I Bought a Property on the Brink of Failure… Here's What Happened

Here's how I bought a failed property and turned it around. So in our company, this is one of the signature properties that we bought from a bank, from a lender. So this one was owned by Bank of America. It was 50% vacant and we felt like there were somewhere between five and $7 million of deferred maintenance and capital expenses. That's a lot. So not only do we have to go in and repair all the 50% vacant units because they're vacant and you got to get a rent ready for the next person, but there's a lot of interior and exterior. And what we found when we walked this property is that there had been fires, there had been floods, there had been break-ins, there was some homelessness, there was a lot of deferred maintenance. And at the end of each one of these projects, when you're heading toward foreclosure, what you're doing is you're robbing or you're cannibalizing other units just to take care of your tenants. So for example, if there's a tenant living at the property and they need a refrigerator and you can't afford a refrigerator because there's no cash flow, you actually go get one from another unit and give it to them. That's called cannibalization. So there's massive negative cash flow, which we're going to go on to in a minute, which is why it's not financeable. There's no bank on the planet that would finance this because it's 50% vacant and negative cash flow. That's just income minus expenses. In addition to that, as always, when you find problems like this, there were an additional 100 problem tenants. And what's a problem tenant? A problem tenant is simply one thing. They don't pay, or they don't want to pay, or they're delinquent all the time, or whatever it is. They just don't follow their rental agreement. The other thing is, it's important to understand that there's about 23.3% of a defaulted loan sitting on the bank's books. So this is your traditional property that's sitting on the bank's REO, or real estate owned department. And it's in really, really bad shape because banks do not spend money on assets that are toxic like this. They look for third parties to go and turn these around and take these off of their balance sheets. So this property did get listed by a big broker, but of course it had all of these problems and a lot of people didn't touch it. So why would I buy a property like this? A couple of reasons. The first thing is, it's a 95% occupied sub market. So whenever you're looking to buy a property that's in really rough shape, you want to first take a look at the existing market. Because the last thing you want to buy is a property where all of them are 50% vacant, let's say. So this is a 95% occupied sub market, which really made us take a look at this deeper, because all we had to do was fix it. The second thing is, it's lender financed. In other words, there's no lender on the planet that would finance a 50% vacant property. So the only lender that could actually make the loan was the actual bank themselves that owned this property. And it was in their real estate owned department or REO. That was very good because they were super motivated to make a really good loan in order to move this off of their balance sheet. The other one was location. This property is located right by the USAA insurance company, which of course, a lot of you might know, is a large insurance company that mostly services the US military. And of course, this sub market was also experiencing rent growth. Not a lot of rent growth, but definitely rent growth. In other words, it didn't have concessions. It wasn't a temperamental market with a lot of supply and lots of concessions by landlords. So the market was fairly stable. The asset was not, and that's why we decided to move forward. So now let's take a look at the math and the timeline. So after 60 days of due diligence and walking 680 units, we determined that we needed at least $6 million of capital expenses or deferred maintenance, both for the interior and the exterior. Now, obviously I have very detailed budgets for every single unit. So as we're walking 680 units, I'm making a mental note. Is it 500? Is it a thousand? Is it 10,000? And there was a large range of the amount of expense for each individual unit. Some had carpets, some didn't even have toilets, some didn't have any appliances, some didn't have light fixtures, some had fire damage, some had water damage. So you basically got an inventory of the condition of over 680 units. Let's don't forget, you are not only fixing the over 400 units that were vacant and sitting there ready to turn, but you're also taking care of the existing residents. And there could be deferred maintenance in those units as well, because the owner clearly and the management company clearly didn't have any money to help those people as well. So the people that were living at this property were severely neglected because the ownership didn't have any cash. The next thing is that the bank had a $25.3 million loan, which we were able to negotiate down to $20.9 million. And I'll talk you through why we got to that point later. So we broke the property up into three different cycles, year one, year two, year three. So in year one, what you're trying to do is just stop the negative cash flow. And I'll show you the math in a minute. But there wasn't enough income just to cover the operating expenses. So don't