How JB2 Investments Beats Projections
Many times, when someone pitches a deal to you, you may hear we are conservative in our approach.
What does that mean? It could mean so many things, and the interpretation of the ways of being conservative can be so different. Here at JB2, we pride ourselves on actually having a conservative approach to our underwriting. That's evident by our latest project already performing 67% better than projected in year 1.
In this article, we will dig into which levers can be pulled to be conservative and how we use them in our business.
Knowing the 5 Real Estate Investment Levers to Pull
1. Vacancy and Rent Bumps
The two main levers that can be pulled, especially during COVID, are vacancy and rent bumps. When it comes to vacancy, that could mean physical or economic. What we mean is that you can have a building 100% occupied but only 90% paying, so in essence, you still have a 10% vacancy factor.
Right now, in times of COVID, we are factoring higher vacancy in the first year or two even if the property is stabilized. We try to be at least 25% higher than the market average during that period. Also, we assume that we will have some higher vacancy at the beginning as we take over and get rid of or evict bad actors. We also determine at what vacancy percentage we at least break even. We like to be in at least the 70% occupancy range to breakeven. This is a stress test to make sure we can endure any unforeseen circumstances.
In the OKC market rents have been going up through COVID-19, but we still do not model the full extent of rent increases. The only rent bumps we are modeling in the first years is bringing it to the current market rent and not future market natural appreciation. Most of our rent bumps have been pretty modest, around $50 total a door over a 2–3 year period. If we can perform better than that, then it's just an added bonus.
2. Cost Reduction
The next factor we take a deep dive into is expenses. Though we are reducing costs often because we are running the complexes more efficiently, some line items are hard to change. Some of those are things like utilities. Though we also explore if we can implement some water conservation features to save there.
If we have historical bills for the complex and aren't implementing water-saving strategies, we will usually add 20-25% more for a possible change in rates or higher usage by tenants. A lot of times, this isn't necessary, but it is more conservative. On our property Norman Creek for example, on utilities, we are doing much better than projected.
3. Staffing
Another large line item is staffing needs. Do we need the same number of staff as the property required before, or can we cut staff when technology makes it possible? We try to allow for a little more staffing than we actually may need. For example, now that we are fully stabilized on our Norman Creek deal, we may begin running it with a part-time manager. Therefore, we can now run it with less salary and can beat our projections that much more.
4. Emergency Reserves
Lastly, one of the most overlooked items to watch out for is the emergency reserves held. We usually like to reserve at least $1,000 per unit and close to $2,000 per unit if we do a more significant value add. Those funds are earmarked to repair any unexpected significant damage like a roof, for example. A lot of times, that is covered by insurance, but there is a deductible to consider.
During the life of an investment, we continue to grow that reserve. It can also be used eventually as the reserve grows for any new value-add projects. Speaking of reserves, we try to have about a 15-20% buffer on our capital improvements separate from reserves. This is very important so that we never have to go back to our investors for a capital call to take care of any possible surprises.
5. Loan Rates and Inspections
A couple of other items we use to be prudent investors are loan rates and inspection. When it comes to loan rates, we try to leave a little bit between what we think we can get and what we underwrite. So, we have some spread in case we see a bump in rates during longer escrows. We do a thorough professional inspection of buildings and at least 1/3 of the units. This allows us to contemplate needed repairs for the present and the future.
You bring all these conservative measures together, and you should be able to withstand a lot. We look at our numbers almost as the worst-case hoping that we beat them or even crush them. So, if you come across any real estate deal that claims conservativism, you need to fully understand what that means. This can vary significantly depending on the operator. Here at JB2, we pride ourselves in it, and it's starting to show.