Tag Archives: apartment investors

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.

How Your Down Payment Affects Your Bottom Line Return

When apartment investors evaluate a potential new property, they have many points to consider. If their preliminary analysis looks promising, they’ll eventually start figuring how to finance the project.

At this point they will check with various lenders to discover their current loan parameters. What loan-to-value (LTV) percentage will they honor? What debt service coverage ratio do they look for? What interest rate do they offer, and for what length of time before the balloon? For how many years will they amortize the loan?

In addition to the debt side of the equation, the sponsor must look to his or her investors for equity to cover the down payment, loan and acquisition fees, and reserves for known or anticipated capital expenses. They will poll their potential investors to discover how much they might contribute, as well as their tolerance for risk. They might also ask if any of them need to do a 1031 exchange, or need help setting up a self-directed IRA.

Once all this is done, they calculate how much equity to raise to complete the purchase. Most often, a sponsor hopes to raise just enough capital to meet the target LTV their favored lender is looking for. Currently, most lenders require a minimum of 25-35% down. So for a million dollar purchase, an investor group might look at raising a minimum of $250,000 to $350,000 for the down payment. However, not all groups want to get in for the minimum amount down. For their own reasons, they may prefer to put half down, or even pay all cash. How do these decisions affect the bottom line return after the holding period and subsequent sale?

In order to determine the answer, we’ll compare the internal rate of return (IRR) for three different scenarios. The IRR reflects the total return on investment, taking into account annual cash flows and final profit at the sale. All the following numbers reflect pre-tax dollars.

Assumptions

  • Purchase price (all-inclusive) = $1,000,000
  • Buy at 8% cap rate ($80,000 net operating income first year)
  • Vacancy rate = 7%
  • Rent income escalators = 3% per year
  • Expenses = 50% of gross operating income
  • Expense escalators = 3% per year
  • Expense of sale = 7%
  • Loan interest rate = 6%
  • Amortization period = 25 years
  • Loan term = 7 years
  • Sell at end of year 5
  • Sell at 8 % cap rate

If you’d like to see how the following numbers were derived, the spreadsheets are included below.

Down Payment

Year 1 cash flow Year 5 cash flow Sale @ 8 cap Sales Proceeds

IRR

$1,000,000 (all cash)

$84,600 $95,218 $1,225,932 $1,140,117

11.17%

$500,000 (50% LTV)

$45,942 $56,560 $1,225,932 $690,457

15.66%

$250,000 (75% LTV) $65,271 $75,899 $1,225,932 $915,287

24.16%

Upon close inspection, you will see that compared to putting 25% down, buying with all cash will give you better cash flow, but an overall smaller return. Putting in an intermediate amount gives intermediate results.

So why doesn’t everyone go for the maximum return? In these variations, putting in the smallest amount gives the biggest bang for the buck because you’re leveraging your money with the loan. It must be easier to raise $250,000 than a million dollars, so why do some folks buy for all cash?

One reason might be the ability to get a discount for an all cash purchase, where the seller doesn’t have to wait to see if your loan will go through in time, if at all.

It might also have to do with the mindset of the investors in the group putting up their cash. Younger investors with many years to go before retirement usually have a steady and growing income from their job and are often looking to work for a big payday down the road. Their risk tolerance may be relatively high since they have a long time to make up for any errors they make now.

People approaching retirement or already retired may place a higher value on a more robust cash flow today to supplement their fixed income. They may also be worried about that balloon payment a few years down the road when the loan term expires. They simply don’t have as high a tolerance for risk as they did in their younger years.

Many of the deals we see today are the result of projects not being valuable enough in the current market  to refinance the loan to pay off that debt coming due. So, paying with cash means there is no loan, so there is no balloon. As with all investments, the greater the return, the greater the risk. Therefore, successful sponsors will match the equity required with the risk-tolerance of their investors.

All Cash

50% Down

25% Down