Why I’m Moving from Apartments to Notes

In the last year, opportunities to buy apartments at a reasonable cap rate pretty much disappeared from my Colorado Springs market. This was mostly due to all the cash coming from Denver brought down by investors who had been priced out of the Denver market.

Last fall I bid on a 30-unit over-55 property. It needed new windows but was otherwise clean and full. My bid was rejected and it sat for a couple months. Late in the year it went under contract, but fell back out in March. My broker called to tell me it was back in play and to ready a proof of funds letter. He said only one other investor had been told about it. When I called in the next day, it was already under contract for more than the asking price, all cash.And just last week, a 60-unit apartment in my buying area was bought by an out-ot-state investor for all cash. Tough to compete with that!

I had already been training in notes for several months, and this apartment sale was the final tipping point for me. I decided to go full time into buying, selling and creating notes.

One of the big problems with this field is that hardly anyone, even long-time real estate investors, has any idea what notes are, much less how to leverage them into a great investment. There is fantastic training available from note pros who have been operating under the radar for decades, but it’s my job to in turn educate my investors so they feel comfortable in the note space.

To that end I have created a new company and new website dedicated to telling the note story to investors looking for a strong return backed by cash-flowing real estate. I am now working with a few of these to help them build a portfolio of notes to diversify their investments. I’m putting them into performing notes, ones that have a strong and ongoing record of on-time mortgage payments. You can learn more here: The Riverstone Fund.

Colorado Springs Apartment Sales in 2013

Here is a list of the 32 apartment properties sold in Colorado Springs in 2013. I’ve sorted them by dollars per square foot and have separated out the two outliers that were built in this century.

The remaining sales were mostly of the 60s and 70s vintage and made up most of the transactions in the city last year. Among the older stock, the average price per square foot was $64, with a range from $30K to $124K. The average price per unit was $46K, with a range from $23K to $80K.

If you click on the little arrow at the top right of the chart, it will open into a bigger version that should be easier to see and print. Data are from reliable sources but are not guaranteed.

Colorado Springs Apartment Rents Continue Upward Trend

The Colorado Springs apartment market continues to show strong growth through the third quarter of 2013. Not only has the vacancy rate stayed at its 12-year low of 5.4% (down from 6.1% a year ago), but the average rental rate set a record at $830.34 per month, breaking the previous record of $807.21 set during the previous quarter. That makes 15 quarters in a row that the Colorado Springs apartment rental rate has increased over the previous year.

English: Centennial Plaza Apartments, 516 E Ki...

Centennial Plaza Apartments, 516 E Kiowa St, Colorado Springs, CO (Photo credit: Wikipedia)

The average rent for a one-bedroom apartment is now $730.54, and two-bed, two-bath units are commanding an average of $1005.40. Three bedroom apartments are renting for an average of $1192.17.

In further promising news, although Denver has now returned to its pre-recession rental rates (adjusted for inflation), Colorado Springs still has a way to go. Therefore, there is still room for rental increases just to get  back to what folks were paying here in 2001-2002.

You can read the full report at the Colorado Division of Housing site.

Should You Be a Passive Apartment Investor?

Many people today are unhappy with the returns they’re getting from their current investments and are looking for alternatives. Of course CDs and savings accounts don’t return enough to keep up with inflation and the stock market is such a roller coaster that it’s hard to feel comfortable putting your entire retirement nest egg there.

With so many homes in foreclosure, some folks have tried buying a house to fix up and resell. If you know what you’re doing you may be able to work on it for a few months and sell at a profit. This strategy does come with obvious risks, but with proper training, mentorship and a good team, you can make a tidy sum on each property. However, unless you want to make a career of it, doing fix and flips requires a lot of time away from your regular job.

If you’ve been looking for alternative investments you’ve probably read about the opportunities in commercial real estate. One way to get in on these investments is through a Real Estate Investment Trust, or REIT. Investing in a REIT is a lot like buying a mutual fund, but the managers are acquiring portfolios of apartments, office buildings or shopping malls instead of stocks. You can get quarterly distributions based on the cash flow produced and are a part owner of the properties.

