REIA 103 Omar Ruiz: Discover The Secrets Of Using The Due-Diligence Process To Discover Hidden Value

Welcome to Real Estate Investing Abundance, the show for busy, fulfilled professionals like you to learn how to develop financial independence built on solid passive real estate investments. Now, here is your host, Dr. Allen Lomax.

Hello, enlightened investors. I'm your host, Dr. Allen. As investors, we are always on the lookout for value-add properties Today, we have the opportunity to discover the secrets of using the due diligence process to discover hidden value. Omar Ruiz is co-founder of LaRue Investments, LLC. His company acquires value-add multifamily properties and single-family homes to increase value, improve residential appeal, and achieve higher investment returns. Omar, please start us off by talking about an experience from your formative years That's helped you to be the person you are today.

Absolutely. And Allen, thank you for having me on your show. When you asked that question, it brought to mind very early on, one of my first actually property management experiences. I started a company with my partner, Jeffrey, and we actually did kind of a win-win situation with an owner that was trying to sell their multifamily. They had a smaller 7-unit multifamily that they just weren't keeping really good books. And So we made a proposition. We said, hey, you let us manage the property because we're looking to get into this business. And what we'll do, we'll manage it for you, lease up whatever vacants you have, and then we'll give you some good financial statements that you can produce to a prospective buyer. And that's what we did. And it worked out great for us. We learned a lot in that process and the owner was able to eventually sell the property. But when I was there onsite, and I took every advantage to be onsite at that property as much as I could. And I remember one specific moment where I was just kind of standing in the parking lot, and I treated the place like it was my own. You know, I would grab the broom and the sweeper thing, and I'd be out in the parking lot, you know, just sweeping it around, bringing up— and, you know, I just remember one day just visualizing the place and saying to myself, you know, someday I'm gonna own something like this, as I was sweeping around the parking lot. And eventually I did. And so I always remember that moment.

Well, that is a memorable moment that obviously changed your life, and it is those visualizations that really make so much difference in forming the futures that we actually do turn into realities. Well, it is difficult finding value-add properties in hot markets, and we certainly are in a hot market today, but you really specialize in finding the value that is not always obvious up front and finding that through that due diligence process. So take us through that process, how it is that you find those things in due diligence and actually turn them into value-add propositions.

Absolutely. So I'm gonna go through some things that are kind of typical out there. I'll talk about some things that are not typical out there. You know, my background before I got into it was in aerospace. I was in quality control management. And so I was always the lead on doing internal and external audits. the operation. So having that experience and bringing that into the multifamily helped me out tremendously in looking for clues. Because what we're doing is that we're hunting for value, right, Allen?

Mm-hmm.

