Preface: Yes, I’m a professional real estate investor and if you read the whole thing I’ll tell you how to make millions (even billion) in real estate. Sound crazy? Keep reading.
Disclosure: I have not read the whole NYT story nor do I plan to. There is no need because there’s nothing there worth even discussing. Let me explain by taking the prime example that lefies are pointing to on twitter and demanding Trump go to jail over.
Donald Trump and his sibling claimed 25 apartment complexes with 6,988 apartments were worth only $41 million. Less than a decade later, in 2004, banks valued them at $900 million.
Sounds like an open and shut case of fraud right? If so, I can tell you don’t understand real estate. What if I told you he could have lost money on that deal?
Two points before we get started. I have no idea the details of this example, but neither does the NYTimes. That’s the whole point. Second, I could spend a full semester explaining all the possibilities on this deal but we live in a 140 character world, so let me start with the easiest example. (And I’m rounding the # of apartments to 7000)
Trump was well known for taking C and D class properties and making them A++ properties. Would it be crazy to believe Trump spent -including the common areas- $150,000 per apartment on rehab? If that seems plausible that means he sunk over a BILLION dollars into a property worth $900 million.
Wait wut? He might have lost money? WTH NYTimes?
Again, I have no idea how much he spent on improvements (btw this is called CAPEX) but my point is that eye-popping paragraph is meaningless without the rest of the details. He could have sold it at $900 million and easily lost money. (And if he did the same lefties on twitter would point to it as an example of his incompetence.)
By only showing you one side of the deal the NYTimes lies to its readers. I know you’re shocked.
While my simplified example above is quite plausible, below the fold I’ll give you some more likely examples of how those numbers worked and -yes- teach you how to make millions (or billions) in real estate at the same time.
(end political post, start explanation of the real Estate Biz)
Lesson One: Appraising investment property.
Unlike your single family home, if you have 7000 apartments the investment is not appraised by the value of the physical buildings, it’s appraised by how much rent they produce. The first rule of rental property is that you’re not buying buildings you’re buying a business. (Or more accurately 7000 little businesses in this case)
In real estate there’s something called a cap rate. In few words, it’s how much money the building makes each month vs the value of the property. The cap rate dictates the price. (think interest rates and bonds) A great cap rate today is 10%. A 10 cap (as we call them) is hard to find but not impossible and the math is simple so I’ll use it a lot during my examples.
BTW if you doubt that’s how we appraise property, look at an investment property website, cap rate is often disclosed right on the listing and always disclosed at some point in negotiations by reputable people.
So let’s use our new knowledge to look at this deal again:
Assume it was a run down property with a 85% occupancy rate and 10% of the renters were behind in the rent. (Pro tip: Often people just quit paying rent and often they never get evicted. Sounds weird but I promise we find it all the time. ) Also let’s assume the owners are 5% below market value in their rents and assume water is part of the rent.
THE ABOVE EXAMPLE IS INVESTOR GOLD. That’s the exact deal you’re looking for. [and Trump’s deal was likely much better than this]
Lesson Two: Cap Rates are magic. (And I’m admittedly simplifying a few things but not much)
Here’s the magic of a 10 cap. FOR EVERY DOLLAR YOU INCREASE MONTHLY INCOME YOUR EQUITY GOES UP TEN DOLLARS.
Ever wonder why the new landlord always raises the rent? It’s not just for the extra income. Here’s the real reason:
With 7000 apartments, if you increase rent $50 a month that’s 350K per month or $3.5 million in equity with the stroke of a pen. (On a $41 million property that’s not a bad start. Now let’s get the paying occupancy to 95%. Thumb nailing: 350 units x $2000/month (very modest for NY) and that’s $700,000 per month extra income. X a 10 cap is an extra $7 million in equity. — So you bought it for $41 million and now it’s worth over $50 million and all you did in raise rents and get the occupancy rate up.
So now let’s tackle the water problem. You start changing people flat rate $100 per month for water.
$100 x 7000 units is $700,000 per month X a 10 cap and that’s another $7 million in your pocket. EVEN IF if you’re still losing money on the water, you’re still much better off than before the flat rate bill.
LESSON THREE Rental property is a business. Manage it like a business.
So now you’ve taking a $41 million investment and just by fixing management issues (not the building) you’ve increased the value to almost $60 million. Not too shabby for a few months work.
Now I hear some of you at home calling B.S. You can’t go in and just bump the rent and not have people leave. And you’re exactly correct. And that’s where the Trump’s of the world make their real money.
You see, that dump property was probably sold at a fire sale price. It was underperforming and high risk.
An investor will come in, and buy a C-D class property of 7000 doors for -say- $50,000 a door. (Or less) He’ll dump a ton of CAPEX into it and make it an A class property. (Or B class if that’s all the area will support) AND fix the management problems. Yes, most of his people will not pay the rent for an A class property. Some will, but there will be a lot of turnover. The investor is repositioning the product in the market.
