Disruptions in Oregon Real Estate Episode 7:
Money Is Cheap, Should You Trade up Your Apartment Complex in Eugene?
As a commercial real estate investor, you want your investments to achieve the returns you are looking for. One way to keep your investments working for you is to stay abreast of trends and interests rates. Is your Eugene apartment complex doing what you need it to do for you? Is it time to make a change? Learn about your options and how to evaluate your motivations and goals as an investor.
What You Will Learn in Episode 7:
- The cost of money these days
- Normal interest rates for small apartment complexes and how that is changing
- Why now might be the right time to consider buying more units or going into something newer
- How rent control is affecting investment choices
- Benefits of commercial real estate investment: tenant pays taxes, insurance, and for maintenance and repairs
- Understanding your motivation as an investor
- How to analyze investment returns to achieve goals
Many factors influence how you evaluate your investment opportunities in Eugene and Lane County real estate. Interest rates, inventory, your own motivation and goals, and rent control laws are just a few. Commercial real estate broker and investor Rene Nelson explores these factors and how to measure the value of your current real estate portfolio and make decisions for the future.
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Money Is Cheap, Should You Trade up Your Apartment Complex in Eugene?
Barry MacGuire: Welcome to the Disruptions in Oregon Real Estate podcast with your host, René Nelson, helping you stay in the driver’s seat of your investment portfolio. As a commercial real estate broker and investor herself, author René Nelson’s passion is to keep your heart earned real estate investments working for you. Her goal is to help Oregon real estate investors analyze and measure the value of their current real estate portfolio while exploring available opportunities. And now your host, René Nelson.
René Nelson: Hi, Barry. How are you?
Barry MacGuire: Good. How are things in the market right now?
René Nelson: They are crazy.
Barry MacGuire: Tell us René.
René Nelson: Okay, so here’s the deal. As you probably know, if you’ve heard, read any media or heard anything on the news, interest rates are super low.
Barry MacGuire: Money is cheap.
René Nelson: Money is really cheap. Here’s what’s motivating that. Unfortunately, as most people know, in China, there’s the Corona virus.
Barry MacGuire: Sure.
René Nelson: And that is making an impact on international investors who are bringing their money into America now. They’re flooding our markets.
Barry MacGuire: America’s a safe haven, is that what you’re saying?
René Nelson: Yes.
Barry MacGuire: Okay.
René Nelson: Yes. That also means then money’s cheap because we have a surplus right now. Lenders, the treasury, the tenure treasury just dropped, so lenders drop their interest rates again. So I’m going to just give you a measurement, a tool, a measurement of how to look at this. Normal interest rates for a 10 to 20-unit apartment complex have been around 4.25 to four and a half percent.
Barry MacGuire: Which is historically pretty good, isn’t it?
René Nelson: Yes.
Barry MacGuire: Okay.
René Nelson: It’s really good. I got a quote yesterday on a 20-unit apartment complex, just your two story bread-and-butter, built in 1970s, no real bells and whistles, not a lot of amenities, the lender quoted 3.95%.
Barry MacGuire: Wow, under four.
René Nelson: Yeah. I mean, it’s just crazy right now what’s happening with interest rates and the cost of money. So what that does for sellers, it’s a good time to look and see if you want to trade up and go to bigger units or newer units. Because a lot of people that have an apartment complex in their portfolio, most people have owned that for a couple of years, on an average like seven to 10 years.
Now’s a good time to look at moving up and buying more units or going into something newer. So you might wind up going down to fewer units but newer, so you’re going to have less maintenance, less repair, and less headache of stuff to deal with.
Barry MacGuire: So this would be a 1031 exchange?
René Nelson: Yes, you would do a 1031 exchange into newer units.
Barry MacGuire: Okay. Are we finding a lot of people are thinking about doing this or are they just sitting there with the properties that they’ve been happy with over the last few years?
René Nelson: It’s really interesting. I have a California investor that’s looking to buy up to 10 million worth of real estate right now. He specifically wants campus. So he called me and said, “I have cash up to 10 million, find me campus. I want something within walking distance to the U of O.” I started calling all my clients and my database as well as all the multifamily owners within a one and a half mile radius of the U of O area.
A lot of people I’m finding are saying, “I don’t know what I would do if I were to sell,” and when I start asking them questions about, “Well, tell me about your property. Are you happy with your cashflow?” “Yeah, I’m pretty happy with my cashflow.” Then I start asking them questions about, “Well, how’s your maintenance been and how’s the property performed?” Then they really start to think, “Well, maybe I want to get out of student housing.”