So I'm going to start off here with, first off, looking for value opportunities during the analysis. So this is prior to having it under contract. You got some basic financials and you're looking at what the broker has provided to you. And some of the more standard stuff is what I call looking for gaps in the other income item. So you have your rents and then you'll have your other income. And some gaps that might be in there are things such as things like pet rent, renting of appliances, pet fees. And that's something that, to the individual, some people, some owners may not allow pets. And if they don't, that may be an opportunity for you to allow residents that do have pets. And more so nowadays with people staying inside and especially with older folks, they want to have some sort of companion or at least something to make them feel not alone. So pets are something that we've always allowed and we've been very successful at generating extra income through the pet fees and the pet rent that that generates. A pretty common item as well as also utility reimbursements. And I can give you an example of that on a previous building that we owned, that the owner there, he had a kind heart and he had some tenants, and this was kind of an older C-class type of building. I didn't think he was doing really great well of qualifying his tenants, but nonetheless, for certain tenants, he was paying the electrical bill to kind of give them a break. As they were applying, they would say, hey, because they had to put Put a security deposit to change the electric into their name. They said, hey, I just don't have the money to do that. And, you know, him being anxious to get the unit rented out, he'd say, okay, don't worry about it. You know, I already have history with them. They're not going to ask me for a security deposit. So there was a significant amount on this particular building, and it came out to about— it was, it was somewhere in the range of about $20,000 a year for the electric that he was paying on these particular tenants. And once I did get it under contract, it turns out what he was charging them them because they were just charging my utility allowance was not enough to cover for the electricity they were using. So that's something that's becoming, uh, very popular now, and it's called resident utility bill back, what it is. And it's something that's— I think it's going to be becoming more popular, especially with water bills. You may have heard in the news recently that, you know, California here where I'm at, you know, we're in a drought situation. I know there's several other states and municipalities out there that are dealing with these drought situations. So I'm expecting that in the future we're be seeing more of these. And on one of the buildings that I own, we actually do have the bill back for the water. And there's companies out there that they attach a meter to either the water heater or some other mechanical systems there. Well, it'll calculate the water for you and then bills it out. So that's one way to— or a couple of ways there to increase the value on the income side of things. Okay? Now you also have the expense side of things. And this is where we're looking to save money on things. And through experience, expenses that are kind of out of whack, outside of industry standards, you'll spot them out right away. But how do you get that experience? Well, there's several books out there that can kind of give you some reference as far as what are expenses per unit for the year. And there's several books out there that talk about that. But on a recent deal, actually it's a deal that I'm actually looking at right now, the accounting expense, I noticed that right away was way out of whack. And I asked the broker about that and I compared, because I own a building. The building I own is twice as big as the one I'm looking at, yet the expense on the accounting is less than half of what this particular seller is getting charged for. So I already automatically, I know he's getting overcharged, he's getting ripped off there. And there's a value add because I know when I take it over, You know, I'm not going to have that expense. Okay, on repair maintenance too, when you're looking at the expense statement, repair and maintenance, with more kind of mom-and-pop type owners, people that are not as savvy, sometimes they'll tend to include expenses for turnover and even capex. Okay, and that's something to, you know, you, you, you can ask the broker if they have any of that in repair maintenance. And in fact, on my website, I just recently wrote a blog article talking about that. So turnover, those are the expenses that you're going to pay whenever a unit becomes vacant. On bigger properties, that's going to be a consistent thing. On smaller properties, maybe not so much. And so when a seller is preparing to sell their property, it's not uncommon to see the repair and maintenance numbers be a little bit inflated. Because what they're doing, they're making improvements to the property so that when a prospective buyer comes in and sees it, okay, they see, okay, this was fixed up and that was fixed up. You know, they might even spend money on repainting the whole building, okay? And that can be a significant expense, but it's an expense that you're not gonna be doing every year, right? So if you know that's gonna happen, that's a scenario there, well then you can deduct that CapEx expense from your repair maintenance. Does that make sense?

Right, yeah. 'Cause they're handled very differently. I mean, it's not just an accounting difference. It is also going to affect your taxes and it's also going to affect your equity investment and the proportion of that which is debt and that which is equity. And so those are, are big differences.

Absolutely.

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Yeah, yeah, that's very true. That's very true. So if you can spot those things out, And the broker will let you know sometimes, hey, they did this, they did that. And, you know, but you can pull them out of your repairs and maintenance so that you know, okay, well then the way this property typically operates is at these numbers. There's several examples there during the analysis that will help you spot some value-add. Common nowadays, you know, you mentioned it before with the, you know, values going up and, you know, the difficulty with finding value-add opportunities. You have to be very diligent in looking at these things. And what brokers will typically tell you, not just in these times, but in normal times even, is the possibility to raise rents. And that's very common right now. Rents are going up pretty much across the board. But how much can you raise those rents? That's the more important question there. And on a deal, same thing. I was actually talking to a broker about this earlier this week. There's always going to be this ceiling Or where you can take rents, okay? And the brokers always wanna tell you the best picture, the best numbers and all that, right? But reviewing the rent roll that's provided to you will give you a lot of clues, okay? So for example, on this particular deal, pretty sizable property, and on the rent roll, I was able to see that over 50% of the 2 bedrooms were within the upper range of the rents. Okay. And then, you know, then from there, the other half, some of them were below and then some of them were above. Okay. So when I'm looking at that rent roll, I'm saying, okay, the ones that are below, where can I take those to? Can I take those to the ones above? Maybe, maybe not.

