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René Nelson: Let’s use the example of a 1970s 20-unit apartment complex in the Eugene-Springfield market. You and I have talked in the past about how sometimes owners are slow to raise rents because they’ve had tenants there for a long period of time, but now they’re behind the curve for where market rents should be. One thing I talk to my clients about is before you get ready to sell that, maybe what you want to do is go in and remodel some of the interior units, let’s take 12 months, increase rents, and then put it on the market. Talk to me about that value-add opportunity and how do you weigh that as an appraiser?

Strategy for Rent and Utilities as a Value-Add Opportunity for Real Estate in Eugene

Zoe York: I love that you say that you counsel your clients on doing that, because that’s so important. I see a lot that property owners, particularly estates or properties where they actually really do need to get rid of the property quickly or they have pressure from family members, where they go and list the property in as-is condition, as-is state of income, and they don’t spend a lot of time either before the sale or even years before considering selling it, making sure that they’re maximizing their income potential. Unfortunately, what that means from an appraisal perspective or from a value perspective is that you’re losing a lot of your potential property value just upfront. When you have a property that has below-market rents, sometimes deferred maintenance, or maybe it needs unit updates, particularly in a market where rents are increasing and there’s a lot of demand, and you just sell it as-is, somebody else is taking on that risk.

Zoe York: Even in a market where there’s a lot of demand, there’s still risk. There’s risk of construction costs, there’s risk of timing, there’s risk of rent loss. There’s just overall risk, and somebody else is assuming that risk. When somebody else assumes that, they are going to want to discount the property significantly. So not only are they discounting the property for the current state, but also the property is being valued on income that could be higher, maybe on rents that are below market because of long-term tenants, and this can sometimes cause 20 to 30 percent value difference on a property.

Zoe York: When I say a 20 to 30 percent value difference, I don’t even necessarily mean that you would need to put money into it to get that 30 percent extra value. What I mean is that you could spend some time raising rents and making sure that you’re on par with market, and then sell the property and without putting another dime into it except your time and efforts to make sure that you’re maximizing your income. You might achieve a 30 percent higher sale price just from doing that. That’s a really, really important thing to understand for anybody who not only is looking to sell their property soon, but also if you don’t anticipate holding your property for a long period of time, you should start thinking about those things now. Even if you do anticipate holding your property for a long time, it should be in everybody’s best interest to maximize your income.

Zoe York: There’s a lot of ways to do that, particularly in a market with rising rents, and the first is to raise your rents. A challenge that people are running into right now is that particularly owner-managed properties, they might be $200 or $300 below market rent, and it doesn’t mean that you can’t raise it $200 or $300 on all of your tenants, I’ve definitely seen that happen, but a lot of people have sort of moral problems with doing that. So what that means is that if you want to raise your rents $50 every year, you have a pretty long catch-up period. If you don’t want to raise your rents by a massive amount all at once, then you want to start working on it today. You don’t want to wait any longer, so you would want to have a property manager that you talk to about strategizing some sort of rent increases, but that’s definitely one place to start with your value add.

Zoe York: Another thing that we’ve talked about quite a bit and that I’ve seen is instituting a utility bill back. Utilities are not a fixed expense. They go up each year, and you can kind of temper your exposure to increasing expenses by passing that on to the tenants. A lot of times, it can’t be a dollar-for-dollar expense pass through, but you could charge a flat fee, $25, $35 per month to your tenants, and a lot of times that doesn’t translate to a mental rent increase for your tenants because it’s market-wide. It’s something that if you rented a house, you would have to pay those utilities. If you rented a duplex, you would have to pay those utilities. Pretty much market-wide on the larger professionally managed complexes, you can expect a base rent plus a utility bill back, so it’s a way to raise your rents without raising your rents. That’s another value-add opportunity.

Investing Capital as a Value-Add Opportunity for Real Estate in Eugene

Zoe York: The third value-add opportunity is investing some additional capital into your property, and what that would look like would depend on what your property looks like—its condition. Sometimes you have deferred maintenance and you have to invest capital just to bring the property up to market standards. That’s also a necessity because if you went to sell the property and it had substantial deferred maintenance, the buyer is going to expect to pay you what it’s going to cost to cure that plus a profit to account for their time management risk. In any circumstance where there’s deferred maintenance, you’re better off curing it before you sell or before you go to market it if you know about it. Also, a better opportunity is just not let it get deferred to begin with. Make sure you’re staying up on maintenance on a regular basis so your units don’t need substantial improvements to just stay on par with market. That’s one way to add value, but really that’s more bringing your property back up to where it should be.

