AMA - First Multi-Family Investment

Today is another AMA episode (ask me anything) 

Ryan asks:

"I live in Los Angeles and have been working on my education and networking to break into the Commercial Multifamily Investing space (particularly in Arizona); however I do have an opportunity to possibly break into ground up development of built to rent units here in Los Angeles. A buddy of mine who develops (completed 24 units, 6 units and currently raising capital for 33 units in decent areas such as West LA, Hancock Park) is willing to let me tag along on his projects to learn while being a passive investor.

Any advice on which path to choose (B & C class MF in AZ vs. ground up build to rent here in Los Angeles, CA)? I am leaning towards MF in AZ given the business friendly atmosphere there, but it's hard not being in the market."

Ryan this is a great question.

You’ve presented your question as one of two choices. Either new construction in Los Angeles, or B & C Class in Arizona. For reasons that I’ll go into in a minute, I probably would not choose either of the two asset classes you’ve presented.

I’d like to encourage you to consider additional alternatives. In fact, I’d suggest that before you commit to a single project, you get clear on the type of project that is going to meet your investment criteria. In my world, an investment needs to follow the laws of supply and demand. That means I want to be in a market with growing population, growing employment, and a shortage of supply for housing.

Los Angeles lost population in 2018, 2019, and it has lost population in 2020. In fact, LA ranked fourth in the nation in terms of population loss in 2018. All other things being equal, that means that prices will drop for both rentals and purchases. The problem with rentals in an expensive market like Los Angeles is that the cost to deliver a finished product is quite high compared with the net income you can generate. In addition, many submarkets are rent controlled. That means that the properties often don’t meet their potential because the rents are being artificially held down.

I’m not a fan of C-class properties in Arizona. I’ve owned investment property in both Maricopa County and Pinal County. The problem with C-class is that the income strength is not there. If you’re renting property to people who don’t have stable income, then your investment is at risk every month. If they’re relying on government subsidies, you’re renting to people who are broke. They’re not going to take good care of your property. I’ve never lost money in A-Class properties. But I have lost money in C-class. You will find that C-class properties tend to have more than their share of surprises and unplanned maintenance.

In terms of meeting your investment criteria, it’s important to get clear on what constitutes a good investment for you. I can’t decide that for you, I can only share what my investment criteria are.

1) I’m looking for projects that generate 30% net profit margin within 12-24 months. That means I’m buying at enough of a discount that I can generate that 30% margin after all expenses and interest carrying costs.

We’re at a unique cross-roads in history. This is an exceptional time to start in investing. We are on the cusp of a repeat of 2008 all over again. Except this time it is happening in slow motion. We know it is coming. We can prepare. The moratorium on evictions, and the moratorium on foreclosures are both holding the market in a form of financial hibernation.

I would hate to see you jump into the market a few months too soon in what amounts to the absolute top of the market, only to have a huge number of distressed properties hit the market all at once. When that happens, even with low interest rates, the laws of supply and demand dictate that we will see a precipitous drop in prices in some markets.