Top 10 Lessons Learned from our First Full-Cycle Deal

After a lot of education and with the help of great mentors and partners, we were able to close on our first multifamily deal, which was a 125-unit class C property just outside of Houston. This deal had its share of challenges including dealing with Hurricane Harvey a week before closing, which delayed closing by 60+ days and then having multiple management company changes post-closing. However, we were able to manage through these issues, execute our plan and successfully exit in less than 2 years and generate strong returns to our investors.

The following are 10 key lessons-learned (in no particular order) from this full-cycle deal experience:

1) Be Patient

This was an off-market deal that we originally lost to another group. We were given the option to improve our offer, but we had already pulled all the levers we had so we stood firm. After the initial buyer could not perform, we were given the chance to buy the deal at our last offer and terms. Having the discipline to stick to your investment criteria pays off in the long-term. No deal is better than a bad deal. 

2) Buying Right Lowers Downside Risk

Many investors only look at the potential upside on deals. While upside is important, it’s even more important to understand the downside risks and how you can mitigate them. This was our first deal taking on investors who invested $2M in equity. We ensured that we bought right by buying at well below market value (bought at a 8%+ cap rate in a 6.5% market) while having strong upside as the property had 100% non-renovated units and was not professionally managed.  

3) Hire Slow, Fire Fast

Initially, we engaged a small local prop management (PM) firm, but in less than 6 weeks we realized they were not the best fit to execute our plan. We quickly made the right decision to replace them with a national firm. The national firm was better initially but after a few months of high turnover, we had to make the difficult decision to change companies again. Having 3 PMs in less than 8 months takes a toll on the property, but we learned that if the PMs can’t correct course quickly, it’s often a downhill battle that results in more damage. 

4) Build a Deep Bench

The process of identifying, interviewing and selecting vendors is time consuming. When we made our final management change, it took us longer to decide on a company as we were slightly trigger shy but more so due to the fact that we didn’t have as many relationships developed with potential management companies and had a longer vetting process. We finally picked a great management that executed tremendously and delivered on our business plan but we learned the importance of having a very deep bench of resources.

5) Always Over-Capitalize Upfront

We had our due diligence completed by professional contractors and used their guidance to build up our capex budget. However, the property was nearly 40 years old and things will happen that you did not plan for. We had a small contingency bucket but having more would have given us a lot more breathing room. Even though net returns to investors will decrease, it’s always better to over-capitalize, especially on older value-add properties. 

6) Set Clear Roles and Responsibilities

Internally, my partner and I have clearly laid out roles and responsibilities. However, real-estate is a team sport and we had many external partners, vendors, etc. During the acquisition phase things move really fast as there are multiple moving pieces to get to the closing table. Post-closing, we encountered some inefficiencies with some external partners. This could have easily been solved if we had clearly discussed roles and responsibilities upfront. Since then, we have always clearly laid out expectations in written form with all of our partners from the onset of the deal.  

7) Secondary Markets Have Higher Execution Risk

As competition increased, it was harder to find deals in primary markets so investors began looking at secondary/tertiary markets for more yield and less competition. On paper, these markets are attractive because you get higher cap rates on purchase. This is partly due to the fact that there is more risk in these markets and less buyers (liquidity). Further, the talent pool is smaller, it’s harder to find good quality site employees / PMs and contractors are generally hard to find/keep. These elements increase the execution risk in secondary markets that needs to be evaluated and mitigated by the sponsors.

8) Aligning Debt with Business Plan is Critical

Leverage is a key component of this business. There are many different sources of debt available. We originally planned to execute a long-term agency loan but had to switch lenders due to Hurricane Harvey. We executed with a bridge loan and in the end this was a great decision as we had NO prepayment penalty on exit, which gave us flexibility to sell the deal. If we had the permanent loan, we would have hundreds of thousands of dollars in penalties that would have eaten up our returns. It’s extremely important to align your debt with your business strategy.

9) Significant Lead Time Required to Exit

One of the drawbacks of real estate is the lack of immediate liquidity. Similar to the significant amount of work that goes into acquiring a property, it takes strong planning to execute the exit. Once we had the right property management company in place, we meticulously planned monthly targets that would help get the property ready for a sale or refinance within 12 months. Sponsors should have regular planning meetings on short and long term goals to position the deal for capital events.

10) Investor Communication is Paramount

Given my experience in consulting/program management, I was very keen on transparent and consistent investor communication. As a passive investor myself, I have been in deals where sponsors have kept me in the dark and I assumed the worst. Passive investors are generally understanding, but the key is to get out in front of bad news and let them know what has occurred and how you intend to address it. When we were transitioning to our 3rd PM company we sent out short weekly updates to investors for 6 weeks to show the great progress we were making and investors really appreciated it. It’s always better to over communicate than under communicate. 

Summary:

Though these lessons were from a multifamily project, many of them can be be applied in all facets of real estate, business and life. At Catalyst, we are firm believers of continuous improvement and hold regular debrief sessions to take stock and see what we can do better. I would encourage you to do that same in all aspects of life. I will take a deeper dive into some of these lessons learned in future articles. 

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Shane Thomas is co-founder of Catalyst Equity Partners, a Texas-based private equity firm focused on helping busy professionals earn double digit returns through investing in apartments. To learn more, visit www.catequity.com and connect with Shane on LinkedIn and Facebook.