Zoe York: The other opportunity is to basically rehab units upon turnover or as you can to make your property more appealing. I see a lot of that happening with 1970s properties. Usually property owners will rehab upon turnover. They won’t go through and vacate all their units and rehab them all at once. It just happens upon turnover, so this ends up being a two-, three-, or four-year process sometimes depending on how big your complex is. But because the wider market area is doing that, it’s something that if you have a project with dated finishes that you haven’t gone through and done unit rehabs in the last 10 years, then it’s something you should really consider if you want to maximize your rent opportunity because you can’t continue to increase your rents year after year if you’re comparing to other units in the market that have had rehabs.

Zoe York: The last thing I want to talk about in terms of unit rehab is how much unit rehab is enough. I don’t really specialize in feasibility analysis of cost benefit in terms of cost and do a rehab and resulting rent, but I do see a lot of units. I inspect a lot of units. I look at a lot of rents. I look at a lot of market activity in our multifamily complexes, and the units that I go through that are in the best condition, that seem to get the highest rents and don’t seem to have a lot of value loss in terms of return of their improvements are kind of doing the bare minimum to make the unit look fresh.

Zoe York: In a 1970s unit, you’re not putting granite countertops. You wouldn’t update the cabinets to the highest quality cabinetry in a 1970s unit because you’re not going to get the return on your rent increases. Why? Because you’re going to be comparing to other units that have just new flooring, new laminate countertops, some new paint, and some new fixtures, and that’s going to look the same and rent the same to a tenant as your granite countertops. You might get more wow factor and get tenants in that they are really excited and it has more appeal, but that doesn’t always translate to rent.

Rene Nelson: Yes. Don’t you see sometimes that investors put it in because they have pride of ownership and they think, oh, I really want this because maybe they have it in their own personal residence and they think, well, my tenants would like this, but then when the tenant comes in, they’re not willing to pay for that extra granite or the tile or whatever has been added in?
Zoe York: I do see that a lot, and most of the time it’s the owner giving me the tour and they say, well, I want to make this unit something I would want to live in. That’s a great moral practice, and I think in general in terms of cleanliness and overall feel of the complex, safety, I think that is important. Make sure that your tenants are living someplace that you would be okay living, but I also think that there is a threshold.

Zoe York: There is a threshold for return on your investment, on your capital, and cost does not equal value. It very rarely equals value in a lot of circumstances in appraisal, and so you want to be very careful about how much money you’re putting into a property. You don’t want to put too much into it depending on how old it is and the overall feel of the complex is. If you’re going to do a full rehab of your entire complex and make a 1970s complex look like a 1990s or 2000s or a brand new complex, go ahead and do that. But if you’re going to keep your property looking like a 1970s complex, you don’t want to go through and put too much over improvement into the units.

For more information about investing in commercial real estate in Eugene, call me today: René Nelson, CCIM, (541) 912-6583 / rene@1031guru.com / www.eugene-commercial.com

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René Nelson: When a borrower calls you and they want to get pre-approved and actually go through the lending process, what information do you look at when you’re deciding how much they qualify for in relation to the property? What do you want to know about the property?

Starting the Pre-Approval Process for a Loan for Multifamily Property Investors

Isaac Grant: When we have that initial phone conversation or meet in person about a subject property that someone’s going to purchase, some of the best information to have for that conversation is going to be the offering memorandum from the selling broker. That’s going to give your lender a good snapshot as to what it is that they’re looking to purchase and ultimately what they’re asking you to finance. This helps your lender size up how much they think they’d be able or willing to lend against that subject property.

Isaac Grant: Another great thing to have for that initial conversation is some of the personal financial information for anyone that’s going to be part of the purchasing and borrowing entity for that subject property. We need to see a personal financial statement and some personal tax returns and really get a good picture as to that individual’s financial strength.

