Creating the Perfect Deal

Last week we closed on a 2-property 34-unit multifamily deal in Little Rock, Arkansas. After closing 50 units in Idaho last February, I faced some friendly criticisms and hurdles about why I was going smaller instead of bigger, and how everyone had an opinion, whether investing in the deal or passing on it.

How could the same deal be simultaneously awesome enough for people to want to invest their retirements savings while others we so uninterested they even tried to talk me out of buying it at all? While for some of them it was bad timing either personally or professionally, for others they didn’t like the size (too big, too small, too medium, too any size), the market (where’s Little Rock again? And why is there so much crime there?), or maybe they just hated us as humans? Because 9 out of 10 not only won’t invest in any given deal, they’ll also tell YOU not to buy it!

Every deal is more like a scatter plot of strengths and weaknesses. The nice thing about owning your own business is that YOU get to decide what your best fit is! If you’re smart, you’ll seek advice from those more experienced than you, and if you’re smarter you’ll know when to ignore that advice. Recklessly risky or bad deals aside (don’t ever do those), you do get to form your own opinion in your own business. Imagine that!

Let’s dive into why we are excited about this awesome opportunity in Little Rock, warts and all.

-18 units tucked away from crime in a beautifully forested area

LITTLE ROCK MARKET

PROS: Some areas of Arkansas are on fire with high population growth, but Little Rock itself is the only Arkansas market with a large population at 200,000 residents to have a diverse job base between government, military, health care, higher education, and distribution. Population growth is strong enough to justify the buy, but low enough to push this into a cash-flow buy-and-hold category, which for many investors is more attractive than a quick flip. Plus, I’m not even sure tenant law is a thing in Arkansas: it’s pretty landlord friendly! Biggest takeaway here: match the deal to the goals of the money partners.

CONS: Crime is the biggest issue in the Little Rock market as a whole, so it’s important to find low-crime pockets. When people questioned why I would invest in such a high-crime city, it was a valid question, so I had to dig deeper and zoom in on the crime maps. On one property, it’s on some quiet side streets with low crime, and another property that is in a nicer area, the crime centers over our buildings themselves. When our own building is the source, that is crime we can control! And the neighbors will thank us, hopefully with cookies at the Holidays.

DEAL SIZE

PROS: 34 units is large enough to get experience at scale for partners looking to either transition out of or skip single family/small-multi investing and go into commercial deals.

CONS: 34 units is just small enough to make economies of scale not apply (typically on multi-family 60-85 units is needed for full-time property management on site), and for this reason it's also more difficult to raise investor capital.

JV OPPORTUNITY

PROS: unlike syndications, joint ventures can be both publicly advertised and accept non-accredited investors. According to SEC regulations, syndications hamstring deal sponsors in one of several ways: they must either be private with only investors we already know, like, and trust; or if publicly advertised they are limited to accredited investors only (with requirements such as a net worth above $1 million or individual income above $200,000). That’s because in a JV, everyone has a job: no limited partners means no SEC involvement! Social proof sharing deals and progress is a huge part of raising capital, so deals that can be legally shared publicly are important in raising capital for public and private deals alike.

When people questioned why I would buy so few units (only 34 instead of taking advantage of economies of scale in the 60-150 unit range), it’s because at that larger size we typically need to syndicate in order to bring in enough partners to cover the down payment and reserves needed to close. Not many of us know ultra-high net worth individuals to do large deals with just a few people, but most of us know lots of people with a few hundred thousand dollars in cash or retirement accounts. Multiply this across 2-3 partners, and everyone can be involved with hands-on management experience on a mid-size deal they can both afford and use as a step to scale up. Again, match the deal to the investor's goals.

JV deals typically have lower legal costs than syndications ($12-20k range), but only a little higher than solo ownership. Plan on roughly $5,000 to set up the structures and have the documents reviewed by each partner’s own attorneys.

CONS: Joint ventures that get too many partners where everyone needs a job start to smell like syndications, meaning some partners are limited partners, especially on a deal of only 34 units. These smaller multi-family deals can’t usually feed a large group of investors, nor can they carry the high setup cost of a syndication. To keep the partnership small, each investor needs to bring in a substantial amount of capital, and if 1-2 partners in the deal are contributing no or low capital (because they have the deal under contract or have experience managing, etc), then the remaining partners need to come up with even more to cover the managing partners' low capital contributions. Proper business accounting and calculating distributions also have fees that need to be added into the operating costs.

CORONAVIRUS

I hate having to add this part because that word will kill the SEO for this article. However, while I found this deal before the pandemic ushered in the apocalypse, it ended up being a great fit to prepare for the end of the world as we know it. It has little to no rehab needed to reach our pro forma rents (raising rents is a great way to wash away the riffraff in a property, and most residents recognize if they’re way under market and won’t find a better deal elsewhere, so prefer not to move. Even if they own no furniture). Once the crisis ends, the comps on nearby renovated units show we can do a fair amount of rehab to push rents (and property value) even more. So it can weather the storm for a year or few and save dessert for last.

Class C real estate has been a “scary” asset class during the pandemic with massive job loss worldwide. However, think about where “essential workers” like checkers, clerks, medical techs, mechanics, warehouse pickers, and tradespeople live: Class C real estate. We have seen some job loss in this tenant base, but what we’ve seen more of are bemasked front-line workers still going to their jobs every day.

If cash flow can keep the asset alive during hard times, it’s time to buy and hold to realize values when things come back to amazing, so never let a good recession go to waste!

SKIP TO THE POINT

If you're smart, you just skipped to this point for the short version. Recognizing that every deal has some aspect of wearing its wash-day underwear, we are not buyers but CREATORS. Always look for reasons to kill a deal, it’ll save you from making bad investments. But ultimately, as problem solvers, if after diligent research a deal has problems that your team’s unique abilities can solve, just wash the underwear and don’t wait until the clouds part revealing angels nodding permission from on high to buy the perfect deal. Get creative and do the best deal for YOU!