Posts Tagged: Why Scale is the Holy Grail
And that’s why scale is the Holy Grail in real estate.
Why do real estate investors like Donald Trump, Grant Cardone, and Sam Zell have real estate portfolios with thousands of units under management? Like them or hate them, when it comes to real estate, these are men to be respected. In addition, these men know the power of what scaling can do for a business.
The smaller the deal, the more of a liability if you ask me. Now let me clarify, everyone that invests in real estate doesn’t have the same goals. Not everyone wants to scale and grow, and acquire 10s and 100s of millions of dollars in assets overtime. Some investors are content with making $200 of passive income a month, and using that to save over time into retirement, and that’s ok.
10-unit Scenario: Priced at 100k a door at an 8% cap rate (return on investment based on the income a property is projected to create) for $1,000,000.
- Purchase Price: $1,000,000
- Down Payment: $250,000
- Debt: $37,500/yr. Assuming buyer financed 750k at 5%.
- Monthly Rent Per Unit: $1000
- Net Operating Income (Income minus Expenses) : $48,000 (120k – 50% expenses, minus 10% management fee = 48k )
What happens if a tenant moves out?
Well as the owner of the property you now are responsible for $1000 for the month and have to scramble to find a new tenant. Not to mention you just went from 100% occupancy to 90%, imagine if two or three other tenants decide to move out. Your Net Operating Income for the month plummets tremendously, and there goes the deal.
What happens if something breaks and needs to be replaced?
The property manager will handle that if you decide to hire one, which comes at a hefty fee on smaller properties at 10% of the gross income a year. Not to mention small property management companies are notoriously known for stealing. Now if you manage it yourself, you save the 10%, but just be prepared to receive phone calls about the typical tenants, termites, and toilets that landlords get.
100 Unit Scenario: Priced at 100k a door at an 8%cap rate
- Purchase Price: $10,000,000
- Down payment is $250,000
- Debt: $37,500/yr. Assuming buyer financed $7,500,000 at 5% interest
- Monthly Rent Per Unit: $1000
- Net Operating Income: $600,000
Isn’t property management still going to be an issue?
As the owner of a deal this size, the property manager in place will typically be an investor of yours as well. Once you have an established relationship with a property management group, your percentage gets sliced to around 4% opposed to the 10% of gross income.
Tenants will still move out?
Of course tenants will still move out. Imagine if 5 tenants move out, the property will still be at 95% occupancy, opposed to 50% on a 10 unit. The deal has more legs, due to the number of units it has.
Not to mention, it is going to be less of a headache for the owner and the passive investors involved in the deal. An asset like this is stronger, and will be able to handle all kinds of swings in an economic cycle.
Another strength on bigger deals comes from not overleveraging on your asset. Simply allowing the asset to take a relative hit from the market and still maintain solid numbers is a huge plus in the midst of a down turn. Which in fact is what we saw in the last swing, people overleveraged and weren’t able to take a 10 to 15% hit on their assets. This is why you see small deals get crushed in corrections and recessions.
Once again, this isn’t to say money can’t be made on smaller deals, and that smaller deals are a terrible investment. But if you want to make money in all cycles, and know no matter what happens your investment is safe, bigger is the way to go.