René Nelson: You do a lot of multifamily units in the Eugene Springfield area, and tenants in apartments is really my passion. That’s what I enjoy working on. A lot of times a listing broker will bring a property out and we’ll see a pro forma statement that includes typically last year’s expenses and next year’s rent for what I call kind of a market. There’s a difference between market rent and what you could get rents to on the upside for rent. I always try to point that out and really look at it and analyze it for my clients, but when we’re doing that initial inquiry and the borrower is trying to get pre-approved and you’re starting to dig into the financials, how do you deal with that? With market rent versus the proposed rent or where it could be?

Isaac Grant: This is a fantastic question, especially in the current marketplace. We’re seeing a lot of properties that are marketed price-wise at market rents, but maybe the in-place rents are lower than the current market. What we typically like to look at is the historical performance of the property. We want to see some trends. The trends in the rents going up, have they stayed stable to begin with, to get an idea as to whether this property can support an increase in rent. If we think that it can support an increase in rents, then we’re going to look at the management that’s going to be in place also. Is this borrower going to have property management in place? We might even have a discussion with the person that’s going to be managing the property if they won’t be managing it themselves, to see what they think they’ll be able to achieve based on the other properties that they manage in the same market area.

René Nelson: That makes sense. That really helps because I’ve seen a lot of situations where maybe an owner/manager has a property and they’re selling it, but my investors typically use professional management because they’re more passive investors. I just had a situation where market rent was $400, but when my client took it over, they were able to raise rents to $550 but they used a professional manager. In a situation like that, if they can be documented and demonstrated, will you take that into consideration?

Isaac Grant: We can take that into consideration on a case-by-case basis.

For more information about investing in commercial real estate in Eugene, call me today: René Nelson, CCIM, (541) 912-6583 / rene@1031guru.com / www.eugene-commercial.com

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René Nelson: Yeah. When I send a client to you to go through the loan process, I know you want to look at their personal financial statement. Tell me what you’re looking for in the review of the financial statement.

Personal Financial Statement for Commercial Property Eugene

Isaac Grant: The personal financial statement is going to be made up of your assets and liabilities personally as well as your income and expenses on an annual basis. [For a template of a personal financial statement, visit Pacwest Commercial Real Estate.] Typically, we’re looking for some liquid assets. We want to see that you have some cash and you have some ability to support the debt that you’re taking on in the case that the subject property doesn’t perform as we expect it to. We want you to have a strong personal financial statement in regard to some liquid assets. It is good to see some other real estate assets on there as well, for some more seasoned buyers, to see how they’ve managed properties previously.

Isaac Grant: What we don’t want to see is too much leverage. We don’t want to see someone who has low cash liquidity, a lot of assets that aren’t going to be producing cash. If that’s the case, it’s going to be much harder to get them qualified.

René Nelson: You mentioned to me previously that you had someone that you were not able to help with financing, even though they had a pretty healthy asset portfolio. Talk to me about that. What did that look like?

Isaac Grant: It was an interesting scenario, and it’s come up a couple of times actually, with folks that have a high net worth. So maybe they have $10 million in net worth, but a lot of it is tied up in fixed assets, and some of those assets aren’t producing cash. As a lender, what we’re looking for is cash flow to be able to repay our debt. So we’re going to lean heavily on the subject property first, but when it comes to the personal financial statement, we want to see assets producing cash to be able to support the loan from a secondary position. This means there are scenarios where someone may have a high net worth, but they have non-cash-producing assets, and therefore we can’t get them qualified for a loan opportunity.

René Nelson: Ideally, how much cash would be a good rule of thumb to have in the bank?

Isaac Grant: It’s a case-by-case basis, but a good rule of thumb is to have 10 percent of the loan that you’re looking to acquire.

René Nelson: Does that have to be liquid, like cash in the bank? Or could it be a combination of retirement accounts, if they could access those retirement accounts?

Isaac Grant: Again, that’s going to be a case-by-case basis, depending on what those retirement accounts look like. The best rule of thumb to use is going to be real cash in a bank account.

René Nelson: So ideally you’re looking for something that you could access in the event, maybe if it’s a commercial property, like an office, that the tenant moves out and there’s a vacancy, you’ve got a bank account to dip into to cover your payments.

Isaac Grant: Exactly.

