Building Multifamily Cash Flow with Charles Seaman

For a lot of people who were just starting out, they probably looked at some of the year over year rent gains that you saw in 2020 and 2021, and maybe they were underwriting to those as if they were normal. Now, what I would say to anybody here, especially if you’re on the newer site, you should never be underwriting a 15 to 20% gain for multifamily property.

Let’s dive right into the topic at hand, which is building multifamily cashflow. So Charles, what’s the number one secret to doing just that

Buying? Right? If you buy wrong, it’s going to be very tough to correct afterward. Two things I would tell you. Two secrets. Buying, right, financing, right. If you do either one of those things wrong, it’s going to be very challenging for you.

I could agree with you more. I call that matching cashflow with debt flow. Most people are so focused on cashflow, and cashflow technically is a associated, it’s debt flow because after debt service, but more than that, it’s underwriting in the proforma of what could happen with the debt, and this is part of why we’re in this challenge that we’re in right now. So walk us through, perhaps for the deals that you’ve done and how you were underwriting. Were you able to kind of anticipate what, no one really could anticipate how fast it went up, but what were you doing to protect investors for the debt flow scenario to make sure you’re locking in for longer rates?

Yeah, good question. So with most of our underwriting, I like to think we’re conservative with a lot of our assumptions, but to your point, we were no different in the sense that we certainly didn’t anticipate how fast interest rates would rise. So the things that we generally do is, one, we like to be a little more conservative on some of our rent bumps. If we see a clear difference between the subject property that we’re looking at and the comps in the area, and we believe that there’s a way to go out there and to close that gap, we will usually underwrite for that most times over a two to three year period. One thing I think that’s been very common the last couple of years, for a lot of people who were just starting out, they probably looked at some of the year over year rent gains that you saw in 2020 and 2021, and maybe they were underwriting to those as if they were normal.

Now, what I would say to anybody here, especially if you’re on the newer site, you should never be underwriting a 15 to 20% gain for multifamily property. While that’s a very nice thing that happened for property owners in 2020 and 2021, it’s certainly not a historical norm. So most of our underwritings, outside of a value add bump is probably going to be 3% annually, and that’s a more historical norm, something that we’ve seen many times throughout the past. Another thing is your terminal cap rates. Two years ago, a lot of deals were trading at cap rates in the 3% range, which looking back on it now, I think a lot of us look at it and say, well, it certainly couldn’t have continued forever, and it obviously didn’t. So you always want to be more conservative with your terminal cap rate, and you want to make sure that you’re predicting, you want to be focusing on cap rates, decompressing versus compressing. Look at them as compressing as a bonus, but not something that you want to be relying on for your deal to work.