And instead of netting $100 a door he’s netting $1000 a door. (Cough x 7000 doors x 10 cap)
And remember, every dollar extra you make per month puts TEN in your pocket for equity.
Lesson Four: Occupancy rate is THE BIGGEST FACTOR in appraising rental property.
Of all the factors I listed above, occupancy rate is THE BIGGEST FACTOR. Consider 7000 doors. A certain number will be off-line for repairs. In this example it was 25 buildings . Probably several whole buildings were closed. If you’re buying off the income the properties produce (and you are) in effect the non producing doors are free. It’s NOT uncommon for the occupancy rate on a large deal to be below 50%. Getting those units on line is free money.
Lesson 5 in Real Estate everything is a multiplier.
Really we’ve covered this already. When you’re dealing with 7000 doors x rent x cap rate, things add up fast.
Lesson 6 You can have multiple Business plans for the same building. And they might all be valid. But some will be more valid than others..
To keep math simple, let’s say you borrow the whole $41 million. You start with zero dollars of your own money. You could buy the 7000 units bump the rent to market and get the occupant rate up and sell it for an easy $5-8 million more in a year. Nice. But that’s the small game. You also pay tax on $5-8 million.
Borrow $100MM buy it for 40, dump 60 into Capex. Fix the management problems, reposition in the market, and sell it for $200MM. $100 Million for a year or two of your life… Not bad but that’s the mid game. And Oy that tax bill.
Borrow $200MM buy it for 40, dump 160 into Capex. Get it reappraised for $500MM, borrow $400MM against it, pay off original loans and you have $200MM in profit in your pocket. (Tax deferred) AND YOU STILL OWN THE BUILDING and are making rent from it.
Now take the $200 million in your pocket and buy……
NOTE: Throwing CAPEX at a property has diminishing returns. Let’s say you have a unit that is not rentable only because the toilet is broken. $500 in Capex gets you a whole new door on line producing money. (Say $2000 a month or $20,000 in equity) That return on investment is amazing. The more Capex the lower the percent return in general terms, but there’s a big plateau where you can increase rents because you’re raising the class of the property. Trump’s instinct was “Mr. CAPEX”. He did not look at just the return on those dollars he looked at his brand image. And let’s review he’s POTUS so he was right. — Point being at some point he’d make LESS money on this deal by over CAPEXing it.
OK so I hear a few of you screaming at me. I’m not teaching you how to make millions I’m teaching you how the Trump’s of the world make billions. That’s only half right.
And I should stop and say, yes, the above is how large scale investment real estate is done. That is how the big guys make billions. You may flip a house, they flip 7000 at at time. (And they don’t even flip, they refinance and take the money out but keep the income from the rent and avoid the tax hit.)
But everything I taught you above applies to that 4 plex or that 20 plex less then 10 miles from your house.
If you find a 20 plex owned by a mom and pop chances are good that only 12 or so units are making money. And they’re below market at that. Chances are 1 or 2 units need a repair Pops has been meaning to get to, 1 or 2 are unoccupied and there are a few deadbeats Pops didn’t have the heart to evict. (Or at least on the buildings we’re buying this is the case) Oh and Pops thinks it still 1995 and hasn’t raised the rents in years. — You’ll be surprised to know when this happens, none of the tenants inform Pops, he’s below market in rent.
Buy it and get that BUSINESS functioning properly and you can make a half million+ on the deal easily. (PRO TIP: you can often get owner financing for these units. The owners want the monthly income but not the business) And you’ll be surprised often the tenets are THRILLED to pay a few bucks more to live in a nicer place without the hassle of moving.
It does not take near the money and credit your think.
Here’s the 6 words that will make you millions in real estate. YOU. MAKE. MONEY. ON. THE. BUY. You collect your money on the sell or the refinance. But you made the money the day you bought it. NEVER NEVER NEVER believe otherwise.
I once bought a piece of property for $64,000 and it appraised for $197K a week later. (And the neighbor which was an equivalent property sold for $200K just 7 months later) I FULLY ADMIT that’s a once in lifetime deal, but it happened. Look long enough and you’ll find that one you’ll be telling stories about for years.
The key to the whole thing is buying right. But where are these magic deal? Yes, you gotta hunt. But ask yourself this question. If you took a full year in your spare time to find a deal that made you $500,000+ is it worth your time?
Very few people can say no to that.
If you’re young enough and bold enough the above will make you a billion dollars. You’ll need to learn a bunch more, but the framework above will always be the same. Buy a mismanaged business, get it right and sell or refi. Lather rinse repeat.
Just don’t learn about real estate from the New York Times, those guys are clueless.