For more information about investing in commercial real estate in Eugene, call me today: René Nelson, CCIM, (541) 912-6583 / rene@1031guru.com / www.eugene-commercial.com

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Rene Nelson: Let’s talk about the process. From my perspective as a broker, whether I’m listing a property or I’m representing a buyer, I pretty much go through the same process. For multifamily, the first thing I do is get a rent-roll, and I get the last three years of operating statements and seller’s tax returns. Then I start to analyze those.

Rene Nelson: What I’m looking for are trends. How have the expenses been? Have they been pretty consistent across the board or have we seen maybe a big spike one year or two, especially for repairs and maintenance? Can that be explained? Were there capital improvements included in there, like a roof or a paint job?

Rene Nelson: But if I see either really low factors for maintenance and repair, I instantly become skeptical. I’m kind of wondering, “All right, has this property been managed on kind of a band-aid effect—where they’re not really putting in the true maintenance and repair that they should be?”

Rene Nelson: I look at that from a listing broker situation because I know that most likely a buyer is going to have to obtain a loan and then there’s going to have to be a price that my seller and I agree upon, and that has to be defendable when an appraiser comes out. Or if I’m representing a buyer, we don’t want to overpay for a property if then they get into it and there are a whole bunch of issues down the road with deferred maintenance or different things, so that maybe the operating expenses change once my client takes possession of the property.

Rene Nelson: So, walk me through what you do when you analyze a property from your appraisal process.

Market Standards in the Appraisal Process for Investment Real Estate Eugene

Zoe York: It’s a very similar process as what you do. I collect all the historic data, because I really need to understand what’s been going on in the past and understand the full picture of what’s going on with the property. I also like to ask for three years of profit and loss statements. I ask for a current rent-roll. And a lot of times I’ll interview the property manager or the owner and ask them when their last rent increases were and how frequent their turnover is.

Zoe York: That’s something that’s also really important to ask, because if you have very, very long-term tenants, then there’s a good follow-up question: “Okay, how are your unit interiors? How often are you updating? If you have several 10-year tenants, are the finishes the same that they were when they moved in?” Because a lot of times you’ll have lower rents but also those rents will be associated with a inferior condition of the unit. So I ask those questions to just get a picture of exactly what’s been happening historically in this property.

Zoe York: But from my perspective, because I’m doing these appraisals day-in and day-out, I have a very large database in my head, also in my files, of expenses of similar properties, so I have what we call an appraisal of market standards.

Zoe York: Market standards are basically again this collective database of what other property owners are paying for expenses, not just what this property owner is paying. For example, if a property owner is doing their own maintenance, they might have a very, very low maintenance expense. But when it comes time to do an appraisal, everything I project is market standards. A lot of times, if it’s a property that’s been professional managed and has very consistent expenses, market standards will be exactly what their historic operations have been.

Zoe York: Categories where I don’t see market standards match up very often is repairs and maintenance. A lot of times you’ll see huge variations in repairs and maintenance, and that doesn’t always correlate to the property owner not doing their scheduled maintenance or doing too much. A lot of times what that will be is they’ll do a bunch one year and nothing the next year. And then if I’m only able to look at three years of operating history, I’m not really able to get a very good idea of what an ongoing average expense would be. So then I’ll use market standards because I’m going to say, “This is how much per unit I’m seeing across the board over expenses that I’ve analyzed over decades.”

Zoe York: That’s an important thing to understand from the listing broker versus the appraisal perspective: You’re also trying to look at market standards, but you’re really trying to get a feel for what’s been happening historically and what they might expect to spend moving forward. But when it comes to the appraisal process, I might completely throw out their history if I feel it’s not relative to market standards and only use what the market is expecting.

Zoe York: Again like you said, when you’re dealing with a property listing, you also have to consider that because the appraisal is going to go off market standards. So if maintenance is projected too low and your expenses are too low, that isn’t going to correlate when it comes time for me to do the appraisal because I’m going to project that higher expense.

Zoe York: Another thing that I like to talk about is vacancy. A property owner might have a zero percent vacancy ongoing vacancy for a property that has very low turnover, long-term tenants. They might have even had a 2 percent vacancy over 10 years.