Mm-hmm.

But I know because the majority is right here in the middle, I know that I can take these guys at least to here. Okay. And so that's a value add, because I know these guys, I can take them at least to here. Now, you can underwrite the deal with the expectation that you're going to take these units up to here, but now you run a little bit of a risk. And here's where you need to review your rent roll, is that, okay, why are these— first of all, these guys that are up on top, the higher rents, is it a significant amount? What percentage of it? If it's only 1 or 2 units, it's probably not, you know, very reasonable to expect that you're going to be able to take even these guys, a majority of the guys in the middle up here. Does that make sense?

Mm-hmm.

So you're really kind of trying to see, okay, what percentage of these higher rents is it of the total mix? Okay. And does that give me confidence that, okay, I can take these guys and even some of these guys up to that top? Okay. So you really have to Dig deep into the rent roll and kind of look, you know, where's the majority? And usually that's where I tend to do my underwriting. If the majority are in here, I already know, okay, great, I can automatically go, go there. And as these come vacant, you know, I can go there. Now, the guys that are up on top, and on this particular deal that I'm, that I'm referencing, what they did is that they did Installed washer and dryer hookups in those units. Previously that didn't exist. So that's a major upgrade there, right? And, and especially in this kind of market where people are very focused on saving as much time as possible, you know, having, having on-site laundry, that's, that's fine. That's not a problem.

Mm-hmm.

