Bill Ham is Chief Operating Officer and the driving force behind Broadwell Property Group. He has upwards of 20 years of experience in Real Estate with a proven track record of identifying, acquiring, operating, and divesting of large footprint Multifamily Housing as well as SFRs. He is also a coach and mentor to the future titans of multifamily real estate investing.
In today’s episode we discuss a creative financing strategy known as Master Lease Options and when to use them, we answer the question should you use third party property management or build you own company, where Bill believes we are in the market cycle, and much more!
Bill acquired his first 400 units without traditional conventional financing. Bill used methods such as seller financing, master lease options, debt partners, lines of credit, and credit cards.
A lease option, or a master lease option if a multifamily property, is two separate contracts. The idea is that the document gives the buyer the ability to rent the property and buy the property at a later date. A purchase price is agreed upon at the beginning. The buyer can then take control of the property and make improvements or other changes. The buyer has the ability to actually purchase the property before the date on the contract. They could also sell the master lease option contract to another investor.
The buyer attempts to bring the value of the property up much higher by taking a distressed property and adding value through rehab and renovation. For the buyer, they can ideally bring the value of the property up above the agreed upon sales price.
This strategy works in all asset classes, it's just a negotiation structure.
"That's the nice thing about the master lease part, not the option. It's how we control the cash flow. It's a way of creating and controlling a stream of revenue without necessarily owning the property."
"That's the key to creative financing. Especially when we go into a recession cycle, debt pulls back, somebody has a distressed asset... How are we going to get these deals done? Through lease options. We take over [the asset], bring them out of distress, and then exercise the option."
In a bull market, some of these creative financing techniques may not be as relevant. As asset prices continue to rise, sellers can generally sell any piece of property, even if it's highly distressed. In a market decline, however, as lenders pull back, especially on distressed assets, these techniques become significantly more relevant.
Understanding market cycles is key to creating and customizing a strategy.
"There's a lot of lending, but so what? The underwriting is terrible at the moment. [The market] shifts back and forth, where there's available funds or available deals. As we go forward into a lack of funding and a lack of lending cycle, these are the tricks you use to replicate debt when you can't find debt."
There are four primary stages of a market cycle. The stages go by many sets of names, and Bill explains them as: expansion, peak, recession, and the trough.
We're been in a very long, extended upward expansion. Some may say a peak. Bill believes a recession is imminent, and his warning sign is lenders.
"All you've got to do is watch the debt. When you see debt starting to pull back from the market, it's a tip you're going to go into a recession cycle. Lenders can kind of see forward and see the market cycles coming, so they stop lending as much."
"Right now, what are lenders doing... escrows are higher, agency debt is very difficult to come by because they're really looking for quality borrowers. It's not about interest rates..."
Bill is in the Southeastern US and lives in Atlanta. Bill has considered diversifying further out of Georgia, but he's delaying because he doesn't believe now is the time to be desperate or aggressively seek a deal. He's sitting tight until some metrics return to more regular levels. He'll do a deal, but only if it's really good.
Cap rate and price spread between asset classes is extremely narrow right now. B and C assets are extremely overbought - you're paying A prices. With lower-quality assets, when they're priced too high, the impending and unknown CapEx needs are a critical threat. On older properties, large expenditures can come due without warning. Bill foresees a "CapEx tsunami" coming to C Class properties in the next few years. The CapEx treadmill may get started, and this kills cashflow.
Bill decided to enter into property management, almost out of necessity. Once he had added several properties, he formed a separate entity and began managing his portfolio. He grew and hired others at the management company.
Bill recommends that investors experience self-management on a few properties at some point in their investing career to learn the business and have an understanding of property management.
"It's a completely separate business it has really nothing to do with real estate. It's employees, it's systems, it's management, so, stop and think about that..."
Bill sees pros and cons of in-house property management. It's not passive income, or "mailbox money". It's an active business. Some investors may have more overall success if they solely pursue deals. Bill feels he has missed out on deals in the past due to the time and effort commitment to property management.