In today’s economic environment, both offices and retail centers are dealing with high vacancies. Since all real estate is cyclical, these property types should rebound sometime in the future, but apartments are doing well now, since everyone needs a place to live.

One reason investors favor apartments right now is the continued growth in the 18-34 year old age group, which makes up the bulk of apartment residents. In addition, houses are no longer viewed as the great investment people thought they were a decade ago. Not only have thousands lost their home during the economic downturn, but the banks have tightened up the lending requirements so much that even people with decent jobs are having trouble qualifying for a loan.

Even if you believe apartments may be a good place to invest, you may not be attracted to the returns and control of a REIT. Unless you’re very wealthy, it’s not practical to buy an apartment building yourself. Is there another way to participate safely and wisely in this current boom without having to deal with tenants and toilets?

As a matter of fact there is. You could pool your money with other investors to buy, manage and sell an apartment property. But what if you don’t personally have the knowledge, experience and team to pull this off? Now what?

You may be lucky enough to have a friend or family member who does these kind of deals who can offer you a spot in one of their syndications. A syndication is a group of investors who go in together on a project that none could pull off by themselves. Hollywood movies are often the result of a syndication, but they can be assembled for many purposes, including the purchase of commercial real estate.

Before putting your money into Uncle Bill’s syndicate, there are several things to consider. First of all, do you already believe in commercial real estate as an investment tool? Specifically, do you think the need for affordable housing will continue to grow? Have you seen that new construction has not been able to match the current demand, leading to lower vacancy rates and rising rents? I’d suggest that you don’t let anyone fast-talk you into this model if you don’t already believe in it yourself.

Once past this hurdle, there are several more to go. First of all, do you feel comfortable with the promoter/sponsor of the deal? You will be partners for several years, so you absolutely must not only trust, but actually like, this person. You will be putting some substantial cash into their hands, so pay attention to your gut feelings. Sometimes the best deal you ever do will be the one you avoided. At the same time, they will be judging if they want to be tied to you for the length of the project. If you’re hard to get along with, or are a micro-manager, they may well decide it’s not a good match to have you in the group.

You also want to consider the sponsor’s experience with this type of project. If they’ve done similar deals and they’ve worked out well for the investors, that’s all a plus. Everyone has to do a first deal, so if that’s the case, you need to feel that their experience in smaller real estate endeavors has prepared them for this specific offering. If they’ve owned and operated several fourplexes, you may feel comfortable trusting them to pull off a smaller apartment complex, but maybe not one of several hundred units. It’s your call.

Make sure they have a professional team in place. No one does this alone, so they should let you know about their real estate attorney, securities attorney, management company, commercial broker, accountant and title company. Feel free to call them as a reference.

Consider your timeline for this type and size of investment. Most apartment projects will need you to commit your funds for several years. If you think you may need your cash back sooner than the projected holding period, this is not a good investment for you.

Once you feel good about all these considerations, it’s time to get more information about the specific offering being presented to you.

If you are looking for current cash flow, make sure the property is throwing off enough cash to provide your required return. The sponsor will probably provide you with a spreadsheet that projects expected gross income, less all the operating expenses. This number is the net operating income, or NOI, and it’s the basis for figuring the value of the property. After that, the mortgage payments are subtracted and the result is the before tax cash flow. This should be greater than what has been promised to the investors so that you can feel comfortable that even if things don’t go exactly as planned, you will still get your promised return.

The group of investors will most likely be promised a percentage of ownership in the deal. You will collect your pro-rata share of this once the property is sold. The combined result of distributions from ongoing cash flows, plus the chunk you receive at the end is called the Internal Rate of Return, or IRR. You’ll want to make sure this number is substantially higher than what you are getting with your current investments.

Even though apartments seem to be a great investment today, all investments come with some risks involved. Don’t invest any money you can’t afford to lose, and whatever you do, don’t take out a loan to put into any investment, including the “can’t fail” deal Uncle Bill has for you.

