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New Construction Fourplexes in US Growth Markets
Welcome to Passive Real Estate Investing. I’m you’re host, Marco Santarelli. On today’s show, I want to bring you one of our great providers that we work with in several different markets around the United States. They have a particular niche. They focus on brand new construction fourplexes in growth markets in the United States. This is a great product for certain types of investors. I would let Steven explain that. I don’t want to steal any of his thunder. First, let me welcome you on the show, Steven.
Thank you, Marco. It’s such a pleasure to meet with you. Thank you so much for taking the time to have me on your show.
It’s my pleasure. I think this is great because the information that you’re going to share today about the three different markets that you’re in and the product that we’ve been selling to clients is going to be very beneficial because we can reach a wider audience and do it very effectively on the podcast. First and foremost, let’s start off with you for a few minutes here. Why don’t you share a little bit about yourself, where you came from and how you got involved with real estate and real estate investing?
I started out as a full time student. I was going to university. I knew that I wanted to get into real estate. I got my real estate license back in 2007. One of the mentors that I met with gave me some really insightful advice. I live in a mountainous region. He said, “If you go to the top of the mountain and look down on your market, you now have a license to do something that impacts that place for good. You get to choose what’s the highest and best use of your time to do that.” That was my mindset the entire time I was in real estate. What can I do to make a difference? Not just get commissions. What can I do to make a difference in this industry?
At the time when I was working with a builder, there’s plenty to compete with: a first time buyer, home builders, etc. you sit model homes. I didn’t have a flavor for that. I had no desire to sit in a model home and hear about people who wanted to change a room color or a flooring option or move a light fixture over three inches. That just didn’t do well with my brain type. At the time, there was a scarcity of a multi-family. I had investors that wanted to buy fourplexes, duplexes or eightplexes, etc. because of the ability to leverage decently and have one rooftop for more renters, rental sharing. There was very little available.
I talked to this builder I was working with and said, “Why don’t we build them?” The very first product type we put out, I sent out an email just to my database saying, “We’re going to build this fourplexes. We had nine of them. They’ll be new construction. You’ve got to get your own construction loan because we’re not going to finance it for you. It’s a really good return. If you’re interested, let me know.” Within 30 days all nine had sold out. Nothing sold at that speed. It was when the market was down. We found that there was really a lot of demand for stable new construction fourplexes specifically. That’s how I got started in investment and since then had done about $250 million in sales with this product type and have expanded to three new states.
The states are Texas, Houston is the metro area. Salt Lake City would be the other metro area. We’re actively involved in those two markets. The third, which is something that we just started talking about, is in Boise, Idaho. The market is important to me because when you approach real estate investing, you want to start with a top-down approach, which means you want to start by looking at the market. Does the market make sense? Is it fundamentally sound? Is it economically sound? Is there a diverse economy? Is there job growth? Which is critically important. Is there population growth? Are there major employers in the area or is it a one-trick pony type of market?
That’s very important. That’s always the starting point. Let’s look at these three markets and just break them down. You can answer the fundamental question of, why should I, as real estate investor, be investing in Houston, Salt Lake or Boise, Idaho?
We often get asked to go into areas that people liken to second home market because they want to put their investment and combine it with the place they would like to go. We retreat from those areas for those exact same reasons that you just mentioned, Marco. They don’t have the key indicators that were looking for. We also stay away from the boom and bust market that are driven exclusively by things like energy. Sure, they have very high rent until they absolutely fall apart and have no one renting.
We’re looking for some key indicators. STEM jobs: science,technology, engineering and mathematics in a growing market tends to create stability when markets slow down. They have a large rental pool of good employed individuals that have decent credit and take care of the unit. We’re looking for low unemployment, 4% or below, high income growth so the wages are increasing not decreasing by the types of jobs that they’re bringing in to their economy, and low vacancy rate, on average our vacancy rates throughout our markets go between 3-5% vacancies in any market we’re in.
Another thing that we’re looking for is that we want states that are expanding or growing in their population base. A little lower median income, which means they still have families and creating children that are coming back into their economy and staying or they have good educational programs, universities that turn out good talent that can grow the companies that they are surrounded by. The Houston market has about six and a half million people in the Houston metro market. It fits all of these categories. Salt Lake and Utah County, they are becoming one with all the tech boom that’s happening here. You have almost two million people in these two counties and the population is expected to double by 2050. The Boise market is just over 600,000 and it should double over the next 20-25 years.
When you have that kind of growth, it gets me excited because it tells me that there’s going to be continued strong demand for housing units, whether they’re buying them or renting them. But at the end of the day, it’s the demand that drives the need for housing that pushes prices up, increases rental amounts. I’d rather be in a market like that than a flat market and especially in a declining market.
There are a couple other factors that we really like to pay attention to, Marco. It’s that these three states are landlord friendly states as well. They tend to legislate on the side of business. The landlord, as long as their taking good care of their properties and are creating a competitive edge by having nice atmospheres or good amenities etc., they’re going to attract great tenants. Because those tenants are trained that they can’t be delinquents and stay in this place for 120 days. They don’t pay, they leave. It’s a good thing to have a very landlord friendly state that’s good for our owners.
