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In this episode, we're joined by John Wilhoit, a real estate professional specializing in residential asset management and property management. Throughout his career, John has focused on high volume, large multifamily communities including market rate and fixed financed developments. He has also authored two books on real estate analysis: How To Read a Rent Roll and The Rent Roll Triangle.This episode is the second part in the series of episodes with John WIlhoit. On today's show, we discuss The Rent Roll Triangle book, the three variables taken into account when making the rent roll triangle calculation, how the calculation can help you make a decision on how to cure deficiencies with your property to increase the income and collection, and two case studies on how to apply the rent roll triangle calculation (duplex and multifamily). We also discuss the potential impact of COVID-19 on real estate investing and tactics that can be used to mitigate vacancy.
If you haven't listened to episode 91, the first part with John Wilhoit, you should check that out before listening to this one!
We have created a Slack community for real estate investors to share ideas on how to protect their business and investments and to stay up to date on the laws and best practices as the coronavirus progresses. The community already has over 500 members and some great conversations are taking place. Visit www.cashflowcommunity.slack.com to join!
The Rent Roll Triangle
The Rent Roll Triangle measures the interaction between gross potential rents (market value of rents), stated lease rents, and collections. These three always have a differential, and the rent roll triangle takes into consideration the elasticity or strength of income. The Rent Roll Triangle is John's take on the outcomes and what we can derive from how these numbers interact. The end calculation tells you the strength, but the components of the triangle help show you where you can focus.
Gross Potential Rents: This is the maximum potential rent on every unit owned - not what the investor wants to receive, but what the market determines is the maximum.
Stated Lease Rents: The amount of rent that a resident has agreed to pay per the lease terms.
Collections: The dollar amount that is actually collected monthly. Though it seems like this should match, your collected rent will never exactly match your stated lease rents.
How do you suggest modeling for the current environment in the US with COVID-19?
There's a rubber band that's always occuring with respect to prices, the elasticity. Nobody know what will happen next. California, for example, has suspended all evictions for the last 90 days. Houston, every year, builds more multifamily units than any city, and construction is likely slowing in this time. Operators will come in and start to offer 1-2 months free in exchange for a 12-month lease. Concessions increase and rent goes down during this scenario. From a bankers perspective, it looks like you have a 12-month lease. From a books perspective, the rent has just decreased 14% for that unit. Many operators believe this is necessary to remain competitive and also may do things such as reduce the schedule of routine maintenance. Emergency maintenance, however, must always stay in place.
The case studies try to give an array of options, a starting point to applying the RRT to your property and circumstances.
Duplex Case Study
In this scenario, the duplex is in an upscale neighborhood, the residents have been there forever, and the rates have been the same forever. In a smaller property, especially one that's managed by the owner, there are likely more disparities and errors in how operations are done. The owner decides they want to sell and creates "pluck from air numbers" and concludes at $500K asking price.
The owner comes to a broker, and the broker agrees. After market analysis, the broker believes the property should be listed at $400K. The RRT calculation for this property is 62.85% - meaning that the property is gaining 63% of the maximum income possible.
The number is comprised of $1,100 of in-place rents and the market value of rents being $1,750. The primary cause of this is complacency, coming from the owner not wanting to be bothered. The owner and residents are both content. Both parties live in bliss. Once we look at the property more closely, we start seeing deferred maintenance and repairs and below market rents.
In this case, increasing rents any amount closer to $1,750 is going to increase the value of the property.
Is gross rent vs in-place rents the cause? Or is there an issue with collections? The Triangle will help shed light on which areas to focus on. Part of what the RRT represents is an opportunity to do this to a property before you buy. By doing this before, you know which areas need work before acquisition.
48-Unit Workforce Housing Case Study
These properties are all over the country and are usually C or D class assets in working class neighborhood. Usually there's no on-site property manager, management is used on an as-needed basis. In this example, the credit quality of residents is usually in the 500s-600s and median income is ranging between 60%-120% of the average.
Our case study depicts that the property is renting 13% below market rents. This lower rent is usually due to operators looking for maximum occupancy. This leads to lower quality tenants and more neglect on the property.
Collections for this property are running at 90%, except of the 48 units, 15% are already vacant. There are gaps all over the place: occupancy, tenant quality, gross potential rent. How do you know where to start? First put all these variables in one place to review them. This is the Rent Roll Triangle. All three of these, along with the average length of tenancy, this property comes in right at 50%.
The RRT tells us there are gaps in all three of the variables. Which one can we have the most effect on? That's the decision you have to come to, with limited resources and gaps everywhere, which efforts are going to make the biggest difference. By having this calculation, you're able to understand the areas that need focus and priority.
With 15% vacancy, an issue with collections, and deferred maintenance, there's likely not many people looking to move in. In this case, the highest value may be to eliminate deferred maintenance to increase the occupancy. You may not have much success in raising rents where these areas have many similar properties close together. Clean trash, paint, make everything square. Window screens, lights, locks on doors, powerwashing, and other similar improvements and maintenance should be done and need to be consistent and functional. A resident should come to the property and have pride of ownership. Incremental differentials are the way to look at this process, both in increasing rent and bettering the property.
Tips for Maintaining Income/Reserves in COVID-19
Don't spend any cash that you don't have to. That may mean you do maintenance yourself, or hire kids or family members instead of a janitorial service. In hards times, you have to do what you have to do. Keep your paperwork in order and figure out payment plans if applicable. Assure that you have good legal, tax, and accounting council. This is necessary during these times and don't presume you'll know how to do everything yourself. We have a great segregation of skills in this country, and professionals will almost always help so surround yourself with specialists. All you have to do is survive, faithfully and securely, during these times.
Learn more about John and his work: johnwilhoit.com