Three Things Real Estate Investors Need to Look for During COVID

COVID-19 has disrupted just about every aspect of our lives, from working from home to distance learning, to restrictions on businesses, to mandates on wearing masks. The pandemic has also disrupted the real estate industry, and passive investing as well. I’ve noticed that many passive investors have decided to sit on the sidelines and wait for COVID to be over before investing any money in multifamily properties. I always tell investors that if they feel uncomfortable in any way about investing, they should honor their feelings. But investors were able to make money in many different investment opportunities, and sometimes you have to be creative in order to make the deals work. People made money when the economy was strong, and people lost money when the economy was strong. The same applies to a market downturn.

There are three main things that investors must consider when they invest in real estate, and this is especially true during COVID.

Consideration #1: Sponsor’s Experience

One question I’m frequently asked by new investors is, “How are your properties doing during COVID?” That’s a legitimate question, and one I would ask myself if I was a new investor thinking about investing during COVID. The sponsor’s response will be all telling: are they upset about the questions, or do they try to avoid providing an answer? If they are not comfortable talking about their performance during COVID, then it’s not someone I would want to invest with. A sponsor has to be willing to talk about the negatives as well as the successes. Measure how comfortable the sponsor is in answering uncomfortable questions. If they’re upfront and honest, it’s someone you would want to invest with. It’s all part of vetting the sponsor.

If you invest with a sponsor, you want that person to call or email you to let you know how things are going. Pay close attention to their response to see how comfortable he or she is in answering an uncomfortable question. If you ask how properties are doing during COVID, and their answer is, “All properties are doing fine,” try to get a more specific response. Ask about Net Operating Income (NOI) and whether it’s increasing or decreasing. Ask about collections, and also find out about evictions.

Another important question is to ask about distributions, and whether or not they were paid on time. If they weren’t paid on time, ask for an explanation. There may be some legitimate reasons that have since been resolved. By asking those type of questions, you’re trying to find out whether or not the sponsor is being honest. That’s critical, because if you’re going to invest your money, you want to invest it with someone who is honest with you, and not making up stories. A sponsor who is honest about their investment experiences during COVID is someone I’d want to invest with; I’m sure you would as well.

Consideration #2: How Conservative is the Underwriting?

Many sponsors will tell you that they are conservative investors, and that what they’re offering you is a conservative investment. The best way to ascertain whether or not the investment is a conservative one is to look at the numbers. Rather than spending a lot of time running the numbers yourself, simply look at the proforma that’s attached to the deal.

When looking at the sponsor’s proforma, pay attention to the income growth, and compare the Year 1 income to the last 12 months of operations. If you see a 20% growth, for instance, you may have an exceptional deal, or the sponsor may be using a very aggressive assumption. For example, during COVID we project a 0% to 1% growth in income in the first 1-2 years of operations, which is an extremely conservative approach. Certainly, we try for a 3-5% growth in income, but with all the uncertainty surrounding COVID, that might not be possible.

Another measure of a conservative underwriting is the renovation schedule. Pre-COVID we managed to renovate over 10 units per month. Once we took over management, we would schedule renovations on vacant units, and then schedule renovations as tenants moved out. After renovation, we’d add a premium to the rent, increasing our rental income. However, during COVID there may only be an opportunity to renovate fewer units each month, as not many tenants can afford to pay a premium.

To remain conservative on our deals, we’re underwritten zero renovations per month during the first 12-18 months, depending on the deal. We certainly plan to renovate as many units as demand will allow, but it will be at a slower pace compared to pre-COVID. We’re showing investors the returns if we don’t renovate a single unit during the first 12-18 months of operation, which is truly a conservative underwriting.

Another metric to look at is bad debt. When a tenant doesn’t pay rent or is late, it’s delinquent. If the tenant leaves and the delinquent rent can’t be collected, it becomes bad debt. Look at the bad debt in the sponsor’s underwriting, and if It’s a very low number, it’s not a conservative underwriting. Bad debt that is below 1% might be aggressive (as a “normal” pre-COVID range is 2%-3%). Vacancy rates are another thing to consider. During COVID, you have to assume that vacancies might increase, which should be reflected in the underwriting. Concessions (which are the discounts the owner offers new tenants) are also part of a conservative underwriting. The sponsor should earmark some money for concessions in order to retain tenants, and the first year should have higher concessions, not lower.

Finally, the debt structure is a big part of a conservative underwriting. I like agency debt and fixed rate loans, because there are no fluctuations from year to year. In addition, interest rates are now at historically low levels and should remain there for the foreseeable future.

Consideration #3: How do Properties Perform During COVID

The biggest question on everyone’s mind is when will COVID-19 be controlled. There are mixed messages about when a vaccine will become available to the general public, anywhere from the end of 2020 to mid 2021. In addition, many Americans are concerned that drug companies are politicizing the vaccine and wondering if it’s really safe to take.

All of this uncertainty over COVID is causing concern among passive investors as well. When looking at deals, the impact of COVID on multifamily properties is impacting their decision making. However, one thing is clear - if a property is performing well during the COVID pandemic, it is more likely than not to continue to perform well during, and after, the pandemic has resolved.

The pandemic has caused vacancies to rise in certain Class properties, particularly Class C. So, there is concern that projected income might be affected if COVID continues. But there are metrics you can look at to see how a property is performing now. First, check to see if the vacancies are stable or if they’re rising. If they’re stable, it means the tenant base is strong.

Look to see if concessions are increasing in order to retain current tenants or attract new ones. If they have leveled off, the property is likely doing well. Another metric to look at is bad debt. If it has increased as delinquencies increased, there may be a problem. If the numbers have remained level, it’s a good sign. The bottom line is if there hasn’t been an increase in these areas, it’s an indication that you’re looking at a strong performing asset.

Summary

While some passive investors have chosen to sit on the sidelines during the COVID pandemic and wait out some of the uncertainty, others are actively investing in multifamily properties. The bottom line is that some investors are able to make money in all types of markets. There are three key things to consider when investing during COVID.

The first consideration is the sponsor’s experience. Find out how their properties are performing during COVID. Look at the Net Operating Income, collections, and the evictions. Also, ask about whether they’ve paid distributions on time to investors, and if not, find out why. You want to be sure you’re getting honest answers, because when investing your money, you want to invest with someone who is honest with you.

Another consideration is whether or not the deal is a conservative underwriting. Use the numbers shown in the deal’s proforma, comparing the past two months with the same period last year. Look at the renovation schedule to make sure it’s realistic and check on bad debt. If it’s increasing, find out why. Also, look at the concessions that are planned to retain or attract new tenants. The first year’s concessions should be higher, not lower. Finally, look at the debt structure. Agency debt and fixed rates are more conservative, as there aren’t year-to-year fluctuations.

The final consideration is to look at how properties are performing during COVID. Look at vacancies to see if they’re stable or if they’re rising. Also, check on concessions and bad debt. If the numbers are stable, it’s a good sign. If there hasn’t been an increase in these areas, you’re probably looking at a strong performing asset.

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About the Author

Ellie is the founder of Blue Lake Capital, a real estate company specialized in multifamily investing throughout the United States. At Blue Lake Capital, Ellie helps investors grow their wealth and achieve double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.

Ellie is the host of REady2Scale , a podcast that highlights honest, insightful, and thought-provoking discussions on the multiple approaches for successful real estate investing.

She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations.

Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management.

You can read more about Blue Lake Capital at www.bluelake-capital.com and learn more about Ellie at www.ellieperlman.com.