Zoe York: But almost always we’re using a 5 percent vacancy factor in apartments moving forward when I’m doing the appraisals. The reason for that is even though the cap rate, the performer in an income approach, is a one-year snapshot, what it’s meant to do is reflect the property over a holding period. Typically, we consider a holding period to be about 10 years. So that vacancy factor is not only the vacancy; it’s vacancy and credit loss during that time period. But it’s not just what the vacancy in the market is today. For example, in Eugene, Springfield, it’s about 3 percent today. It’s not just what the vacancy is today, but what your expectation as an investor would be—what your vacancy over that 10-year holding period would be.

Zoe York: In the recession, for example, our vacancy was 6 or 7 percent. Even in this best time it’s at about 3 percent and it could go a little bit lower than that. But if I’m projecting over a 10-year holding period, we see 5 percent to be about the market norm. That’s an important thing for property owners to understand, that when they see an appraisal, when I project a 5 percent vacancy, that doesn’t mean that there is 5 percent now or there has been 5 percent in the past. What it means is that any investor looking to purchase the property would reasonably expect 5 percent vacancy and credit loss over the holding period of the property.

Rising Flood Insurance Rates

Rene Nelson: An expense that I’m also starting to see factored in is insurance cost. It seems like insurance premiums are starting to go up for many owners. Are you seeing that also?

Zoe York: I am seeing that. I’m also seeing flood insurance as a huge factor. It’s something that I have to ask about constantly. If I see a property that’s in the floodplain and they’re going to need flood insurance, then I have to ask the property owner for their most recent premium for this current year because the past premiums don’t necessarily reflect what their ongoing expense is going to be.

Zoe York: This is something that needs to be shopped around when you go to buy a property. It’s also something that I see huge variations in because if an investor owns a portfolio of properties, they’re going to get a lower insurance rate on that one property because they own so many properties. Whereas if you just buy your one apartment complex, you’re going to pay more because you don’t have this whole portfolio of properties insured under the same company.

Zoe York: This is another one of those market standard things. When I project forward, if I see that an investor, who I know owns a very large portfolio of properties, has a very low insurance expense, I will project market standards for that insurance, not what that investor has historically paid.

Rene Nelson: Yes, obviously this increase in the expense of flood insurance makes a direct impact on the bottom line for net operating income.

Zoe York: This is kind of a new thing, and it isn’t something that I have seen frequently impacting rents. But I do wonder how it’s going to impact triple net rents for offices and retail, moving forward.

Rene Nelson: Well, it seems like FEMA just repositioned their map in the last 12 to 24 months, so owners are just now getting those notices of either, “Your premium’s going up,” or, “Now you are in the flood zone.”

Zoe York: For brokers, appraisers, and property owners, this will be a very important thing moving forward because there’s always an adjustment period in the market where people realize this expense and then how that gets translated into the market as value or rent or risk. It will be an important thing for us all to watch moving forward over the next 12 to 24 months as to how that impacts property values and net operating income.

For more information about investing in commercial real estate in Eugene, call me today: René Nelson, CCIM, (541) 912-6583 / rene@1031guru.com / www.eugene-commercial.com

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Rene Nelson: I know you’re an MAI appraiser. What does that designation mean?

Zoe York: MAI actually doesn’t stand for anything. It’s not an acronym, but it’s a designated member of the Appraisal Institute, a globally recognized organization of appraisers. When you’re an MAI member, you’ve reached the highest designation that you can get in this professional organization. To become an MAI, you have to have 4,500 hours of additional specialized experience above your typical license. You have to have several additional classes that you’ve taken, specialized advanced courses. You also have to take a two-day comprehensive exam and write a demonstration report. The demonstration report is really kind of like a thesis. All in all, it takes about four years above your typical license certification to reach the MAI designation.

Rene Nelson: Wow. And how long have you been an appraiser?

Zoe York: I’ve been licensed since 2011, and I’ve had my MAI since 2014. I’ve worked with Duncan & Brown since 2005. I started as an intern back when I was in high school.

Rene Nelson: Wow. That’s amazing. So talk to me about the appraisal process. What changes or difference do you see between private work versus a bank? I know the banks have a process they have to go through, right? How does that work?

