Check back as SMC will regularly share our thoughts on the direction of the real estate industry and articles that we believe indicate important trends.
Two years ago I joined a fabulous networking group called ProVisors where I have met many highly competent “trusted advisor level” professionals. In one of the group meetings about a year ago, I participated in a group exercise on verbal branding. I became intrigued with the concept of messaging and how little time we in have, in this day and age, to articulate our message and to differentiate ourselves from others in our respective businesses.
Recently, through one of our investors, I met a corporate consultant, Stephen Melanson www.melansonconsulting.com, who teaches “Differentiation and Game-changing Simplicity”. Over lunch, Stephen emphasized an extremely critical point – people don’t remember much of what you tell them at all. They only remember a small handful of things that stick out in their minds. Therefore, we all need to communicate our differentiators in 5 seconds or less..!!!
I immediately set off to define our key differentiator(s) at SMC. My conclusion: “SMC reports and pays its investors monthly”. You will see this mentioned throughout our website and our literature. I like to call it “mailbox income”.
I recently explained this to Steve Chapman, our Managing Partner. He responded, “don’t forget that investors and their advisors also love the fact we always put assets into our partnerships “at cost”, taking no money out up front, subordinating our interests to theirs.”
“Not now, I own too much real estate” is a statement we hear often from investors who own multiple homes around the world. While second, third and fourth homes most certainly are real estate, they are a completely different asset class from the real estate we purchase and develop on behalf of our investors. Like boats, homes are consumers of income. Direct investments in multifamily residential real estate are generators of income.
Recently, an investor announced to me that he plans to sell his $4MM home and he and his wife plan on investing the proceeds into income producing real estate. Smart move. Let’s do some simple math on their $4MM house:
|Annual maintenance and capex (2%)||($80,000)|
|Total annual cost of home ownership||($127,000)|
Sell house and invest the $4MM in equity at an annual 9% current yield on the $4MM. Use our average IRR of 14% and the $360,000 becomes $560,000!!
|Sell house and invest the $4MM in equity at an annual 9% current yield||$360,000|
|Rent luxury townhouse in same town @$7,000/mo||($86,000)|
|Annual cash flow swing with only 9% current.||$389,000|
Without taking into consideration modest appreciation, total IRR and tax benefits, that’s a cash flow swing of + $389,000 per year, over $25,000 a month. That’s what I call owning too much real estate!
August 10, 2015
Many investors choose REITS over direct ownership because of liquidity, but they give up tax benefits and returns in doing so. Curious about the basics, I did a simple analysis on the performance of the top ten rated REITS by thestreet.com and below are a few of my observations:
- Going-in valuation of the top 10 REITS average a PE of 34 which translates to a 3.7% yield to equity. Going-in valuation of direct investments typically average a 7% or greater yield to equity.
- Average annual dividend yield for the top 10 REITS for the last 5 years was 5.34%. Average current annual distributions for direct investments typically average around 8%.
- Average total returns (IRR) for the top 10 REITS for the last 5 years was 9.14%. Average IRR for direct private equity real estate investments averages 12% industry-wide and ours is just over 14%.
- Dividends and profits from REITS are taxed by the IRS using ordinary income tax rates. Direct investment limited partnership income is taxed through K-1 tax reporting, with cash distributions sheltered by depreciation and tax losses due to new construction and/or renovation. Profits are taxed, for the most part, at long term capital gains rates. Tax benefits of direct ownership can add as much as 4% to annual returns.
Of course, past performance does not guarantee future results.
While spinning at the gym recently, I observed a commercial on the TV for Reese’s Peanut Butter Cups that said: “Same as last year, no changes, nothing new, perfect.” I was struck by the ad because it reminded me of the consistent nature of what we do year in and year out at SMC. While not perfect, we consistently maintain a culture of discipline, patience and diligence while executing, delivering results, reporting and distributing cash flow to our investors and partners.
SMC is what one might refer to as a “downstream developer” purchasing assets that have most often been painstakingly planned and permitted by highly qualified professionals who have run out of money, experienced bad market timing or both. Stephen M. Chapman, our Managing Partner can often be heard saying, “We are not creative. We acquire great projects from others that have taken the ball down the field as far as they could. Our business template enables us to forecast start dates, cash distributions and eventual dispositions.”
Thoughts on real estate investing, monthly income distributions and the similarity between a garbage collection route and multi-family real estate investment:
In a former life I owned a waste management (garbage collection) business which actually bore a very close resemblance to the multi-family real estate business. Both have a large subscription customer bases paying monthly generating cash flow that can be enhanced, annualized and resold for a substantial profit. The large subscription customer base is what sets multi-family real estate asset class apart from other real estate asset classes such as office, industrial and retail where one vacancy can leave a gaping hole in the cash flow of an investment. Costs of replacing a tenant in these other asset classes can be very significant. In the multi-family asset class, to prepare for a new tenant the landlord simply needs to clean, paint and install new carpet, all at an average cost of less than one or two month’s rent. Furthermore, in multi-family, once you have a property up and running you can rely a quality management company to make day to day decisions thus freeing up your time to add value and source new opportunities.
Today’s lending environment:
Banks are not lending as freely and loosely as they did pre-2008. A typical residential mortgage now requires 25% to 30% money down with very strict credit requirements. This makes buying tougher and barriers of entry AND exit much higher than just a few years ago. Recently, I spoke with a residential real estate broker who said her appraisal business was out-performing her brokerage business because banks are now requiring three appraisals on many new loans.
A significant demographic shift:
Over the last few decades our thinking about career and how we live our lives has changed. Our parents taught us to buy a home, have a successful career, pay off the mortgage, save money, and eventually retire with a paid off home and a nest egg. Today’s workforce is much more mobile and it’s no longer common to remain with a single company for an entire career. To accumulate wealth, many are now choosing diversified investment strategies through financial advisors and family offices rather than home ownership. Those investment professionals are recommending investment in multifamily real estate through a quality operator/developer (like SMC) as a hedge against the volatile stock market.
On the other end of this demographic shift:
An equally important driver are the aging Baby Boomers who are downsizing, selling their homes and moving to locations with amenities similar to those desired by Millennials and Gen Y, but with convenient health care. For these reasons, a growing and very successful segment of our population is choosing to rent rather than own.
On the Greater Boston multi-family real estate market:
The metro Boston Area continues to rank within the top three multi-family markets nationally, with an annual compounded growth rate of almost 5% since 1995. During that same period, the average annual vacancy rate in Boston has been just under 4%.”