There are over 160,000 licensed real estate agents in California. When it comes to investment real estate, specifically apartments, the number of qualified agents drops dramatically. In the Bay Area, there are about 75 agents who specialize in apartments. Of those 75 agents, only about half of them conduct regular transactions.
Income and Transactions
When the component of income is added to a transaction, as is the case with apartments, an agent’s knowledge needs to increase dramatically. Your agent needs to know how the income affects the value of the property in question. If you are wondering if your agent understands apartment brokerage, ask a few simple questions to find out. Ask your agent, What is a Capitalization Rate and how is it calculated? (NOI / Price) What is the Gross Rent Multiplier and how is it calculated? (Price / Gross Rental Income) What is the Debt Coverage Ratio and how is it calculated? (NOI / Debt Service). How does it affect my purchasing power? If your agent cannot answer these simple questions immediately, then you are working with someone who is more likely to hurt you than help in a transaction.
By the Numbers
Good apartment agents can quickly identify poor and misleading underwriting when evaluating apartments for their buyers. Expenses are the most commonly misrepresented item, giving the asset a higher Capitalization Rate and ROI (return on investment) than what is actually occurring. Apartment agents will know that expenses should be around 40% of Gross Rental Income. Vacancy rates are also often misrepresented or not present at all in the underwriting. Poor and misleading underwriting can be tremendously costly to buyers, if not caught. For sellers, poor underwriting leads to complications during escrow and larger credits to the buyer.
The Human Element
Experienced apartment agents have extensive knowledge of the human element in transactions. The agent should know the buyers and sellers in transactions within their geographic area, and what their motivations are. Who are the agents involved on either side of the transaction? How strong of a negotiator is the other agent? Is the seller just fishing for offers? Is the buyer difficult to work with? Are they likely to perform? What type of experience does the other agent have in apartment sales, and can it be exploited? An experienced apartment agent will know the answers to all these questions, and each answer gives the agent and his client further insight as to how to proceed with a transaction. Agents who are consistently involved in apartment transactions will know these internal aspects of a deal and it will give you greater power when it comes to negotiating.
Negotiating credits is one of the most difficult parts of any transaction. Every buyer sees far more damage to the property than the owner sees, creating a strained negotiation. Typically, the only part of the transaction that is negotiable is the Section 1 damage. Those are the areas of the property with visible damage. Section 2 reports areas of the property that will likely need attention in the future. Controlling this aspect of the deal can make a great difference in the price. As a seller, it is advisable to take action and purchase the Section 1 inspection before the property goes to market to control the information a potential buyer will see. Your agent should be able to guide you to an inspection company that looks only at Section 1 damage. Often times, the buyer will request no further reports. As a buyer, you want your agent to seek a more thorough investigation of the property, helping to push the negotiable dollar amount of the damage higher than what a limited report would show.
Sellers of apartment buildings who plan on doing a 1031 tax deferred exchange should have an agent with a higher degree of contract and tax knowledge. A 1031 seller must be aware of the time constraints mandated by the IRS in order to not default on the exchange and pay large capital gains taxes. The toughest constraint placed on a 1031 exchange seller is the identification period. This identification period is 45 days after the close of escrow of the client’s down-leg, or relinquished property.
In my opinion, the 45-day time period to identify your up-leg or replacement property is unfair. Your agent needs to know how to structure the contractual agreement between buyer and seller to offer the seller more time for the identification of the replacement property. There are several ways to accomplish this, and a seasoned agent knows how to buy you more time. It is also important to understand at what point a seller planning on entering a 1031 exchange becomes a valid buyer in the eyes of the market. This allows for more time to identify your replacement property before the 45-day IRS deadline begins.
Once you sell your down-leg, you must find another property to replace it in order to remain in compliance with the 1031 guidelines. In the current market, there is a very limited supply of available properties for sale. The last thing that you want to happen is to make a poor decision on your replacement property due to the restrained inventory of available apartments. A good apartment agent will have access to off-market deals for the 1031 buyer to view. An agent who is not an apartment specialist will not have access to off-market buildings, and is limited to what is publically available. An apartment specialist will likely also have good relationships with other apartment specialists, giving you a larger choice of otherwise unavailable apartments.
Third Party Connections
Apartment brokerage is a very specific niche that requires many third party interactions with escrow officers, 1031 accommodators, inspectors, transaction coordinators and loan officers. Since every transaction is different, your agent should have relationships with multiple third party service providers. For example, your agent should know several lenders to help their client find the right lender for the job. Some lenders cannot do loans with non-conforming units, while others can. Escrow officers not familiar with apartments can bog down a deal with unnecessary paperwork. Choosing the right inspector can make the difference of tens of thousand of dollars. Poor decisions regarding these third parties can cost you a great deal of money and sometimes cost you the deal.
Selling Your Apartment
When it comes to actually advertising your apartment and creating a market for your asset, the difference a qualified apartment agent makes is immense. Agents who are not apartment specialists really only have one avenue to advertise your asset, the Multiple Listing Service (MLS). Their strategy is to place your property on the MLS and wait for a buyer to show up. This passive advertising may be suitable for home sales, but negatively affects the value of an apartment sale since competition is not fostered. Apartment specialists can create an environment that invites investors to the negotiating table. They use highly focused techniques such as specially designed marketing packages, electronic media designed for investment properties, postcards, cold calling and reaching out to their personal clients. Most apartment agents have data bases of thousands of owners and investors of apartment buildings, and it is likely that your apartment specialist already knows the buyer who is going to perform at the best possible price and terms. The agent just needs to reach out to them. The goal of any agent trying to maximize the sales price is to bring as many investors to the negotiating table as possible, effectively removing the seller from the negotiation and letting the buyers compete among themselves. This process allows for buyers to re-bid on the asset until the best price and terms have surfaced.
Typical apartment transactions range in value from about one million to ten million dollars. There is a lot of money at stake and choosing the right agent can make or break a deal. Always use a specialist suited for the transaction you are undertaking, since they have specific knowledge that can save or earn you lots of cash.
Christian Losness is the Broker of Losness Group Apartment Brokerage, DRE 01506985. For more information visit www.losnesgroup.com.