the deals, and their performance metrics, such as cash-on-cash returns, internal rate of return (IRR), and equity multiple.
- Complementary Skill Sets: Your partner team should have complementary skill sets. For example, one partner may have a background in finance or accounting, while another may have experience in real estate operations or property management. The ideal partner team should have a blend of expertise that covers all aspects of multifamily apartment syndications.
- Transparency and Communication: Your partner team should be transparent and communicative with investors. They should be willing to share information about the deal, including risks and challenges, and be responsive to investor questions and concerns.
- Alignment of Interests: Your partner team should have a strong alignment of interests with investors. This can be demonstrated through the investment structure, such as a syndication or joint venture, which should provide for shared risk and shared rewards.
- Reputation: Look for partners who have a strong reputation in the industry. Check references and ask around to understand their reputation among peers and investors.
- Local Market Expertise: Your partner team should have strong knowledge of the local market where the property is located. This includes an understanding of the demand for rental properties, the local economy, and any regulatory or zoning issues that could impact the investment.
- Investment Strategy: Ensure your partner team’s investment strategy aligns with your goals. This includes the property type, location, value-add potential, and exit strategy.
2. The market and submarket
Once we’re confident in the general partner team, we next consider the market and submarket. Here are some of the factors we investigate before deciding to invest:
- Population Growth: We look for markets and submarkets that are experiencing population growth, as a growing population can lead to increased demand for apartment rentals and can support rent growth.
- Job Growth and Employment: Strong job growth and employment opportunities can also drive demand for rental properties. We look for markets and submarkets with low unemployment rates and a diverse employment base to reduce risk.
- Supply and Demand: To understand the balance between supply and demand of the local market, we always look at the vacancy rates, absorption rates, and the local construction pipeline.
- Rent Growth: We use industry data and statistics to examine the historical and projected rent growth in the market and submarket. Strong rent growth can increase the property’s value and increase investor returns.
- Affordability: The “affordability gap” (difference between the average home mortgage and average apartment rent) is an important variable in the apartment’s submarket. We also look at the median income and rent levels and compare them to other markets to ensure the property is competitively priced.
- Amenities and Infrastructure: We always compare a potential investment property’s amenities to nearby comparable properties. This helps us assess our ability to add value to our property by matching the expectations of the submarket. We also look for properties located in areas with good schools, public transportation, and access to shopping, dining, and entertainment, as these extras are attractive to renters.
- Economic Diversification: We like properties located in areas with economic diversification of the market and submarket. Diverse economies with multiple industries can be more resilient to economic downturns and provide a stable demand for rental properties.
3. The deal
Once we are comfortable with the general partner team and the market, we THEN look at the deal itself. While not an exhaustive list, here are several things we consider for each deal:l
- Occupancy Rates: Higher occupancy rates indicate a strong demand for housing in the area, and we look for properties with occupancy rates above 90%.
- Cash Flow: Because new financing can significantly affect the bottom line, we look for deals with a healthy cash flow AFTER the takeover. This means that rental income should be higher than expenses. Specifically, we like to see a post-closing net operating income (NOI) of at least 1.25 times the debt service or mortgage payment.
- Value add opportunity: To increase our total return and to help mitigate the risk of a downturn in the market, we always look for deals that have value-add opportunities. This may include bringing rents up to market, renovating units, adding reserved parking, or adding wifi packages.
- Property Condition: Most deals we purchase have some amount of deferred maintenance or lender-required repairs, and we always account for this in our underwriting. However, it is critical to identify high-dollar repair expenses such as roof replacements, foundation repairs, or parking lot repairs, as these can affect the cash flow to investors if not accounted for in the business plan.
- Tenant Quality: We’ve learned that tenant quality is a significant factor in accomplishing our monthly income goals. Although it’s difficult to fully understand the renter population before the property takeover, we look at the current owner’s books for current delinquency in rent payments. We also drive the property to get a feel for the community and current tenants.
4. The financing plan
The debt payment on an apartment deal is always the biggest expense, and the loan terms have a major effect on investor returns. We look at the type of debt (fixed or floating), the interest rate (is it competitive in the current market), the interest-only period (more interest-only years means more cash flow to investors), and the pre-payment penalty. Because we intend to sell or refinance our deals within five years, we pay special attention to the penalties and fees we’ll pay the lender to get out of the loan early.
- Debt type: Fixed-rate debt locks in the interest rate and protects the deal from increasing mortgage payments over the lifespan of the deal. In contrast, variable-rate debt often has a more attractive interest rate than fixed-rate debt, but it comes with the risk of rising interest rates over the deal’s life. We saw this first hand in the rising interest rate environment of 2022, and many deals became cash constrained as their mortgage payment rose with the rising variable interest rate.
- Loan term: The loan term is the time we’ll have to repay the loan. Fixed-rate debt is typically ten years or more, which gives us plenty of time to execute our business plan before having to sell or refinance.
- Prepayment penalties: Multifamily loans typically come with some type of prepayment penalties, which means we have to pay the bank a fee if we sell or refinance the deal before the term is up. As investors, we want to understand the penalty and how that might affect the timeline for selling or refinancing.
- Debt service coverage ratio (DSCR): The DSCR measures the property’s ability to generate enough cash flow to cover its debt payments. We look for financing that will allow a DSCR that’s at least 1.2 or higher, which indicates that the property is generating enough income to cover its debt payments.
- Loan-to-value (LTV) ratio: The LTV ratio is the amount of the loan compared to the value of the property. The market typically dictates this value, but the higher the LTV, the more leverage we have and the more profit we can potentially make.
5. The risk mitigation plan
Through our years of investing in multifamily apartments, Miranda and I have learned that unforeseen challenges arise in every deal. This is why we look closely at the underwriting and risk profile of every new investment – we want to ensure that we’ve got plenty of cushion and protection when unexpected things come up.
Although there are many risk-mitigating characteristics to consider, an underwriting “stress test” gives us a good high-level overview of the deal’s reserves. These “stress tests” look at how the returns and profitability would be affected by various negative events and market factors. At a minimum, we like to see what happens to the numbers if: 1) there is zero rent growth over the hold period, 2) if the rent decreases due to an economic downturn, and 3) if occupancy drops into the 60-70% range. If the deal can cover the expenses and loan payment through these significant stresses, we know we’ll unlikely lose money in the deal.
Passive investing in multifamily apartments is a great way to grow wealth without getting another degree or becoming a landlord. It allows investors to experience the reward of real-estate income without giving up more of their time. That said, the passive investor should have a system for analyzing deal opportunities and assuring the deal fits their criteria.
Miranda and I use the above five-point checklist for every deal we invest in. It allows us to analyze each deal more quickly AND gives us confidence when investing our money. And while the checklist doesn’t guarantee that any given deal will be successful, It has helped us pass on many deals that looked great on the surface but had poor fundamentals or didn’t match our investing strategy.