So we’re starting to see people that are looking at getting out of a certain type of real estate and go in to something that’s more passive in commercial real estate where they’ve got a tenant that’s maintaining the property and paying the taxes and the insurance and the maintenance and repair.
That’s in more of a true commercial property compared to an apartment complex where you’re going to have a property manager that’s going to be taking care of things, but you’re still going to be responsible financially for the maintenance and repair.
Barry MacGuire: Are you finding people who are gravitating more getting out of apartments, maybe getting into more retail and stuff like that?
René Nelson: Yeah, a lot of people have been concerned about the rent control and so that’s been one of the key motivators is people have watched their real estate portfolio, specifically apartments really grow and get at the top of the market. They know that it’s probably a good time for them to do something different with that property.
So now they’re looking at other opportunities like, “Okay, if I sold my eightplex, what can I 1031 exchange into?” So an example, I have a client right now that’s going to sell an eightplex and a fourplex that are side by side. He’s going to sell those, and we’re going to 1031 exchange him into an office building where it has two tenants. They’re long-term established tenants. One tenant has been there since the year 2000, that’s how long he’s been a tenant.
Barry MacGuire: Yeah.
René Nelson: He just signed a new five-year lease with two options to renew, and both of those tenants in that office building are responsible for the taxes, the insurance, and the maintenance and repair. I know that I keep mentioning that and most people are probably like, “Why is that important?” The reason is because the rent that you are anticipating, that’s all your money, that all goes into your pocket and you don’t have to take care of the maintenance of the building. The tenant is responsible for that.
Barry MacGuire: Oh, really?
René Nelson: Yeah.
Barry MacGuire: That’s nice.
René Nelson: It is, and the taxes and the insurance and everything else. So you get to keep the building. Tenant pays everything, and that’s also nice because I find that office tenants will take care of a building better. They’ll fix things faster. They’ll take care of it better because they know they’re on the hook for the repairs.
Barry MacGuire: Good point.
René Nelson: So rather than tolerating a leak in the ceiling of, “Ooh, don’t want to call the landlord because he’ll be mad at me or he’s going to raise my rent,” instead of doing that they get on it right away and fix it.
Barry MacGuire: That’s a very good point.
René Nelson: Yeah, I see that all the time. I can’t tell you how many times I go through an apartment inspection and I’ll see either a bucket under a kitchen sink or a leak in the ceiling and I’ll say to the tenant, “Have you notified your landlord of this?” “No, not yet, because I’m afraid my landlord’s going to be mad at me, my landlord will evict me, my landlord will raise my rent,” which none of that can happen.
Barry MacGuire: It’s the opposite.
René Nelson: It is. The landlords really want to know that stuff so they’re going to fix it.
Barry MacGuire: Yeah, they want that feedback.
René Nelson: Yeah, yeah, but I just see all the time tenants are scared to approach their landlord with issue. So they don’t say anything until they have a bucket under the sink catching a drip with an issue.
Barry MacGuire: All right, so money is cheap. What’s your suggestion for people that have properties might want to trade up? What do you say?
René Nelson: Here’s what you really need to know is how’s your property performing right now. If you were to 1031 exchange into something different, how would that perform for you in the future? So I first look at cashflow. What are you earning and cashflow right now off of your property and what are you going to be receiving for the new property that you 1031 exchange into?
Some of my clients are deciding that capital gains are probably as low is there going to be and so a lot of my clients, I have one client in particular that selling an apartment complex for four million. He’s just decided he’s going to pay the capital gains and sell it and pay the tax and be done with it and put the cash in the bank. He’s tired. He just doesn’t want to own real estate anymore.
Barry MacGuire: Has it been a real headache for him or?
René Nelson: Not really. He’s got a professional management company that manages it. They do a great job. The property was built in 2012. He’s really financially secure, obviously.
Barry MacGuire: Okay. I guess he just wants to simplify his life.
René Nelson: He wants to simplify his life and he’s just at that point where he’s like, “I’m just going to pay the tax and sell and put the cash in the bank.” For him, it’s peace of mind.
Barry MacGuire: Sure.
René Nelson: So what I find for a lot of sellers is we have to really dig into what’s their motivator. If they could wave a magic wand once and could take their current existing property and go into something new and different, what would that look like? Because some people say, “I want ease of management.” Okay, that tells me they probably don’t want to go into multifamily. They probably want to go into a triple net commercial building where the tenant is responsible for everything, and they just get the check in the mail.
