At Crescendo Equity, our business consists of identifying, evaluating, buying, and operating prime Canadian multifamily properties on behalf of our investors. Our geographical focus is on Canada and in particular Niagara, Hamilton, Kitchener and certain parts of Montreal, Quebec.
Our investors trust us to make the best possible choices and generate the highest possible returns. As we run our business, we know it’s important to share with our investors our approach to the business and, more specifically, how we go about selecting and making offers on multifamily apartment properties.
1. Identify The Commercial Real Estate
Initially, our job is to identify prospective properties for acquisition. This is done with a three-pronged approach. The first is passive, by simply scouring the listings for appropriate opportunities. Anyone can do that, and so do we. The second is by proactively working with our extensive network of real estate agents, lawyers, and property owners, and keeping tabs on when a choice property may be offered off-market or before its comes onto the market.
The third, is by using technology and land records to find potential sellers who may not have considered selling or may be facing a financial issue that we can help out with. This is how the best deals are often found, and to succeed at the proactive approach the company must be well regarded and have deep ties in the industry.
When a property becomes available, we quickly screen it to determine whether it’s “in the ball park” for the company and our investors.
2. Qualify The Apartment
Once a property has passed the initial screening—very few do—then we develop an opinion as to whether the property will make a good investment. We look at every angle. For example, the old maxim “location, location, location” is important. The location has to match the value. This means we look not only at the property itself but at the bigger picture, including:
- Population and population growth trends
- Local employment
- Vacancy Rate
- Land rezoning applications submitted in the area
- Numbers of building permits
- Regional economic data
- Economic health of local employers (especially for smaller markets)
- Crime and safety data
- Quality of life—schools and parks
3. Crunch the Numbers On the Property
If the property qualifies as a good place to live, then it’s time to determine whether the building will make a good investment. One does not necessarily ensure the other!
Information from the seller is collected. This includes:
- Gross Revenue. Total revenues in the current month, over the last 12 months, and the last 3 years. The gross income is a factor of the rents being charged, any additional fees, and the occupancy rate. If the occupancy rate seems low, then we ask why, and if it’s a problem we can correct.
- Net operating income (NOI) which is the total revenues minus the operating expenses. As the NOI goes up, the property value goes up. As NOI goes down because of high operating expenses, property value goes down. This is the driver of commercial property value, but it’s not set in stone. Some property owners aren’t very good property managers, and they leave money lying on the table.
- Current Mortgage. While it’s not part of a property’s operating expenses, unless you pay cash for the building, you’ll be using some form of financing. (We like to use seller financing whenever we can.) We always know the current mortgage details in order to determine what the owner’s equity position might be and the reason for the sale.
Financing Options. We like to know what lenders and what financing options are available where the apartment or multi family property are located.
- Capital expenses. After we purchase the property, will we need to spend money on large expenses? Will we need to buy new windows, install a new roof or a new boiler? Capital expenses are the expenses not included in the typical costs of a deal. We determine these expenses prior to making an offer.
- Cash on cash return. This is the term that determines how fast our investment money comes back to us. Faster is better.
- Cap rate. This is our return on investment if we were to pay all cash for the property. If we buy a property for $2 million and the annual NOI is $150,000, then the cap rate is 7.5 percent. On the simplest level, we ask, “If an investor had $500,000 to invest anywhere, for a low-risk investment would a return of 7.5 percent be attractive?” If the answer is “yes,” then we move ahead. If the property is properly vetted and has the proper value add opportunity then the return will be much higher.
- IRR. Internal rate of return is a metric used to calculate the profitability of a potential investments. It is useful in determining if an investment’s capital could provide a better return if invested in another apartment or multifamily property. It is the lowest level of return that is accepted in order to justify the investment. The calculation omits external factors such as the cost of capital to finance an apartment building and inflation from the calculation. The higher the IRR and the amount it exceed the cost of capital the higher the net cash flows the apartment will generate.
We don’t base our calculations solely off the information stated in the broker brochure or seller’s financials, because these are not always accurate. To get a better idea of the true value number, we always do our own research. The seller’s motive is to make the numbers look good and sell the property. For each commercial property deal, we always determine our own numbers and calculations.
4. Make the Offer On The Building
Once we’ve calculated the key numbers and they look good, we’re ready to make an offer. We calculate a cash and cash return that we’d be happy with, and also a cap rate that works for us. We also calculate all of the expenses, and arrive at the highest price for which we’re willing to purchase the property. Of course we’d love to pay less, but the critical number is the highest price, beyond which we will not go.
We look for apartments with upside potential and a chance to reposition the property, which sometimes means buying the property at a lower cap rate than the area would normally command in a stabilized apartment building. This is usually the case and means that we’ll have the ability to increase our NOI by raising rents, introducing fees, adding units, increasing the apartment’s density, increasing the occupancy rate, and/or reducing expenses.
In our first formal contact with the seller, we may approach the deal verbally or submit a purchase and sale agreement (APS). In order to to get the optimal structure we prefer to have a meeting or at the very least a phone conference with the owner (s). This is sometimes how we “test the water.”
Provided both parties can work through all of the details needed to complete the transaction—we’re prepared to close at the price and terms we’ve spelled out in our discussion.