Any experienced investor knows the importance of having and maintaining an investment criteria. If you ask ten people, they may have ten different metrics and even more variation among with regards to what is minimally acceptable.Even as as a working professional who seeks to passively invest in real estate opportunities, it is extremely important to know and adhere to some investment criteria. Below are a few typical criteria categories and examples:
Strategy
An important category of investment criteria is the strategy. What type of opportunity are you looking for and what is the typical business plan. Common strategize in multi-family investment involve the condition of the property, required repairs and associated occupancy. These are best segmented into three general business models:Distressed – Just as it sounds, this type of property requires lots in physical repairs, vacancy is very high, and there are many more problems to solve such as quality of the tenant and surrounding area; this business strategy is high risk, but also presents high reward investment opportunities.Stabilized – On the other end of the spectrum are stabilized, or well-functioning, performing assets. These properties have low vacancy, need little in repairs and provide predictable cash flow on day one. All of these great things happen at the expense of lower returns.Value-Add – While attempting to appear unbiased, I will state that value-add opportunities are a moderate sweet spot between distressed and stabilized assets. They carry the favorable qualities of stabilized properties in that they are largely occupied and require few or no major capital expenditures. On the other hand, there is more opportunity to force equity, either through physical value add (paint, adding units, etc.) or operational value-add (raising rents to market, changing landscaping companies, etc).For more details on these strategies, check out my article, The 3 Business Models of Investing.
Market
After having identified your the types of opportunities for your selection criteria, you should select market based on select characteristics.Population SizeMany experienced investors shun the idea of investing in areas with small populations. For them they consider it to be greater risk and impact from job loss or a change in demand. Those same investors have minimum population requirements for any market in which they enter. For example, on John Fortes’ blog, I shared Adam Adam’s plea with investors to consider investing in metropolitan statistical areas (MSA’s) with populations greater than 100,000. Others, for different reasons may specifically seek out markets with more or less, depending on their expertise and skillsets. In any case, it is critical that you consider the size of your market based as part of your investment criteria.EmploymentSimilar to population, employment is a fundamental in investment analysis. Employment drives population growth in any city, and therefore, it should be a consideration for the types of markets that you select. Consider the same approach Adam Adams suggested, selecting markets where no single industry represents any more than 20% of the overall employment. Why would this be important criteria? It minimizes the risk that any single industry destroys demand for housing in your key market.Building Class and SizeAfter having chosen your market area, it is also prudent to identify the type of building class and size you seek. This is important to know and have handy when communicating the types of deals you are looking for to brokers and other investors. Building Class is usually rated A-C (from highest to lowest class) and is based on the condition, newness and desirability of the property and may be a reflection of your overall investment strategy. For example, if you are looking for a value-add property, you are likely looking at C to B+ classes.Less so if you are a passive investor, but if you are actively seeking deals, based on the amount of capital that you can raise as well as the size of the project you seek, you will want to know the typical apartment building size for your criteria. For example, maybe you are looking for a ”small multi-family” between the range of 12 and 30 units. To summarize my investment criteria, I currently am seeking value add apartment investment opportunities in North and Central Florida Markets with sizes between 30 and 50 units.
Return
The below concepts may be new to you. Rather than describe them here, we keep a list of terms for new investors out our Resources page, and regularly update and add to the list. For the purposes of defining your criteria, I will briefly point out these common examples.Cash on Cash – Investors like to know what amount of cash is produced from their cash invested. Average Annual Return (AAR) – ARR measures the overall return of the investment on an annualized basis. Recently, a private equity investor shared with me that his investment criteria is a 15% AAR. Knowing his criteria helps both him and myself to identify which investment opportunties best align with his expectations.Internal Required Return (IRR) – IRR is a more complex measure of return based on the timing and inflow and outflow of cash. However, if you seek to invest passively in apartment syndications, it is important to have familiarity with this metric. Recall the danger of investing solely for the “high IRR,” as it can be intentionally or inadvertently inflated by the deal provider or the opportunity itself can be risky. As you may know, each of these financial return targets vary (and should) based on the individual goals of the investor. In What to Look for When Passively Investing with a Syndicator, I expand on the importance of alignment of objectives when looking to invest with an apartment syndicator.
Remember
Do not confuse lagging indicators such as cap rate and price per unit as criteria; they may be closely related to a fundamental but could also be simply a reflection of what is happening in the market.I must emphasize that it is important to exercise extreme discipline in sticking to your selected criteria when opportunities. Of course, over time you may modify your criteria, perhaps to become more selective, as you grow as an investor; however, to compromise on your previously established criteria is an ingredient to real estate mistake. Warren Buffett is on the shortlist of the world’s greatest investors, not because he is a genius, but because of his discipline and diligence in knowing and sticking to his investment criteria as well as his areas specialty.
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