Some of the drawbacks of those type of properties, as an example, a lot of times the rent is fixed for five years. You have little rent increases where the rent can go up, say 3% per year annually, but that’s a big difference between multifamily where now your rent can go up 9.9% or whatever the rent cap is plus CPI.
Barry MacGuire: Sure.
René Nelson: Does that make sense?
Barry MacGuire: Yes, it does.
René Nelson: Okay. So sometimes there’s trade offs. Do you still want to be a multifamily and if you do, I own apartments, so don’t get me wrong. Apartments are a great property to own for commercial real estate, but there’s some people that are just starting to see the changes that are happening in Portland right now for the screening laws that are happening. They’re really concerned those will pass statewide within the next 12 to 24 months.
We’ve talked about it in past podcasts, that’s going to be a game changer because that will put more mom and pop operators who self-manage, that’s going to put them under the gun. They’re going to have tough situations where their tenants are going to potentially create issues for them, and they may or may not know how to handle that. If they don’t handle it properly, they can be sued. So there’s a target painted on their back right now for being savvy, knowing what they’re doing and really learning the laws. There’s so much to it with the lies, it’s hard to know it all.
So for a lot of my clients, I look at where are you at right now and where do you want to be. One of the questions I asked my client, “If you were setting here three years from today, looking back, what would need to happen in order for you to be happy with your real estate portfolio?”
Barry MacGuire: That’s a good question to ask.
René Nelson: Some people say, “Well, I want to be on a beach. I don’t want to work.” If they’re working a day job right now and their real estate portfolio is generating them $500 a month in cashflow, I’m probably not going to be able to help them quit their day job.
Barry MacGuire: Not yet.
René Nelson: Go live on a beach in three years.
Barry MacGuire: Yeah.
René Nelson: So it has to be realistic, but what they really want to do-
Barry MacGuire: They could live on a beach, but they just wouldn’t have a house to go to. They just have to stay on that beach and do a little bit of fishing for food.
René Nelson: Exactly. I guess that’s true. We could always get them there. It’s just what they like the quality of life.
Barry MacGuire: Exactly. So it really sounds it’s for those people that have properties, it is a case-by-case basis. It’s like everybody’s individually unique, right?
René Nelson: It really is, and every property is different.
Barry MacGuire: Yeah.
René Nelson: Because to me it starts with the numbers. I’m an analytical person by nature, so I like to look at their current rent roll in the last three years of their real estate schedules and their tax returns. Because a three-year history will tell me how that property is performed.
So I’m going to give you an example. A couple of weeks ago I analyzed 150-unit apartment complex. The owner has a professional management company that’s doing a great job for them. When you drive by the property, it’s got great curb appeal.
Barry MacGuire: Well-maintained.
René Nelson: Well-maintained shrubs and landscaping looks great. The exterior of the building looks great. Interestingly enough when I looked at the last three years of their income and expenses, their expenses are really high. So we’re seeing on that particular property, we’re seeing almost 60% operating expense where industry standard is about 45%.
So by looking at the numbers, I’m able to analyze it and look at it not only how has it performed in the last three years but looking at it then through the eyes of a buyer, how will it perform when they take ownership? The reason that’s important is if I’m representing the seller, I have to be able to defend that most probable sales price.
When I tell a seller, “Here’s what your property can sell for,” I have to be able to defend that number and explain to an appraiser, a buyer’s broker or the buyer. Here’s how I derived at the sales price and here’s how this property should perform based on the last three years of expenses.
Barry MacGuire: Is that what you typically go by, three years, there’s a one year, five years?
René Nelson: That’s a great question. Really three years. The reason that you don’t want to do just one year is what if last year they minimized on maintenance and repair and just scrimped by knowing that they were going to sell?
Barry MacGuire: Fudge the numbers a bit.
René Nelson: Yeah.
Barry MacGuire: Yeah.
René Nelson: So if you look at three years, you really get that trend and you start to see how the property is performed.
Barry MacGuire: Okay. All right, well, like I said, it’s a case-by-case basis. If somebody is a property owner and has been thinking about maybe selling, maybe trading up, how can people contact you?
René Nelson: You can call me at 541-912-6583.
Barry MacGuire: Website?
René Nelson: Best place to go is eugene-commercial.com. I’ve got an easy little app that you can click on and book an appointment online or reach out to me on my website.
Barry MacGuire: René, thank you so much.
René Nelson: Thanks, Barry.
Barry MacGuire: She is here to help you. Once again, 541-912-6583 or eugene-commercial.com. Thanks for listening.
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