What is an IPA in Commercial Real Estate Investing
January 15, 2019
When investing in real estate, picking the right property is paramount, and one way to go about that is by using my “IPA” evaluation philosophy.
The Pacific Northwest grows more than 75% of the hops in the United States. The Willamette Valley, where my office is located, sits on the 45th parallel, where our abundant rainfall, moderate climate and fertile soil provide ideal conditions for hop production. Lucky for us, the result is some of the world’s most innovative and best-tasting India Pale Ales, or IPAs.
Believe it or not, while most of us are familiar with the term IPA from the world of beer, it has significance in the world of real estate, as well. This acronym stands for a guiding philosophy I use to identify multifamily acquisitions for rehabilitation and long-term investment success.
‘I’ Stands for Intrinsic Value
Real estate value is derived by its qualities — some changeable and others that are not. Savvy investors acquire properties with high “intrinsic value,” defined as compelling characteristics that are fundamentally permanent.
Examples of a building’s intrinsic value include quality construction with appealing design, desirable floor plans and an attractive community layout. My firm specializes in acquiring value-add multifamily, typically built in the 1980s and ’90s, usually considered a core or “A/B+” asset when constructed but today is cosmetically aged.
The property’s aesthetics relegate it to “B” status and lower rent levels, but the property still possesses the intrinsic values of comparable “A” properties. We strategically acquire, aesthetically improve and reposition such properties to compete as best-in-class assets.
Property markets and submarkets also possess intrinsic value. Some of the intrinsic qualities to look for in a strong commercial real estate market include:
- Above-average proportions of people moving into the area vs. out of it
- High job gains and forecasted income growth
- Balanced housing supply and demand
- Quality lifestyle factors such as regional recreation, neighborhood amenities, favorable commute times, accessible education and medical centers
- Healthy local/regional economic climate
- Proven public commitment to city infrastructure; high rankings in transportation, renewable energy and internet access
Without these conditions, even the best-managed properties can’t perform to their potential. Our firm has been active in the Southeast (Charlotte, Atlanta, Raleigh and South Florida) and the Pacific Northwest (Seattle and Portland) for more than 25 years. Each of these regions has proven intrinsic value to form the foundation for successful real estate performance.
‘P’ Stands for Price Per Pound
A good real estate investment begins with a good buy. Because real estate investors lock in the basis on the day of purchase, they need to get it right.
Our strategy to buy right, at an attractive “price per pound,” relies on subjective valuation and an objective understanding of market trends. Comprehending the facts reflected in comparable sales and rental data is the first step in an acquisition decision.
As an example of this approach, one of our investor groups purchased a “B-” multifamily property in the Seattle metro in 2015 at a price of $99,000 per unit. Sales comparable were 10%+ above the purchase price, rent comparable suggested significant income upside, and economic fundamentals supported 6% annual organic rent growth.
We then invested $1.5 million into capital improvements and managed a positive turn-around in operations to capture additional value of the apartment community. The property was refinanced in early 2018 — less than three years from its acquisition — at an appraised value of $193,000 per unit. This is a dramatic example of equity growth, but it all began with a smart “price-per-pound” purchase.
‘A’ Stands for Affordability
In commercial real estate, assessing a project’s “affordability” does not mean your cost to purchase the property as the investor. It means understanding your target resident or tenant demographics. In order to sustain your business plan, the rental pricing must provide good value and, most importantly, be considered affordable to an expanding group of renters.
As a real estate investor focused on multifamily, I am only active in submarkets with dynamic economic upside that still offer rental rates at less than 30% of resident incomes. Examples include Atlanta and Charlotte.
At this point in the real estate cycle, rent affordability is showing itself as a major factor as to whether rent growth — which translates into increased property value — continues in a sustained trajectory versus plateauing or dropping. Markets like Boston and Washington, D.C., are now seeing falling rents, which is due in part to a mobility that allows renters to migrate to cities and housing that offers better value and lower rent/income ratios.
Like the favorable conditions that produce choice hops and world-class beer, my “IPA” acquisition approach has delivered successful investment results through changing markets. Hopefully the next time you pick up an IPA from the Pacific Northwest, thoughts of real estate will come to mind. Cheers!