Remember from last week that I’m calling evaluation the things that you do before doing the actual numbers deep dive (underwriting). The initial evaluation is all the things that you do to look at those deals when they first come to your attention. The actual deal finding is left for a different post.
If you are doing a good job with your deal finding, then you should have lots of deals coming across your desk. The more the better, as long as you have time. Which is why it is very important to do this step quickly. You have to be ruthless. It’s like interviewing for medical school. There are hundreds or thousands of students wanting to become a physician. Schools can’t take them all, so they have to weed them out. And that sucks.
The Weed Out
With thousands of applications, it would take far too long to read them all. Though, in a perfect world, that would be the way it is done. Admissions committees will set bottom bar metrics which they require. One will be the MCAT (Medical College Admissions Test) score. Clearly some good candidates will get weeded out. If you are under their cutoff, your application is tossed in the trash and it only took a few seconds. What if everybody is above the cutoff? Then the cutoff is moved up. It’s all in the interest of taking that pool of 1,000 to a pool of 200. Those lucky 200 then get their entire application read. 120 of them get offered an interview. 80 might get an offer. These numbers are different for every school. And they are different for every investor. The bottom line is that you need to be ruthless – at least you aren’t dealing with peoples’ careers.
Your Criteria
You might be wondering what metrics to use if you can’t use the MCAT score. Ultimately you will have to choose, but here are some I suggest:
- Location. Your most important one. Not just a region or city, but an area within a city. Be specific. You may have more than one location.
- Number of Units. Usually a range, like 5-16.
- Asking price. Also a range. Chances are the seller will come down 10% off his asking price. So talk to your banker about the maximum price you could pay. Multiply it by 0.8. That’s your low number. Take the bank’s number and multiply it by 1.1. That’s your high number.
- Unit mix: A little softer criterion. Do you like 1 bedroom 1 bathroom units? 2/1? 3/2? Or some mixture of all? The sweet spot for me is 2/1. I want 80% of my units to be this type.
- Value-add. These are areas of deferred maintenance which you can fix up and raise the rents.
- Amenities. For you it might be a pool or gym. Mainly, I’m concerned with things that bring income, such as coin-op washer/dryers or garages.
- Age. When the property was built. 1980s and newer might be the criterion here.
You can certainly set more criteria than this, but you want general stuff that will be posted on a brochure on Crexi or Loopnet. It can’t be tough to find information or it’ll take too much time. Notice also that mathy things like cap rates are not present at this point. Write down your criteria in a spreadsheet. The columns will be the properties and the rows the criteria. Decide which are must haves and which are just nice things. You can dispense with the nice things right now. Meaning delete them from your spreadsheet. We are looking for hard criteria.
Do the Evaluation
Every deal that comes across your desk now is put into this spreadsheet. This helps you trend out how you are doing with your deal finding and will help you refine your criteria. If any single one of your criteria is not present then the property fails and you dump it in the trash. Remember to be ruthless. Won’t you lose some good deals? Sure, some will be lost, but you cannot waste more time at this initial phase. You will lose out in the end trying to find that one perfect deal.
My rule of thumb here is for every 1000 deals you see you’ll have 100 that pass this initial evaluation. What about AI? This is a good time to use it to help you rule out deals. Never, never, ever use it to rule them in. There’s too much risk. Give the AI program your criteria, answer any questions it has, Then copy the information from the brochure into it and ask it to evaluate it based on your criteria. Works pretty slick. For me, I just use my spreadsheet.
Next time we will talk about the secondary evaluation for those 10% of deals that pass this initial test.