forget, this didn't even have debt on it. So the operating expenses were more than the income. So this was negative and the bank was funding the negative. So it was a really, really bad shape. So the very first thing is just to stop the bleeding. So in year two, your goal is to get all the units rent ready and done. In other words, you want the property fixed by the first 24 months. And obviously this was an extreme property with over 400 units to turn. But that was the goal to be able to turn over 400 units in a 24 month period. Then of course, you're in a lease up because if you have 400 vacant, it's just like having a 400 unit vacant property that you got to lease up, except there's 680 units and you have turnover in the other 280 units. So we had 400 units to fix and turn and rent. And we also had to manage the other 280 people that were living there that had leases in the other existing apartment. So by year three, there's a whole other strategy on stabilization and preparing for the refinance. Because remember, the goal of all of this is to write down the loan, spend the money to fix it, and then do a cash out refinance, which of course is tax free. That was the entire goal. And what's really important to understand is before I bought this property, both Ross and I knew what our target was on the value. We knew what our target was on the refinance. And the entire goal is to actually pay off this first loan and all the equity that we raised in order to fix this property. So we had an idea of what the cash out refi was going to be before we even bought the property. It's really important to understand that we understood this plan before we purchased the property. So we weren't just buying this hoping to fix it. This problem was actually the opportunity. The property was worth just under 30 million dollars, but we knew stabilized it would be worth over 40 million. So it's important to understand that before you're doing this, that you know exactly what the value of the property is going to be after you repair all these problems. Right now we have lots of deals like this coming in. We have a acquisition department out here trying to find broken stuff. So if you guys are an accredited investor, just click on the link below if you want to see everything that we have going. Here's some of the math. The loan was at 20.9 million dollars and we felt like we needed about seven and a half million dollars, which put the basis of the property at 28.4 million. In other words, with the loan and the equity, that would be all the money that we have into it. We're not raising more money from the LPs. We don't need any more money and we've accounted for any and all negative cash flow. And the reason the equity is a little bit lower is because we're able to break even sooner and we didn't need an extra half a million dollars of that interest reserve that I showed earlier on the slide. So here is the math when we took it over. The property, the gross potential rent was about $420,000 a month because remember it's 680 units. Now of course that's just in the like slow $600 rent range, which is also good because that's a very low rent number and we also knew that we could grow that rent over time, which we have done and we still own this property today. The second thing is is that the vacancy was running at about $271,000 a month. Now that's vacancy, that's concessions, and that's of course bad debt or people that are skipping, which only netted about $149,000 a month. Now the operating expenses, now these are utilities, this is insurance, this is property tax, this is labor, all that stuff that it costs to run a project was running at about $172,000 a month, which put the property at about a $23,000 cash flow a month. So as is, if you didn't touch this, the Bank of America is funding this about $250,000 a year just to pay operating expenses at its current operations and so they were happy for us to take this over because they transfer this to the new buyer, which is us, and of course we assume their position. What's most interesting is that this is with no debt. So traditionally when we're talking about deals, we're talking about cash flow, we're typically looking at a mortgage payment, but there's no mortgage payment on here. So this is exactly why this property was not financeable. So the strategy to cash flow was to break this property up into three different buckets. So bucket one was walking all 680 units and specifically the 400 that were vacant and determining how many of those were three-day turns. So a three-day turns means you can walk into the property, pretty much paint it, clean it, and do light maintenance and get it ready to rent within three days. This is a policy within our company and this is industry standard so a three-day turn is very common. In fact, today my entire company is a three-day turn and so we had a little over 100 units that were three-day turns. So I would call this low-hanging fruit because by doing a three-day turn, I was able to generate about $60,000 a month just by knocking out these 100 units and we were able to do this in a little bit less than six months. So in six months, I was able to spend the money and turn these 100 units in three days or less and generate another $60,000 a month. This strategy, number one, immediately stopped the negative cash flow just by getting that extra $60,000 a month. Now we went to what I call bucket number