The Double-Dip in Occupancy and the Reposition
by Jesse Brewer
I know a lot of investors that look for apartment buildings that are distressed in some form or fashion, or the property is a “value add” opportunity. Before I get into the content of this post let me first explain what I mean. A “Value Add” opportunity is just what it sounds like. It is an opportunity for an investor to purchase a property that is “distressed”, meaning there is something wrong with it such as it has a lot of vacancy, been poorly managed, something is physically wrong with it and it needs a lot of work or a combination of the three. So, when an investor purchases a “value add” opportunity they are purchasing a property with these problems, which is usually all three or sometimes even more, and they are going to put in the money, time and resources to cure these problems and increase the value of the property.
So now that we have defined what a value add opportunity is I’m going to talk about the reposition of the value add project itself. Repositioning is the actual process you go through as an investor to take the property from its distressed state to its market value state. This is the act of getting rid of bad tenants, doing renovations to bring the property condition up and then putting new tenants in. Often in that order or something very similar. If the property is a larger multifamily property, then chances are you will start to work on some of the property while leaving some existing tenants in for cash flow reasons. These tenants that you inherit are the real subject matter for the “double dip” theory I’m about to expand upon.
Depending on the time of year and the geographic location your value add property is in will determine how much of the “double dip” effect you will experience. The warmer it is outside the less of an impact, or rather the quicker you will get through the dips. But if it’s colder outside and you take over a property in say late fall going into the winter months then you can experience “tenant hibernation” and the double dip may take a few extra months to fully work itself through the cycle.
The first dip in occupancy you will experience is the easy one to spot. This “first wave” is tenants that simply do not pay their rent. You will find these people out within the first 30-90 days of operation. They will at first have an excuse as to why they didn’t pay. If it’s in the first month it will be something along the lines of they were confused and didn’t know where to send it or they paid the old owner, doing this is a stall tactic while you give the benefit of the doubt etc., or they will simply avoid you. Some of these will pay a partial or even full month the first month or two but you will have identified these wonderful human beings within the first ninety days of operation.
The second dip, or second wave of deadbeat tenants is a little harder to spot and depending on the time of year you are taking over the property it could be prolonged. These tenants are the problem tenants. The ones that pay their rent but they are a nuisance to the property. They have junk all over, they piss in the hallways, they are fighting with neighbors or they have a spouse they are always arguing with or something. These tenants make it hard to get good new tenants in. Now if you are taking over in the summer or spring months and it’s warm outside you will find this tenant relatively quick. They like to frequent the property outside by drinking and carrying on so it’s not hard to spot; however, if you take over when it’s cold or in the fall going into cold months you may not spot them for quite some time since you are initially dealing with the non-payers and these tenants will pay initially then slip into hibernation on you and not emerge until spring.
The problem with this happening is during the winter months if you are doing your job right and repositioning the building then you have new tenants moving in. So, you will take your initial dip in occupancy with the non-payers, start to come back up then you will have the second dip of asshole tenants and then you will dip back down again and then after that you will start to steadily climb back up with a better tenant base.
Unfortunately, there isn’t a cure for this. The only known cure is to buy a property completely vacant and not everyone is able to do that or those opportunities are not always available. The best you can do is ask the landlord during your due diligence for bank deposit records of paying vs. nonpaying tenants. Make sure the deposits match up to the what the rent roll they are providing you. If the rent roll says $10,000 per month and they are showing you consistent deposits in the $7,000 – $8,000 per month then you know you need to ask questions. Did new tenants move in? Why the discrepancy? For the second dip this is harder. You must make multiple trips to the property before you buy it and when you first take over. You need to interview tenants and ask them who the problems are. Call the local police before you purchase the property and ask about police runs to the property. Trust me if there is a tenant that is always getting the police or fire called on them you will find out soon enough and chances are they will be part of the second dip of tenants you must evict.