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“Location, Location, Location.” It is one of the most common phrases used in the real estate industry. The phrase was originally coined by Harold Samuel as the three most important things that matter when choosing a property and was elaborated on further by J. Freeman Plye in 1926 in the Harvard Business Review. The point is this phrase has been used for a very long time.
The premise of the phrase’s creation is to highlight that that the location of a property is the most important factor when it comes to purchasing an investment, or so it was thought. “Location” is about more than just a dot on the map. It also includes the submarket trends, demographics, home values, income levels, who frequents the area, primary industries for employment, etc.
Throughout the pandemic, the thought of “location” being the “end all, be all” for an investment property has changed. Because of COVID-19, many tenants are now protected from eviction due to the eviction moratorium, depending on what state they are located in. This directly shifts the focus of location to the focus of collection rate, which is also known as economic occupancy.
Collection Rate is King
You are probably more familiar with the saying “Cash Flow is King”, but to have cash flow you must have strong collection rates. For a multifamily property to be a successful investment, there’s a trifecta that ideally needs to be in place: location, high collection rates, and a strong tenant base. It’s the tenant base that matters most of all and here is why:
Even if an asset is in an ideal location, if it is not generating cash flow, that’s simply a deal we don’t consider. The majority of multifamily passive investors are focused on cash flow, as oftentimes this is what investors use to replace their incomes and achieve early retirement from their day jobs. Collection rates are a critical number to evaluate when assessing a property, because it can reflect either an opportunity to make a “management play”, which means replacing the current management with a stronger, professional property management team and making the property more profitable. Or it can be an indicator of a far bigger issue that should alert a prospective investor to be very cautious about a potential deal – a weak tenant base.
Tenant Base
If a property has low collection rates and the management in place is not to blame, then this is an indicator the property has a lower quality tenant base. Replacing a management company is quite simple. Replacing an entire tenant base is far more difficult.
Collection rates are often a direct reflection of the type of tenant base within a property. A strong tenant base is simple – tenants that pay their rent on time, month after month, and value their credit score. With a strong tenant base in place, collections rates remain high, the property is cash flowing, and this generally means the investment is providing strong returns as a result.
If the tenant base is weak, the collection rates will be inconsistent, often low, and the property will struggle to prove a good investment. A rule of thumb when evaluating a tenant base is to consider the average tenant income in comparison to the price of the rent. Are the tenants able to pay their rent, say for example, if one of their spouses lose their job? Are they more likely to having savings in place? What are their credit scores and do they care about having good credit? What industries do the tenants work in, and is it “COVID resistant” meaning can the industry adapt to the changes that COVID has created and still remain a strong and viable form of employment? All of these are important questions to ask and evaluate when looking at a new investment opportunity.
Summary
For quite some time, location was considered the most important factor for consideration when purchasing a property. However, now in a time where many things in our world have changed, there are more important things to consider: collection rate and tenant base. If a property’s collection rate is low, the investment will not be profitable, even if the location is “prime.” Furthermore, if a property has a low collection rate, that most likely indicates that the asset has a weak tenant base. Tenant base refers to how often tenants provide rent consistently and with timeliness. Without a strong tenant base, collections will be low, and the investment will not likely prove to be profitable, regardless of where the location of the asset is.
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About the Author
Ellie is the founder of Blue Lake Capital, a commercial real estate investment firm specialized in multifamily investing throughout the United States. At Blue Lake Capital, Ellie partners with both institutional and individual investors to grow their wealth by achieving double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.
A defining factor of Blue Lake Capital’s strategy is founded in utilizing machine learning/artificial intelligence throughout the course of all acquisitions and asset management. This advanced technology enables the company to produce accurate and data-driven forecasting for all assets on a market, property, and even tenant basis. In doing so, Blue Lake is able to lead commercial investments with the full capabilities of today’s technology.
Ellie is the host of REady2Scale , a podcast that highlights honest, insightful, and thought-provoking discussions on the multiple approaches for successful real estate investing.
She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations.
Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management.
You can read more about Blue Lake Capital at www.bluelake-capital.com and learn more about Ellie at www.ellieperlman.com.