two. These are one to two-week turns and what do those look like? So these might need carpets, they might need appliances, but there's not a lot of real damage other than just some heavy lifting. But bucket number two was by far where most of the work happened and this took about 14 to 15 months. So by the end of year one and year two, we had gotten most of these units done and that also contributed to about $150,000 a month. So those two, just those two, is about $210,000 a month. So like $2.5 million in additional revenue is now dropping to the bottom line of this project. Now, of course, we're getting ready to be in a position to be able to look at refinance our debt, but we still had these big ones and these big ones we left to the end and these required major work. So these might have been fire damage or water damage, we might have mold restoration, all the stuff that can happen in really, really bad units. And I know you guys have probably seen pictures all over the internet, you can just imagine how bad these were. These had broken windows and they had smelly carpets, they had mold and they had fire and all that stuff. So these were really, really in bad shape. These were expensive, but they were the last things that we did. And of course, we had budgeted for them as part of that $7.5 million that we raised in the very beginning. So these were done at the tail end of the second year, the beginning of the third year. So once all of these units were back online, then we were able to increase the cash flow $240,000 a month, guys, that's a lot of money. And so now we're in the money, but what you do, it's a fine line between turning units and renting them and trying to get cash flow. So the cool thing is, is we had two to three years to be able to rent units, for example, and then slowly raise them to market. So there's a fine balance between driving vacancy on the units that you have, they're providing cash flow and getting new units into the inventory to rent. And so once we got the whole property stabilized, which is at the end of the second year, in the beginning of the third year, then we could start to gradually increase rental rates to the market. You can never rent these units above the market. So this was the complete turnaround. Let me show you the results. So in year one, you know, our basis was $28.4 million. By the end of year three, we had completely stabilized, which means that the property was sitting at about 95% occupancy. But the cool thing was I still had an ace up my sleeve. I knew that even at stabilization, I still had a lot of room to grow the rents. So this is what I would call our first cash out refi. So we went to the bank, the property stabilized, and with the net operating income that we had at the time, they gave us an appraisal at $41 million. And with that, they gave us a loan for about $32 million. So this is your traditional cash out refi. The other thing to understand here is I still have about $9 million of equity. So I'm not taking all the equity out, but we're taking the $32 million loan. And what's that $32 million loan doing? It's paying off the $20.9 million loan that we got from the write down from Bank of America. It's paying off the 7.5% equity that we raised from all the investors. And at this point, we are infinite. So in other words, the investors have no investment in this deal at all. And of course, there's another $3.6 million to distribute. So what I did is I distributed about $2 million. So I actually gave the $7.5 million back, which is just a return of capital. But now the investors have no investment in the project. And I gave them about another $2 million, but I kept about $1.6 million. And why would I do that? Because now the plan is, of course, to do some additional improvements and raise the NOI again, which is exactly what I did with the remaining $1.6 million. We spent another year to year and a half spending that $1.6 million improving the property even more. Because what I was trying to do was I was trying to grow the value of this property even more. And today, this property is worth about $55 to $60 million. So it's worth significantly more today based on the continued maintenance of the property. So a lot of people get really freaked out with properties like this. But this is where you create value. If you have the team, if you have the experience, and if you see the deal. Now remember, the deal is always something that you see that no one else sees. So if you have the experience, and you're in the game, and you have the team, then of course banks like Bank of America is going to trust you to be able to turn this around. You guys can do this just like I did this. These deals are coming. We're starting to see distress in this marketplace, whether it's multifamily, whether it's commercial office, whether it's self-storage, or whether it's just a house. It doesn't really matter. It all boils down to the math and the opportunity. Whenever you find something that has a lot of hair on it, and it's scary, please don't look away. Look a little deeper. There might be a diamond in the rough there that no one else sees that you can fix. Now while this was 10 years ago, I just bought a deal like this recently in Vegas. If you're interested in taking a look at that deal, just click on the link below, and you can see how I bought a building for $92 million that was appraised for $142 million just two years ago.