Understanding Appraisals in Eugene Commercial Real Estate

Zoe York: When I bid work for a bank, that’s exactly what I’m doing. For any job I tend to give a bid to either a private client or a bank. And I say, “This is how much it’s going to cost. This is how much time it’s going to take me.” Then they can either accept or reject that bid. When it comes to a bank, typically I’m one bid in a pool of multiple appraisers that are bidding for the same job. And the banks tend to do that because it’s not quite as strict as it is in residential work where it’s completely blind and they’re going through an intermediary. But, for the most part, they’re trying to keep the loan officers and the reviewers separate from the appraisers, so they’re not picking who they want to appraise the property.

Zoe York: Typically, it’s me and several other appraisers bidding for the same job, and we give our time and our fee, and the bank will take that time and fee and they’ll select based on their requirements for that particular loan. Sometimes they want the fastest, sometimes they want the cheapest, and always they want cheap and fast. But sometimes they kind of have some wiggle room in terms of who they’re selecting, and I’ve been told by some banks that it is completely blind; other banks will call after-the-fact and they might have a little bit of control over who they’re selecting because sometimes the property owner can say, “We want Duncan & Brown to do the appraisal.” Then the bank will do everything they can to try to facilitate that, but that’s not always something they can accommodate.

Zoe York: When it comes to private work, we’re working directly with clients. The client contacts me, I give them time and fee, and they either accept it or reject it. Typically, they’re not out there looking for other bids. I tend to prefer that kind of work because when I’m working directly with a private client, there aren’t not four different places where data can get lost or there can be miscommunication. It’s just me and the client, and there’s a little bit more of a personal relationship there. They tend to feel comfortable communicating with me, and we can really get the job done more efficiently with private work. Whereas, with bank work, there’s so many different parties involved and sometimes the data just doesn’t make its way down to me in a timely manner.

Rene Nelson: Why would a private individual, say, in the Eugene-Springfield market, contact you at about an appraisal? What are they typically trying to accomplish?

Zoe York: Most of the private work I do is estate work, so it will be for estate settlement purposes. Typically, their accountant will tell them to contact me, or the accountant or lawyer will contact me directly. Often with estate work, there might be a portfolio of properties, or we might be dealing with multiple siblings, but it’s usually the executor of the estate who will actually contact us or facilitate the appraisal. Other reasons we might do private work is somebody might come to us and they might want to get an appraisal done to establish a purchase price.

Zoe York: A lot of times, I will counsel against that, unless they really need it for purposes of negotiating among their family members or negotiating with a board. If they really need an appraisal, they need an unbiased opinion to establish a purchase price, then we do that. But sometimes if they’re just looking for a purchase price, I will refer them to a broker. A lot of times an appraisal is an overboard measure of trying to figure out what to sell your property for, particularly if it’s a type of property that there’s not a lot of data out there for.

For more information about investing in commercial real estate in Eugene, call me today: René Nelson, CCIM, (541) 912-6583 / rene@1031guru.com / www.eugene-commercial.com

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René Nelson: Let’s talk about debt coverage ratio and how you analyze a property. I know that’s changing right now in this market and I know that it also changes for different types of assets. Talk to me about debt coverage ratio and what that looks like.

Isaac Grant: Debt coverage ratio is something that your lender is going to talk about a fair amount, and they should be discussing that in the upfront conversations with investors as to how they’re going to measure the property’s net operating income. As you mentioned, it’s different or different property types.

Debt Coverage Ratios for Commercial Real Estate in Eugene

Isaac Grant: Typically, a minimum debt service coverage ratio that a lot of people use in the marketplace will be somewhere around a 1.25. Some will go as low as 1.2. That means for every dollar of debt that you’re taking against the property, we want to see $1.20 or $1.25 of net operating income so that the income produced by the property far outweighs the amount of debt that you’re taking against it.

Rene Nelson: And in relation to that, you obviously want to see some financial statements in relation to the property. Often, we only have the offering memorandum upfront until we have an accepted purchase agreement and we start into the due diligence process, and then we’ll typically get financial statements from either the owner or the property manager. We get the last three years of the owner’s tax returns. So in the initial upfront process, when you’re just doing some quick calculations to tell someone what they qualify for, are you comfortable going off of the operating memorandum that we have to just start that initial conversation?

