Branching out to solve the Biggest Challenge: Small multifamily properties

In an article I wrote at the beginning of the year, I summarized the biggest challenge of 2014 for long term real estate investors in a single word: Supply. Now that the second quarter of the year is almost coming to a close, that prediction has become reality. And as we go into the summer months, supply historically shrinks even further as demand rises. In the meantime, your financial goals are still there, calling for acquisitions to be made to build income streams that lead to financial freedom. On one side of the coin, you don’t want to acquire assets that don’t make sense from an investment standpoint simply for the sake of acquiring them. But on the other, you don’t have the luxury of simply taking a year or two off in an environment where prices and (eventually) interest rates are expected to rise further. So how should you navigate under these circumstances?

Market “gravity”

In life and investing alike, there are issues that are rightfully up for debate and then there’s “gravity” – a law that applies equally across the board regardless of our beliefs about it. In long term real estate investing, a gravity-type law says that you take what the market gives you and build your strategy around it. Many a fortune have been squandered by investors on a mission to disprove that simple law. While in midair, many such investors actually think they have outsmarted the law – on the way to the eventual pavement.

However, one major distinction is that, unlike physics gravity, which is constant and applies to all equally, the real estate investing market is an ever changing landscape. Today’s market “gives” investors a much different set of circumstances than say it’s 2008 counterpart. So while the law always applies, there’s a variable dimension to it and you must be able to adapt your investing strategies to reach your goals. That’s not to say that you switch strategies as the wind blows – the principles must remain the same. But you shift your investing approach while abiding by those principles.

Principles to assets

Investing principles come first and assets follow. I know it sounds like a Captain Obvious proclamation but you would be surprised to know that the majority of long term investors get that important order completely backwards. Without first devising an overarching strategy and distilling from it investing principles to live by, they make an arbitrary decision on the type of real estate assets they will pursue. They buy “cheap single families and rent them out” or “small apartment complexes at $X per door” or “small condos with a max price of $X”. And all the while there’s no rhyme or reason to it. And most crucially, there’s zero consideration of the fact that the market “gravity” may have changed the landscape to extinguish the opportunities in the asset type they’ve arbitrarily chosen.

The alternative approach: Start with the end in mind (goals), devise a plan to achieve them (Blueprint), come up with clear criteria the asset must fulfill (principles) then look at the market and the asset types it offers that are the best suited vehicles to get you across that finish line.

Asset principles of the Blueprint Strategy

Our Blueprint strategy’s approach to determine investing principles for the type of asset to acquire is very simple. Our investors reach their goals when they own the right size portfolio of real estate leased to great tenants. Great tenants lead to low vacancies, low turnover and profit maximization. In our experience, great tenants look for properties located in good school districts in great, safe neighborhoods with easy access to employment centers through highways and great amenities and low hassle. Constant repairs in a property represent a great hassle to a great tenant (and the corresponding investor which has to foot the bill to boot) and they’re a direct result of the age of the property. It’s better to purchase an older property in a great location than a new one in a bad location but it’s so much better to purchase a newer property in a great location.  Real estate investors should be concerned with two types of returns: returns on investment and returns of investment. The way to protect your invested capital and make it grow through appreciation over time is to purchase a property that can be sold for top dollar should the investor decide to exit. No one pays top dollar for average, run of the mill properties so investors should be looking for a property that will have appeal to the eventual buyer to whom they will sell the property eventually. And last but not least, the property has to have a good price to rent ratio as to provide an adequate return on investment.

So, to sum up, long term investors following the Blueprint strategy look for newer, quality properties in top locations with good price/rent ratios to provide an adequate return on investment.

Asset types

Notice how in the above summary, there’s no mention of specific property types. No “single family homes”, “small multi-family”, “condos” etc. That’s an omission of crucial significance because different markets “give” investors different asset types that can accomplish the goal. For example, in North Carolina, new (or new-ish) attached townhomes offer everything the asset principles above call for at a more favorable price/rent ratio than single families. In Texas, single families substantially outperform townhomes. In some cities, there are newer small multi-family opportunities in great locations while in Houston they’re virtually non-existent – they’re either older properties in good locations or newer ones in bad locations.

That’s the reason most of my case study articles that discuss investing in the Houston market involve single family homes. It is not because, that’s the type of asset we favor but because in this particular market, that’s the best asset type the market gives us to help investors accomplish their goals.

Solving the Biggest Challenge

Let’s come full circle to the initial premise of the article: Rising prices and increased competition for single family homes in the Houston market have reduced the supply of opportunities for long term investors. But if your Blueprint still calls for further acquisitions in a climate of reduced options, what are we to do? We need to look for additional options elsewhere – in markets that have most of the same strengths that perhaps “give” investors access to property types that just aren’t available here at this moment. That’s what we’ve been diligently working on since the second half of last year and I’m excited to say that what we’ve found abides by the asset principles above and gives us some additional benefits to boot.

I plan to present a specific case study with hard numbers in a subsequent article but I’d like to end today’s post with a summary of strengths that this new opportunity offers:

1. New construction, luxury small multi-family (duplexes) zoned to great schools 
2. A growing Texas market with a population growth rate 9 times the national average
3. Quality property management company in place providing a true turnkey investment
4. Maximization of asset value per conventional loan 
5. Low property taxes, hazard insurance, HOA dues
6. Attractive price/rent ratio and low days on market/vacancy rate
7. Luxury low maintenance finishes (brick exterior, granite counters, 11-12ft ceilings, oil rubbed bronze fixtures, no carpet anywhere) 
8. Builder warranties (1 year wall to wall, 2 year HVAC/electrical/plumbing, 10 year structural) 

Next time, I will present the hard numbers and show you how you can weave these small multi-family properties in your Blueprint strategy and utilize some of the strengths above to propel you towards your goals. Until then, take good care of yourselves for me.