Our deal analysis today looks at an 11 unit multifamily building in Englewood, CO. This deal is particularly interesting because of the creative financing and value add business plan the investors are implementing. To help break it down, Travis Sperr of Renovo Financial joined me to discuss the details. Travis is one of our Strategic Partners, and he did the lending for this deal.
- Listen to the podcast “#364: How to Boost Returns on a 1960s Multifamily in Englewood” on the Denver Real Estate Investing Podcast
- Watch the YouTube video (at the bottom).
- Read the blog post. Note, the blog is an executive summary. Get the in-depth breakdown from the podcast or video.
These are sophisticated investors who already own a handful of multifamily investments. They have a unique strategy of using medium term rentals that helps boost their returns.
Medium term rentals are longer than 30 days and less than a year. Usually, they consist of 3-6 month stays.
Investment Property Details
This is an 11-unit building in Englewood that’s in close proximity to several hospitals. It’s a clean, brick building built in the 1960s and has 1 bedroom/1 bathroom units. The property was in turnkey condition and no major CapEx projects needed to be done.
The investors’ plan was to let the leases expire and convert the units to medium term rentals. Getting them in shape for this required some cosmetic updates and purchasing furniture.
A great feature of this property is a storage area that can be easily converted into a 12th unit.
The purchase price of the building was just over $2.1MM, which put the cap rate at 4.5%. While this cap rate is low for the age of the building, it’s still good enough to start the project.
The hardest part was securing financing for the property, which is where Renovo stepped in.
Although the investors were very financeable individuals, banks had a hard time with the loan to value (LTV) of the building in its current state. Banks look at market rents or as-is rents of a building, whichever is lower. In the case of this building, rents were considerably under-market, so the building wasn’t hitting the necessary debt service coverage ratio (DSCR). By going through a bank, they would be required to make a down payment of 35%.
Luckily, Renovo doesn’t have to put as much weight on DSCR. They were able to offer the investors an interest only loan with a 5 year Adjustable Rate Mortgage (ARM). This loan allowed the investors to put down 25%
Leverage was the most important aspect to them because it would allow them to implement their strategy. The interest rate on the loan wasn’t as important to them because they had a plan to increase returns using an entirely different rental strategy. The revenue this strategy will generate for them is much larger than the interest rate. The opportunity cost of getting into this building overrides a 1 or 2 point swing in interest rates.
Implementing a Medium Term Rental Strategy
As mentioned earlier, the leases in place were on a rolling basis, meaning they all expired at different times. This was a good setup for them because it allowed the investors to get consistent cashflow while they were implementing their strategy.
Once they gave the one month notice to tenants that their lease would not be renewed, they would make the updates and purchase furniture for the unit. Each unit cost about $6K in total to update.
The target renters for this building are traveling nurses who will work in the nearby hospitals and those who are in-between permanent locations. Because of Covid, Colorado became a very popular place for people to stay for a few months at a time.
The great part about implementing a medium term rental strategy on a staggered basis is that it gives the investors additional wiggle room. They were still getting consistent rent from the units that hadn’t been turned yet, which helped offset the updating costs. Additionally, if the rooms weren’t being successfully rented on a medium term basis, it is easy to switch back to long term. Because the medium term lease lengths are typically 3 months, they aren’t all ending at the same time, which gives the investors time to figure out how to change course, if necessary.
Returns on Medium Term Rentals
Medium term rentals generate a significantly higher rent than traditional long term rentals. In this area of Englewood, market rents are about $1300. The medium term rents for these units are about $2000 per month. These units will be particularly attractive to renters because of their proximity to a number of hospitals and the fact that they are more affordable than similar buildings in the area.
When all of the units are rented at the medium term rate, the cap rate will be well above 5%.
Long Term Plans
It will take about one year to stabilize the building, including converting the storage area into a 12th unit. The investors will want to start thinking about their refinance options because they are on a 5-year ARM.
Being able to refinance in one or two years will be tricky because of their unique rental strategy. Most financial institutions don’t understand medium term rentals as well as they do traditional long term rentals, which makes them hesitant to take on the loan. There isn’t as much data on medium term rentals, which means there aren’t enough comps for them to feel comfortable.
In a worst-case scenario, the lender will end up owning the property they’re loaning on, which means they have to see themselves running that business. A long term rental is easy to understand, but a medium term rental is an entirely different business.
Once the investors get to year three or four, they’ll have enough historic data within their own property to show consistency and seasonality. They’ll have a much better chance of getting a new loan then, thanks to their large Net Operating Income (NOI).
They’ll have a lot of options at that time to decide whether they want to pull cash out or focus on maximizing cashflow.
Connect with Travis
This deal analysis shows why it’s so important to have a lender who understands your long term goals. Because Travis and Renovo understood the change in rental strategy the investors were implementing, they were able to help them get a loan that would best suit their business model.
If you want to see if Renovo has the right loan for you, Travis would have the opportunity to have a quick conversation see if it makes sense to work together. You’ll both know pretty quickly if his products are the right fit for your situation and business. You can a time to talk with him here: https://meetings.hubspot.com/travis-sperr.