Now, what about the rental market in these three different markets as it stands today? I’m familiar with Houston because we do a lot of business there. Less so in Salt Lake City and even less so in Boise.
If you look at the demographic reports such as Forbes and these other NSA researches or reports that come out by appraisers or investment groups, they are looking at affordability indexes. For similar economies or metro sizes to the markets to go into, there’s still a lot of upwards pressure for rents to continue to increase. In other words, we’re not so bloated where people can’t afford to live in their houses so you get everyone having to have roommates. We still have room for our rents to continue to rise and are delivering cap rates in the 7-8% range where the market on resell can trade at about 5-5.5% cap. Even with new construction, we’re delivering around 2-3% cap rate at higher value to our clients.
What kind of tenant demographic do you find are in the neighborhoods these fourplexes are being built? I’m not sure if you’re attracting professionals or more transient type tenants. What are you finding?
It’s definitely the young professionals that we’re after. These job growth areas that are attracting these young college graduates that are in their late twenties, early thirties. Or the divorced family, that they have two good incomes and someone needs a second home. That tends to be a large demographic of who we appeal to. We don’t get the professional renter who works in a garage and makes $30,000 a year and will make $30,000 a year for the next 50 years of their lives. We’re more the up and coming renter that just got out of college, haw a good paying job from $50,000-$80,000 a year on average, decent credit but typically not incredible credit or else they’d go and buy. A lot of that is because they just simply have young credit. They choose to rent three to five years as they stabilize their new households before they go into their dream home at some point.
A tenant that is staying for three to five years is actually pretty good because a lot of tenants would stay for one to three years. Far fewer stay for three to five and very few stay beyond five. That’s actually pretty good.
A lot of that is because of the product type that we build, either a little larger square footage. Majority of the time they come with a garage. This is a place that the renter says, “I’ve got a garage to store my things. I’ve got a nice town home in a fourplex design.” It feels more like a home to them, which makes them want to stay longer as well.
Let’s talk about the product. We’re talking about new construction, these are fourplexes. Describe the specs, the amenities and whatnot of what you guys are building as well as the price ranges per market and the types of returns in cash flow that could be expected from that.
Product type is going to vary. Every single project, we will tweak it just a little bit and we’re always improving on our products as well. Generally, our flagship is a three-bed, two and a half-bath product, which is unique. Typically fourplexes are a two-bed one-bath or a two-bed two-bath, and we’ve not gone that road. The reason is we want to attract the three to five year renter. We found the three-bed, two and a half-bath market has been very underserved. Majority of them are town homes style, three-bed, two and a half-bath, average square footage between 1,500-1,800 square feet with a one or two car garage.
There are two or three levels in their town home. We also have amenity packages that vary depending on the project we’re putting it in. Some would be a part of a master HOA where there’s a large clubhouse, walking trails, charter schools, park, playground, pools, rec facilities, etc. Some of them are on a smaller scale or they’re isolated so they may just have a small playground and a small gym that the community can work out in. Anything in between is what you’ll see in our communities.
I know this varies by market, but what’s the price point of the fourplex projects?
Our duplexes, in some of our projects we will have a random duplex here and there, they’ll start usually around $300,000. The financing type of these clients who will qualify for is the 25% down traditional Fannie Mae product. 25% down of that, you’re about $75,000. Our fourplexes go as high as about $650,000-$700,000 for a brand new fourplex. Again your 25% down, so around a $175,000. The returns on that, cash on cash return is about 8-10%. The internal rate of return of a ten year hold is typically between 15-20%.
Inventory levels. I know that products like these will come and go and then you run out of land and it’s hard to get more inventory. As far as Houston, what do you have available today in these markets? Will there be inventory in the months to come? Maybe the next year, let’s look out one year from now.
The Houston market, we would like to get to a point where we’re delivering about 600 doors a year. Right now, we have in escrow on a project that’s 200 doors, so that would be 50 fourplexes. We’ve got that project selling into right now, expected to start construction here by late summer or early fall. We plan on having another 200-400 doors being released in multiple different projects throughout Houston metro. This project currently is on the west side. We may go back up to the north side where our first development of 40 doors is at. We’re looking at multiple sites to find land options. In Utah, we’ll have approximately 800 doors that will be built this year. Our typical sales process on a 200 unit project, so 50 fourplexes in a project, will typically take us between four to twelve weeks to completely pre-sell out of the project, it’s our traditional sales philosophy in these developments.
If I came to you as an investor and I say, “I’m interested in picking up a fourplex and I can’t decide between one in Houston or Salt Lake or Boise.” What would be my deciding factor or factors in order to pick one market over another? What would I need to look at in order to make that decision?