Before you send in your check, be sure to read any and all legal documents the sponsor provides. Most apartments are purchased via a Limited Liability Company, or LLC. You will be a member of the LLC and will actually own a membership in the LLC, not a portion of the real estate itself. Be sure to read and understand the LLC’s Operating Agreement, as it spells out in great detail how the project will be run from start to finish. I recommend you have your accountant, attorney or financial advisor review it and answer any questions you have. If you’re not comfortable with the risks and benefits, don’t do the deal.

If you go to a luncheon put on by a promoter, or are otherwise introduced to one you don’t know personally, proceed with caution. Most likely putting a group purchase together creates a security, so SEC regulations must be followed to the letter. They require the sponsor to have a substantial personal or business relationship with you before presenting you with an offer to invest, so make sure you’ve had enough time to get to know them and their history, and they know enough about you to feel good about your ability to participate in this kind of opportunity.

Real estate syndications can be a great way for a sophisticated or accredited investor to participate safely and profitably in a commercial real estate deal. If you understand and follow the suggestions put forth here, you’re well on your way to a successful investment.

Good News for Colorado Springs Apartment Investors

Stories from three different areas point out the continuing investor interest in Colorado Springs.

2012 was a very good year for apartment sales in Colorado Springs. In fact, the $198 million total was the largest volume of sales since 2007, at the start of the recession.

Apartments are a strong investor magnet nationally, and for several reasons. First of all, the returns operators are getting are high enough to attract institutional investors, such as insurance companies and pension funds, who might otherwise invest in stocks and bonds. They also like the relative stability of well-run assets compared to other commercial real estate categories. In addition, apartments remain one of the easiest commercial types to obtain both equity and debt financing.

Apartment Building

Apartment Building (Photo credit: Wikipedia)

Colorado Springs is now getting on the radar of investors who have shopped in Denver, but found the competition there has driven prices way up recently. In fact, a great majority of apartment sales here have been brokered by Apartment Realty Advisors of Denver, which doesn’t even have an office in the Springs.

Prices paid for apartments here have been rising as well, boosted both by competition and rising rental rates. Most of the recent sales were of 1980s product, and they averaged over $120 per square foot.

Read the complete story here.

In more good news for Colorado Springs, WallSt24/7.com recently compiled a list of the best- and worst-run cities in the country. Of the 100 largest cities studied, Colorado Springs came in 14th, just ahead of Portland and Omaha. Factors that helped our city rank so well include its low crime rate and excellent credit rating. They also noted that our housing values stayed basically flat from 2007-2011, when those in the rest of the country was declining by an average of 10%.

Here’s the complete report.

It’s always flattering to be highly ranked in some national survey, but it may mean even more when someone is willing to bet real money on the future of the city.

For instance, billionaire Ray Kroenke, who owns the Denver Nuggets, the Colorado Avalanche and the St. Louis Rams, in addition to vast real estate holdings, recently purchased two Colorado Springs shopping centers for $31.5 million.

Uintah Gardens is a popular 215,00 square foot center on the west side, anchored by a King Soopers and includes a Walgreens, Petco and Big 5 Sporting Goods among others.

Academy Place is on north Academy at Union Boulevard. The Kroenke group bought all the retail shops between the Safeway and Target anchors.

Another Kroenke enterprise, THF Realty, is planning a 350,000 square foot retail mall on the south side that will be anchored by a Wal-Mart Supercenter and a Sam’s Club store.

Local commercial brokers believe it’s a real vote of confidence for the local economy that an investor of Kroenke’s clout (he’s on the Forbes Top 100 list) has turned his attention to Colorado Springs.

Here’s more on his local activities.

As you can tell from all this good news, many are feeling bullish on the Colorado Springs apartment market. However, with the deep pockets of institutional investors starting to buy up local properties, it’s getting harder for smaller investors to locate a deal that makes sense.