Buying An Apartment Building For The Rapid Appreciation Ride
One of the great strengths of the strategy of buying Class C apartment buildings with value plays and then executing the turnaround to stabilize the property and capture the upside is that it is market cycle neutral. It doesn’t matter where you are in the real estate market cycle, up, or down, there is always demand for Class C units. In fact, the demand for Class C housing increases in a downturn and Class C values remain unaffected while office, retail, and residential values are tumbling left and right.
But the fact remains, there is a lot of work involved in a Class C property turnaround. There is installing new management, overseeing the rehab, managing the managers during the lease up, and a good eighteen months worth of keeping everyone in your turnaround focused on rehabbing units and getting them leased until you have filled up the property. In the end though, after you have all the work completed and you pull six/seven figures out of the property with your refi, you know it was worth it.
If you have the taste for a strategy with slightly more risk though, you can buy a Class A or Class B apartment building during the upswing in the market cycle, in a Momentum Market like Los Angeles or San Diego.
A momentum market is a high dollar market that has rapid price appreciation in periods of expansion, and then steep falloffs in values after the peak has been reached and the market contracts. The chief feature of a momentum market is the volatility; the highs are ridiculously high, and the lows are painfully low.
For an apartment investor willing to track the market cycle and manage his/her risk, momentum markets can bestow huge fortunes on you without a whole lot of work.
The strategy is very simple. Instead of buying Class C properties, whose great advantage is the consistency of demand, you buy Class A properties, whose great advantage is being new and highly desirable properties, they are great containers of value. When the real estate market starts appreciating, Class A properties increase in value at a higher rate than Class C properties.
You start buying Class A apartment buildings when market appreciation breaks out of the downturn and starts solidifying itself into an upward trend. You buy the biggest apartment apartment buildings that you can manage, and you continue buying until you near the top of the market.
A couple of very different issues face you when you pursue a momentum market growth strategy rather than a turnaround strategy. One is, how do you raise the money? A Class A 100 unit apartment building in Los Angeles is in the $15M. Yes, the properties are pricey, but remember, your acquisition cost is the basis on which appreciation occurs as the market takes off. You raise the money as you normally would; secure bank financing for as much as the property can debt service, and raise private money for the rest. The “rest” will include; down payment, your dealmaker fee, and reserves.
Given that the cash requirements on a deal like this may run into the fives or tens of millions, you will probably be going outside your warm contacts 🙂 to raise private money. You can hire a securities attorney to raise the money in a Limited Partnership Offering, or do a Private Placement. On the other hand, you can prepare your own Pitch Book to showcase the offering and start networking. One thing working in your favor in a high priced market; there are lots of people who can write a check for $5M.
Once you have your funding under control, the second issue to address is, how do pick the top of the market? This is the big question, and given the recent financial crisis that gave us a front row seat to watch Wall Street drive itself over the financial cliff, and that so many real estate developers still get caught with half finished projects on that fateful day at the top of the market when people stop buying, you could be forgiven for thinking that knowing when a market has peaked is highly elusive information only harnessed by unusually prescient and gifted market callers.
The fact is, it’s not. The fact is, this freely available information has been packaged up and provided for you in a service custom made for real estate investors, called Housing Alerts. You can check Housing Alerts out for yourself, but what it does in a nutshell is allow you to track real estate market appreciation, and provides buying and selling signals at the different ends of the market cycle, for all MSAs (Metropolitan Statistical Areas) across the country. So you can identify exactly when to start buying, and when to sell everything, in every momentum market across the United States. It is an absolute “must have” tool for real estate investors.
So what would our 100 unit deal above look like if we succeeded with our momentum market growth strategy. Well looking at the Housing Alerts chart for Los Angeles you can see if we bought in the recession of 2000, and then held onto the property until mid 2006, when the market was still red hot, but declining, we would have had six years of pretty robust growth. Buying in 2000 at $15M, your appreciation would have been …
2000 Buy $15M
2001 5% $15,750,000
2002 8% $17,010,000
2003 13% $19,221,300
2004 15% $22,104,495
2005 24% $27,409,574
2006 20% $32,891,489
OK, if you look closely at the graph you will see these are the appreciation rates for those years, and the values are simply those rates of appreciation applied each year starting from the acquisition cost basis of $15M in 2000. The numbers don’t lie. This is how the momentum market growth strategy plays out.
If you remember Los Angeles in 2006, the market was still red hot and and a Class A apartment building would have gone under contract within 30 days. The buying frenzy continued into mid 2007, when the music finally stopped. If we put the property on the market in the third quarter of 2006 and closed before year end with a sale price of $32,000,000, our gain would have been $17M. Let’s say we keep half of that after paying off our investors. That’s $8.5M (before taxes).
Not bad for rounding up some capital, paying full price, and then managing the property managers for 6 years.
Using the Momentum Market Growth Strategy with Class A apartment buildings is how REITs and larger apartment players usually play the game. Even then, with all their expertise, many still get caught holding on too long. This strategy requires a keen knowledge of markets, and the discipline to get out when your data tells you to. If you like data and you can master your emotions, your fortune is waiting.
“Must Have” Momentum Market Growth Strategy Tool: Housing Alerts