One might be how involved this investor wants to be with their investment. I know a lot of your listeners really don’t mind the fact that their investments are not in their backyard, which is excellent. They have the right mindset. But for those who like to be a little more hands on or have their investment in the place that they would like to go and visit, that may be one conversation we have. As far as returns Marco, they’re very similar from market to market. We tend to try and always stay in certain equity play or give a certain equity play for the client in every market we go into. To distance ourselves from what we’ll resell by giving it extra cash flow potential for those clients. Some other variables might be places where they could see themselves relocating to at some point. Just so that there is at least some connection they could personally relate to as well. Other than that, returns are very similar from market to market.
Financing with conventional would be a minimum of 25% down. If you’ve got more than four to six, I would assume that’s going be 30% down.
You can do 25% down all the way up to ten loans right now.
That was recent change, wasn’t it?
Yeah, they just changed that with Fannie Mae. Freddy actually just went from four to six loans, which is great as well. They’re starting to loosen up a little bit. Still can’t get over ten loans. But for our clients, they like the idea of getting 40 doors with ten loans instead of only ten doors with ten loans. Getting the fourplex allows you to maximize one of the best loan products out today.
We like encouraging our investors to go out, kick the dirt, meet with the team, see the product with their own eyes, feel it, walk around and touch it. Statistically, maybe one out of twenty actually do that, and that’s fine. You don’t have to go out, but we like when they do. We encourage it. I’m sure that you would want our clients to come out and visit with you. You can show them around and give them a good idea what we’re building out there.
When they are building with us, they get monthly updates that go directly to you, Norada, as well as them so that they can review the progress. There’s a drone video that goes over the entire development with project updates, what the next schedule of completion would be for construction. They get a really hands-on experience that they’re building without having to be hands-on.
Did you cover build time? I’m not sure if you mentioned the build time from contract to completion.
The contract, depending on where we’re at in construction, if we are literally at the doorstep of being able to start construction, then within twelve months of contract they should have a completed fourplex, if not possibly sooner. Traditionally, because we pre-sell out so quickly, it’s about an eighteen month lag time between when they contract and when they actually have a deliverable. There’s a lot of patience that goes with our clients because they’re seeing the extra equity, the extra cash flow in these given markets, yet they have to wait for it. It’s a common concern for some that aren’t quite ready to be that patient, but that is definitely a part of investing with our group.
Are they getting construction-to-perm loans on these? Or is this being financed by the builder and they just put a contract on it and they hold it and lock it in with a particular price?
They’re actually going to get their own construction loan. We line them up with construction partners we’ve got in every single market. We shop them out to make sure that they’re incredibly competitive with their rates because we are going to bring them so many great qualified investors. We basically do the shopping for them on terms. Then, vet those construction lenders out so they know our process so it’s as smooth as possible for investors that work with us.
I just want everybody to be clear. These loans, they do or they don’t have monthly interest payments during the construction phase?
We add on the interest payment to the front of the construction loan. That way it’s a line item that they draw on. The bank will not come to our investors and say, “You owe us a certain principal payment or interest payment at this point.” They draw it on the construction loan itself.
They don’t see their first payment until after the completion and they’ve taken possession of the property.
That’s correct.
It’s basically all one nice tight package.
Correct. You got it.
What else should we talk about that I didn’t ask you about? Because I think you’ve been pretty thorough about the markets and the product. Do you want to talk about warranties or?
Not only did we create it because there wasn’t an inventory, but what we did is separate it so it made sense for an investor that is a country away or a couples states away. Why would they want this? What we did is in every single community we go into, we establish a homeowners’ association specific to the purpose that we don’t want our investor to be next door to an investor who doesn’t want to re-invest into maintaining that roof or the exterior or the landscaping, etc. At the collective HOA, we ensure that my fourplex, if I’m an investor, and all of the fourplexes in this community are managed the same level of quality, which is good for everyone.
When a roof needs to be replaced you can get guarantee that it’s going to be replaced because there’s a reserve account and we’re preparing for that when it happens. When the landscaping needs to be done weekly, the grass is green and it’s trimmed. People are warned if there are issues with junk or storage. It’s a very well ran quality community. As an investor several states away, you don’t have to worry about all those things. We also have our own in-house property management that will take care of that as well. From getting the renters, doing the collections and sending out all the reports to file with your accountant.
These sound great. I’ve seen a lot of photos and the product always looks topnotch. Nothing looks cheap in these things. They almost look too good for a “rental property.” You get a better quality tenant when it shows well and it’s built right. I think that’s more important to have quality long term rental property.
Exactly. Yet we’re not the luxury realm either because that has to be a little more volatile. This is just a nice quality rental that attracts a nice quality renter. As far as warranty, I didn’t touch on that. You’ve got a full warranty for a full year after completion. Honestly, even after that we want to know if there are problems because our suppliers, we hold accountable for building a better product. We’re there. We’re standing by to make sure that our clients have a really good investment experience.
Great. This has been great, Steven. Is there anything else you want to add and we haven’t talked about?
No. I just want to thank you again, Marco. The fact that we can affiliate with a company of your quality and reputation is really just wonderful. Thank you again.
I appreciate it. We look forward to doing more business with you, Steven. We’ll be talking regularly. Thank you very much.
Take care, Marco.
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