Isaac Grant: We’ll typically use the information provided on the offering memorandum, but with the understanding that we’re going to need that information backed up with the historical financials. If we’re looking at a proforma and an offering memorandum, we can use those numbers, but with the understanding that the loan amount may be reduced once we’ve actually been able to take a look at the historical information provided to us. We would do that If there’s a major discrepancy between the proforma and the actual in place net operating income that the property’s producing.

How Debt Coverage Ratios Differ Between an Office Building and a Multifamily Property

Rene Nelson: Do you have a different debt coverage ratio for multifamily versus an office building?

Isaac Grant: We do. It’s on a case-by-case basis, but most financial institutions are going to have written within their policy slightly higher debt service coverages for what would be seen as higher risk properties. Properties that are single use or single tenant may have a slighter higher debt service coverage because they offer a higher risk. If a single-use property goes vacant, there’s nothing else to support repayment of that loan from the subject property. In a multifamily situation, if you have a couple of tenants leave on a larger complex, the property’s usually going to be able to absorb that, so it would qualify for a lower debt service coverage.

Rene Nelson: In today’s market and as just a general rule of thumb for multifamily, should most borrowers assume a 30 percent down payment roughly? And I know it depends on cashflow and net operating income, but as a rule of thumb, does about a 30 percent down payment sound right?

Isaac Grant: Historically we’ve seen 25 percent cash down. In the current marketplace you’re going to probably be looking at more like 30 percent cash down, and, in some cases, 35 percent.

For more information about market trends and opportunities, call me today: René Nelson, CCIM, (541) 912-6583 / rene@1031guru.com / www.eugene-commercial.com

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René Nelson: What are you seeing for cap rate trends for multifamily in the Eugene, Springfield area?
Zoe York: In general we saw a huge increase in cap rate trends during the recession, not just for multifamily. Then, starting in about 2014, we began to see a steady decline. That sort of leveled out last year. We hit fairly low lows on all of our cap rates in 2017 and we’ve seen more stabilization in 2018. I expect cap rates to stay stable into 2019. Then, there’s a little bit of uncertainty in our market as to what’s going to happen mid to late 2019 and moving forward. A lot of that uncertainty is because of rising interest rates. That is a bit tempered by having a market in which we’re in a major undersupply situation, particularly in multifamily, but also in some of the other property types.

Zoe York: We also have very limited land availability and rents are increasing. On top of that, we have a lot of investors looking to put money places. You have undersupply in terms of your tenant base, and you also have undersupply in terms of properties available for purchase. All of that puts downward pressure on cap rates and upward pressure on prices. Even in a climate where interest rates are starting to rise, you still have a very, very high demand. I think that’s going to keep cap rates stable in the short term, but ultimately rising interest rates will result in rising cap rates.

Zoe York: I don’t have the answer to this, but the question is how long that lag period will be. How long will our undersupply and overall market demand temper these cap rate increases? My general feeling based on what I’ve observed in talking to people and looking at the market is that we will see stability in our cap rates over the next year. Then the question becomes what the impact will be and the magnitude of it as interest rates rise.

René Nelson: How do you factor in the uncertainty, but also kind of knowing what the projection will be for, say, six months down the road? As you’re doing an appraisal today, how do you factor in six months down the road? I also know you look in the past, so talk to me about that process because I know you do a lot of analysis trying to read the tea leaves.

Zoe York: The tricky part about cap rates is that even though they are a point in time measure of risk, they actually are meant to inherently reflect risk over a projection period. Even though it measures only a single year’s income, it inherently reflects the market expectation for change. What that means is that if you purchase a property today and I see the cap rate of your property as of today’s projection of next year’s income, that rate should inherently reflect your investor expectations of what the changes in the market might be. The challenge with that is, even though all the cap rates that I might see, if everything sold today, every cap rate should inherently reflect that market perception for change moving forward.

Zoe York: The challenge is that as sales volume decreases, for example, if everything sold today and I appraised property six months from now and I didn’t have any sales between now and six months from now, I’m using cap rates that reflect market expectation of change from six months prior. As I said, in a market like this, cap rates might stay stable for a year. Well, there’s going to be more expectation for change six months from now. That’s always the challenge as an appraiser is looking back. I’m using data looking back, not forward. I have to take into consideration that that date of sale might not reflect the true market expectation for change.

