June 1, 2022

For trophy assets, fundamentals matter—not looks

For trophy assets, fundamentals matter—not looks

Beauty is in the eye of the beholder, even when it comes to property investments. And focusing too much on looks could ultimately decrease your returns.

In my 15 plus years in real estate, I’ve seen what works and what doesn’t. The biggest misconception I see my family, friends, and inexperienced investors make is treating the acquisition of a multifamily investment like buying a house.

They think about investing in neighborhoods in which they’d want to live, or would have wanted to live when they were younger. Think Atlanta’s Virginia Highlands or Washington D.C.’s Georgetown neighborhood. These investors want 15-unit buildings where the cool kids live, near the bars, restaurants, and shopping.

As an older broker told me early in my career: you’re not the one living there. You’re now the one investing. So think like an investor.

Don’t fall in love with a neighborhood

There will always be investors out there willing to pay more for assets located in prime neighborhoods. Some want to be able to point out to friends and colleagues that they own that trophy asset. There are also owners/operators that already own three other properties in the area. They gain efficiencies of scale with the landscaping and other services for their existing properties. Whether for the karmic return or lower operating costs, each is willing and able to pay more than you should pay.

You should even avoid “up and coming” neighborhoods that are about to “pop.” The true value was taken out of them years ago by speculators now seeking to pass properties on to second wave investors (i.e., you).

Instead of reducing margins to compete with them, I encourage people to invest in neighborhoods that are attractive to a different audience: underwriters.

Finding deals in the right places

I advise people to target secondary and tertiary markets surrounding big cities. Here in Florida, I suggest Plant City and Lakeland instead of Tampa. Instead of Atlanta, try Birmingham, AL or Macon, GA. Try Greensboro if Charlotte seems too pricey.

The workforce needs apartments in these secondary and tertiary markets and there’s a shortage of new inventory being injected into the market. Inventory is limited and tenants in these markets have to rent. They appreciate having appliances, two bedrooms, and utilities. Tenants in the hotter, hipper markets view apartments with more frills as a choice. Many primary market renters could afford to buy a home, but they like having a doorman.

Investors in secondary and tertiary markets often face less competition, with higher cap rates and the ability to negotiate an off-market deal.

Better still, Fannie Mae and Freddie Mac (often referred to as the “Agencies”) offer some of the most competitive non-recourse financing. They are mandated by their charters to be more competitive in these markets. The agencies are required to dedicate a sizeable portion of their annual lending budget to financing housing that is affordable to renters earning at or below the area median income. They’ll even lend at a significantly lower interest rate on properties meeting that criterion. Secondary and tertiary markets are, by nature, typically more affordable.

Not familiar with Fannie and Freddie? Check out our financing guide.

Check out our insiders' guide to Multifamily Finance

You don’t have to present the agencies with a property tailored to Section 8 or other housing subsidies. Instead, simply having rents that are in line with an area’s median income can get you the best rates and loan terms — and the same is true for properties in primary markets, if you can find the right deal. Learn more about Walker & Dunlop’s small balance lending options

Additional considerations

Beyond location and affordable rents, what else constitutes a quality asset to an underwriter? A well-maintained property.

Ask a seller when the roof and HVAC systems were last replaced. Request the maintenance records. Remember that you’re buying an income stream just as much as you’re buying real estate. Make sure to protect that income from unexpected future costs.

Most lenders will also typically require a property condition assessment (PCA) to identify deferred maintenance issues or future maintenance needs for your prospective investment. Properties that haven’t been maintained as well may require the lender to underwrite higher replacement reserves or even withhold loan proceeds at closing. Bottom line: well-maintained properties achieve better loan terms.

Expenses are another item to pay close attention to.

Property tax, for example, is one expense that can increase dramatically after you purchase the property, sometimes doubling or tripling after a sale. This will differ by state and county, so make sure you know how reassessments are handled for a prospective purchase. Be mindful of insurance as well, especially if the property is located near the coast or a flood plain or has certain types of plumbing or wiring.

Avoid the common pitfalls of judging an asset by looks and location alone and don’t be fooled into thinking you need something that looks brand new. Most underwriters would prefer a stable, well-maintained 1980s vintage asset over a brand-new Class A deal in an overbuilt market all day long. Place more value on the fundamentals of a deal over looks and location. Then you’ll be sure to build a portfolio of high-return-generating assets.

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