Prior to this present "down market" in real estate, it was relatively easy to obtain financing for both residential and commercial properties from banks and other conventional lenders. In the commercial arena, there was plenty of talk and hype about "condo conversions", "fractionals", and "preconstruction investing". There wasn't so much emphasis placed on the life blood of commercial real estate projects, i.e., cash flow. People would buy properties with bridge financing (also known as hard money), construction financing, or other expensive, short-term loans with the motto: "Get in, get out, and get paid". They were considered to be "financial geniuses" and many weren't shy about letting us know how smart they were. I have personal experience with one such "genius" in Augusta, Georgia who almost conned me out of $160,000 in his own failed condo conversion of a war-zone apartment complex called Wesley Arms. He recently lost the project to foreclosure while taking down other investors with him whom he calls his "friends". I can't fault the developer wannabe of this failed fiasco completely since he just fell victim to loose lending policies by banks as well as his own over-inflated ego. It happens to the most experienced investors, even Donald Trump who recently had a couple of failed condo projects of his own, Trump Baja in Baja, Mexico and Trump Tower Tampa in Tampa, Florida. For the record, I've always considered "preconstruction investing" to be gambling, not investing, and something only the foolish would do. By the way, just so you don't think I'm trying to be "holier than thou", I am one of the foolish as I also lost money investing in a local preconstruction project, albeit on a much smaller scale than those who poured money into Wesley Arms and the two aforementioned Trump projects. Previously, I knew, in theory, not to speculate in preconstruction deals and now, after getting stung by ignoring what I already knew not to do, I know for sure never to do it again. Fortunately, in my case, I was the only one who was financially hurt. I wouldn't want to have hanging over my head the thought that I hurt others who put their trust in me.
In times of easy credit, it's easy to forget solid investment fundamentals based on value investing and cash flow. People start to speculate almost completely on appreciation. In more difficult times like now, cash flow is what will save your investment. But cash flow is boring while speculating is exciting and the real mavericks of real estate speculate to become wealthy like the wildcatters who took big risks drilling for oil outside of the known oil fields, right? Wrong. All the so-called "mavericks" who became wealthy in real estate, and have remained so throughout the years, such as Sam Zell, William Sanders, and Michael Mazzei, built their wealth on a solid foundation of value investing and strong cash flow. There are two books I really enjoyed reading that describe how these long-lasting real estate moguls put together their deals and about their philosophies on private equity investing, Maverick Real Estate Financing and Maverick Real Estate Investing, both by Steve Bergsman.
These days, the "quick-sell after appreciation" strategy that worked when banks gave loans easily doesn't work nearly as well now and is often a recipe for disaster, as seen by the increasing number of commercial properties (and residential, as well) going to foreclosure. In times like this, strong cash flow is key to sustaining real estate investments. In the case of income properties, apartment complexes are the easiest to finance now, although even these relatively recession-resistant investments have taken a hit as well. Our primary targets for commercial acquisitions are apartment complexes now. We already own a 184-unit complex, The Park at Summerhill in Texarkana, Texas, and are looking to expand our holdings.
People are usually more concerned with getting their investments back rather than what their returns on investment are going to be. There are two ROI's we have to address: Return ON Investment and Return OF Investment. Accordingly, we set our investment criteria to optimize both ROI's.
As of the date of this blog post, we look for the following Returns ON Investment for our investors:
Minimum Cash-On-Cash Return for the first year: 8%
Minimum Annualized Return On Investment (total return divided by the number of years invested): 20%
But to minimize risk, we look for the following parameters to address the Return OF Investment (these also meet or exceed lending criteria):
Minimum Debt Coverage Ratio: 1.25
Minimum Capitalization Rate: 7.5%
Maximum Break-Even Ratio: 80%
By following the above criteria, we find that it is still possible to make double-digit returns with greatly reduced risk. Right now, we're finding that the one of the best ways to meet our investment criteria is by purchasing apartment complexes from those who didn't heed the fundamentals of value investing and cash flow. At least for a few more years, our main value play will be to purchase properties from financially-distressed owners. This is how the enduring "mavericks" often became wealthy and remain so today. Don't listen to the doom-and-gloom media. Now is perhaps the best time to buy commercial real estate as long as you always remember to build your portfolio on a solid foundation and not on a house of cards.
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ReplyDeleteWith the crisis that we've all been very difficult for banks to give credit to housing but now that this crisis is happening because banks have helped many people so they can realize their dream of homeownership. also has everything to do with the bank of your choice!