Zoe York: I can’t make things up. I have to use a supported valuation. I’m still using those sales and I can use my best judgment. I can talk to brokers. I can use other market trending data that might be more recent. I can try to project out what’s going to occur and how that risk should be assessed in the context of the data that I have, but it’s always a tricky game, particularly in a market that’s rapidly increasing or rapidly decreasing. Essentially, I have to use my best judgment, but I’m always stuck using sales in the past. That’s always going to be a challenge in being an appraiser and using appraisals in a changing market.

Campus and Multifamily Properties Eugene

René Nelson: Talk to me about campus. I know the University of Oregon has always been on the radar of the national student housing developers. Also, we have a lot of 10- to 20-unit complexes from the 1970s. What are you seeing for cap rates for the campus area?

Zoe York: Truthfully, the campus area has not historically shown a huge variance in cap rates in terms of the larger market area. We did see lower cap rates right in the 2014–15 era when these brand new complexes were selling. I didn’t necessarily think we saw that because it was campus, but It was more because these were newer buildings. It all comes down to the characteristics of the income, not necessarily the location, but the location does drive the income projections. Now I’m seeing cap rates for campus being just the same as cap rates marketwide. The differences arise from the age of the property, the location of the property, and the risk to the income.

Zoe York: If you have a campus property that’s older—not 1970s older, but maybe 2006 older—and it’s on the western fringe or on some other fringe of campus, then that is going to be higher risk because those properties have rents at the upper end because they’re newer, but they’re on the older end of the newer properties. They’re also in an inferior location. That is the highest risk property in terms of your campus sub-market. That might have a higher cap rate, but it’s not necessarily because it’s campus. It’s because of its location and its rent characteristics and its risk characteristics.

Zoe York: Generally speaking, I’ve seen very high demand for smaller, older properties on campus, both in terms of rent demand and also in terms of investor demand. The larger ones—let’s call them purpose-built projects, like The Hub and 2125 Franklin—those have been kind of their own little sub-market. They tend to operate on lower occupancy than the rest of the market, but they also drive down overall campus occupancy. The campus vacancy factor was 2.7 percent last year and 3.1 percent this year. Most of that vacancy is in these larger purpose-built projects. I would say the smaller, newer, locally owned and operated projects have only about a 1 percent vacancy factor right now—or less.

René Nelson: I know a lot of the multifamily owners that own the 1970s stuff on campus, and they don’t want to sell because they’re able to increase those rents every single year. As you know, most students only stay in a place for a year; either they have a roommate they don’t like or they want to room with somebody different. They typically transition every 12 to 18 months. Interestingly enough, one thing that I see with a lot of investors is that not everybody has that appetite for the campus market. They’re afraid of student housing or they have to solely rely on a property manager to manage that property for them because of the inherent risk. What’s your thoughts on property management and student housing? Do you still see that most of those 1970s properties are professionally managed? Or are some self-managing?

Zoe York: With the older properties there’s definitely a mix of owner managers and professional management, just like there is in the larger market. What I’m seeing more frequently is the need for professional management in apartment complexes. If you’re looking at a duplex or a smaller property, then owner management is really not a big deal. It tends to be a pain because you’re dealing with students but I know several people who do own their own duplexes and single-family properties and they manage them themselves, but it can definitely be a challenge.

Zoe York: When you get to five units and more, I see more and more that professional management is important. It’s not just in the campus market. For the campus market, it tends to be important because of the timing of leasing. When there are a lot of students coming to the market and you don’t put your units on the market for lease or renewal in early January, then you’re kind of missing the boat. A lot of people will wait until March or April. I do a campus rent survey every September, but I do an intermediary survey in March, and a good portion of property managers are 90 percent full by March. In terms of pre-leasing for the following year, that really important for professional management. Also in the larger market area, when you have rising rents and low vacancy, it’s important to have a property manager who is keeping their finger on the pulse of the market and raising rents on intervals appropriate with how market rents are rising.

Zoe York: I’m seeing more and more frequently that property owners aren’t raising rents on pace with the market. When that happens, you fall behind the curve and then you’re suddenly $200 or $300 below market and you can’t catch up.

For more information about Eugene market trends and opportunities, call me today: René Nelson, CCIM, CRE (541) 912-6583 / rene@1031guru.com / www.eugene-commercial.com