Given the recent rise in interest rates there has been a slow down in the Purchase Mortgage Applications according to the Mortgage Banker Association weekly survey. REIS put out a very interesting quarterly update relating to vacancy rate trends and associated implications to the apartment investment market.
Key Takeaways for me from Dr. Victor Calanog research:
1) When vacancy rates are below 5% then annualized rent growth should be 4 to 5 % which is no longer the case
2) Given the fact that wage growth has been pretty mediocre, a lot of tenants are now paying well over 1/3 of their disposal income in rents. In turn, landlords are steadily losing their pricing power despite the fact that things are still really tight on the occupancy side.
Once again great video by https://www.reisreports.com/
from Reis Reports
Dr. Victor Calanog PHD from REIS reports on the apartment market performance for Q1 2013. Here are his highlights:
*Apartment vacancy hit 4.3% at the end of the first quarter.
*Asking and effective rents grew by 0.5%
*Multi-family development is continuing to surge, bringing 150,000 units online in 2013.
Here is my 2 cents:
1) Latent Household formations can be a counter to this supply surge that Dr. Calanog warns about. More formations are good news. It suggests more people getting jobs, getting apartments, getting married, having kids, and (in all likelihood) spending more money to furnish their new households and express their independence. This recovery, however, has been a story of few jobs, crowded apartments, low marriage-rates, and low birthrates. Household formation is miserable now, but it’s projected to pick up for a simple reason: an improving economy is bound to encourage young people to get out, buy apartments, and get married, eventually. How fast they start gobbling up apartments and houses is unclear. But Credit Suisse makes three projections: No recovery (unlikely), strong recovery (possible), and consensus recovery (plausible).
2)I agree that pricing power is tipping into the hands of the tenants. Rents have grown so fast that there has to be a slow down if not a negative decline to rebalance affordability in my personal opinion. A key indicator to watch is the buy to rent ratio which is starting to favor buying real estate instead of real estate in certain states and townships. Be cautious as a real estate investor when building out rent growth scenarios in your Discount Cashflow Model.
New Jersey Real Estate Markets prices are artificially popped up in the opinion of Ankit Duggal. “I have reviewed the home price numbers on an affordability standard and in some townships the metrics are out of whack.” Additionally, a study by the New Jersey Judiciary stated that:
“The N.J. Judiciary, which tracks foreclosure activity using different methods, also reported a big jump in the first quarter of this year, compared with last year. It reported 8,571 initial residential foreclosure filings, up 120 percent from last year.:
Just be careful of your valuations is the main advice of Ankit Duggal. Take a review on his video below:
Attracting private investors to fund real estate projects is one of the most important things real estate investors do to make a living. It’s critical to their success. Without those funds projects don’t get finished, the property doesn’t get revitalized, and you do not get paid. So making sure that their investment is protect is in your best interest.
I often ask myself if there is anything new or different that I should be incorporating into my pitch to my private investors to make doing business with me more attractive. I recently stumbled upon an idea that I think has some legs.
The idea originates from a fairly routine and commonplace business practice called “KEY PERSON INSURANCE” or “KEY PERSON PROTECTION”.
What is Key Person Insurance
The concept of “KEY PERSON INSURANCE” is a concept that many businesses use in order to protect themselves against the loss of a “Key Person.” If you are an investor, your key person is the real estate entrepreneur who is putting the deal together. What happens when something happens to them?
That is where “KEY PERSON INSURANCE” comes into the picture.
Key person insurance is generally described as an insurance policy taken out by a business or organization to compensate the business for the financial losses that would arise from the death or extended incapacity of an important member of the firm or business. The policy does not extend beyond the period of the key person’s usefulness to the business. The aim of key person insurance is to compensate the business for losses incurred on account of the loss of a key income generator and to facilitate business continuity.
We are our individual capital investors “KEY PERSON”!
How to utilize Key Person Insurance in Real Estate Deals
Key Person Insurance can be adapted to real estate specific needs and in so doing make you the investor more attractive to potential capital investors. Capital Investors return of the capital plus the anticipated return they will earn is dependent upon a lot of considerations and assumptions. Not the least of which is the assumption that the real estate operator will live to complete the project and return the invested capital and return on investment them.
However, if the real estate operator is not alive to complete the project then it is a virtual certainty that the capital investor will be left an uncompleted property and not the return of capital and return that he/she had anticipated.
That’s a pretty big concern for someone investing a sizeable amount of money.
Three Steps to using “Key Person Insurance” to protect capital investors:
- Real estate operators, should take out a life insurance policy on themselves for a benefit amount equal to the capital borrowed from capital investor plus the return that the investor anticipates receiving. Doing so you are in effect quantifying the financial loss the private investor stands to incur if the real estate operators die before the project is completed.
- You would name your investors as a beneficiary. The capital investor is insulated from financial loss should something happen to you through the death benefit. It is possible to have more than one person named as beneficiary on a single policy. So, you might need more than one beneficiary (ie syndicate investments) but you would only need one policy.
How much will this cost me?
The cost of the insurance policy is what you have to contend with, as it needs to be considered in your cost of doing business.
From a practical standpoint, it wouldn’t be advisable for you to go out and secure a new policy for each and every project. When you receive borrowed funds from individual investors you name them as beneficiary to your “Key Person” life insurance policy for an amount equal to the capital you are obligated to return them.
When you have sold the completed project then you pay off the capital investors and remove them as beneficiary of the “Key Person” life insurance policy. As we acquire new investors for other projects you add them as beneficiaries to your “Key Person” life insurance policy and simply repeat the process.
What is the right policy for Key Person Risk Mitigation?
There are two types of life insurance coverage to consider for this purpose.
Term Life Insurance:this is the cheapest alternative with a guaranteed premium for an extended period of time (ie 20 year term)
Permanent Life Insurance: There are different forms of permanent life insurance protections available that return all paid premium to the policy owner (i.e. you) after a number of years have elapsed. This type of policy costs more, but in the end all the premium you have paid will be returned to you.
Please note that the cost of life insurance, whether it be term or permanent, is to a large extend dependent upon your age, medical condition/history, and you’re your smoking status. For some people, the coverage may be cost prohibitive and perhaps even not available on account of their age, medical condition/history, and smoking status.
Basically it is up to the individual real estate professional to decide whether or not this adaptation of “Key Person” Insurance is compatible with their business plan and model.
This great guest post on mitigating capital investor risk was written by Rick Kelly. Mr. Kelley is the Senior Benefits counselor at Capital Benefits LLC. You can connect with Mr. Kelley through his LinkedIn profile.