But it's a lot more convenient to have it in your unit because sometimes when a tenant, you know, they might be battling for machines. You know, sometimes the machines, especially on the weekends, they're packed. You know, when you wanna go do it, you know, there's no room for you. So offering that level of convenience is a huge value add and something that's very common now. So that's one way to look at the rent roll. See where you can reasonably take those rents up. And then obviously you want to compare your rents to the market. And this is where sometimes the brokers try to be a little bit sneaky about things, is that in their marketing packets, they're going to give you some comparables on rents. But if you're looking to buy, say, maybe a B-class property, something maybe built in the '80s or the '90s, and they're giving you comparables with an A-class property that was built in 2020 and saying, hey, look, you can take the rents up to this guy over here. That's, that's really not a reasonable comparable right there to use. I like to do my own comparables. I'll take some of their information, but I'll do my own comparables and kind of see, you know, similar buildings, similar make, and in the same location. You know, that gives me the confidence that, okay, these are what reasonable rents are. And, and then And then from there I can say, okay, maybe I can push into this, go from there. Now, another thing that you don't hear too often, but I have a friend, he actually focuses, he invests in mobile home parks. And he mentioned this up too, what he does when he looks at rents or what people can pay, he's not really looking for tenants. He's looking more for people that are going to buy the mobile home. But what he's doing is comparing houses, mobile homes to houses. So what can somebody— what's somebody gonna pay on their monthly bill compared to a house? And I do the same thing with apartments. And in fact, I just had a discussion with the broker. This was actually just yesterday. He was on his marketing packet. He's trying to say that, okay, you can take the rents on these certain units up to this amount. And I'm very familiar with the market. It's my market. I know what's going on in there. And I do own some houses in the market as well. So I was already knowledgeable as far as what houses rent for. And I told him, what you're looking to put this apartment for, you can't get that rent because a person that's paying that rent, they're just going to say, why would I rent an apartment? I'll just go rent a house. Makes sense? So that's trying to discover where the ceiling of those rents are. And once you know that, then you know, okay, I can take the rents to this reasonable level. And now you created some value add there for the future of the property there. And there's many questions that you can ask brokers to find where value add potential may be. Okay? Like I mentioned before, you can ask them what they think the rents can go to, but they're going to give you their biased opinion on that. On the flip side of that, on the expenses, I mentioned when expenses are high, they're out of the normal, you can ask them, why are these expenses so high? What's going on there? And I mentioned on that recent example with the accounting, there was such a high accounting expense there. It was the owner was not really minding the store. You know, he was a successful attorney guy, you know, and he's just kind of letting other people run the show over there for him so that he can focus on his main, you know, his main money-making job there. You know, the investment was kind of secondary to that. And so what was happening there is that they were really kind of taking advantage of him there. And that's what the broker explained that back. And I asked him a few things about the payroll as well. On this particular building, they had 2 employees, but expense for the payroll was just way out of whack. So that just goes to show that this particular owner was not really paying close, careful attention to his property. He was just kind of letting it on cruise control. And so all these expenses were piling up and piling up. So then that's information that you get from the brokers there as well. You also want to ask them if they've done any improvements lately, because those are the things that may come up also on the income statement. There was a property where they had done some asphalt improvements, and asphalt is one of those things where you're also not going to do every year. So that was something that came up in conversation, and we were able to compensate for that. And then you also want to ask brokers as far as what's going on in the local market economically. Are there any new employers coming into the area? What kind of economic growth is going on? And I remember on one of my early deals, I was very fortunate this, but I was just blocks away from where Amazon was building a new fulfillment center and right by the airport area. So I actually had some tenants there that were actually working at the Amazon facility. And what I would also do, and this is something that I instruct my onsite managers to do, is that whenever they hear about anybody that's hiring, any new company coming into the area, you know, put it out there to the tenants, you know, because you never know. A tenant may get laid off, they may be going, or they get their hours cut or whatever, you know, they're looking for better prospects, and you might be helping them out. And in helping them out, you're helping yourself out as well. So, you know, you're maintaining, you're maintaining the, uh, the operations in the community there that way. Now, once you get the property under contract here, what some value-add things that you can discover during the inspections? This is once you get boots on the ground, got it under contract, you put your earnest money. Now it's where the real hardcore due diligence comes in because now the clock is ticking at that point. That's one of the fun times for me too as well because that's when I'm able to put my auditor cap now. In the days, you kind of really dig in there. But one of the things that I like to do is to ask the manager, the onsite manager that's there, you know, what do they believe the existing tenants, how many of them they can, you know, support, you know, higher rents? You know, if she tells me, and this just happened recently, I just came back from Texas about a week and a half ago. And she told me that she believed maybe about, you know, 30%, I believe it was 30 to 40% of the tenants, she says, Could support higher rents. Okay. And so that, that response kind of gives me a little bit of pause there. I have to be very careful now and consider where can I take these rents to, because I don't— you don't want a mass exodus of tenants vacating your units because you're not setting the rents right. Okay. So that's, that's a great question to ask your manager. Another question I'd like to ask them, if they had the resources available to them, What would it do to improve the property? Or what things can be done to the property to help boost the income, help the tenants, improve the operations? And sometimes they'll tell you stuff that you weren't even expecting. So that's a great question there to find out value-add. Now you can see, in fact, I remember this, and this was a while back on this particular property that she was saying that if we just improve the flooring in this property, You know, we can— we can just doing that will help increase the rents. I said, oh, okay, that's great. That's, that's pretty easy, you know. And improving flooring, it's not, uh, you know, it's not ridiculously expensive. And, and so that was great information that she gave me there. So 2 great questions there to ask the existing manager there. And, uh, when it comes to appliances also, those are also great ways to add, to add value and on this property that we're just coming on our 1-year ownership timeline on this particular property. What we did on this, and this is a little older, it's more of a C-class type building. It's a great location though, and been working out well for us. But what I tend to see on a lot of C-class properties is in the kitchen, you'll have your stove, of course, and then you'll have just a hood there, a hood with the fan and all that stuff, right? And on this particular property, what we decided to do is to get rid of the hood and instead put a microwave there with the built-in fan in there. And just doing that, not a significant expense at all. You know, the microwave, you know, it's going to cost you, you know, maybe $200, $300, something like that. You know, the install and all that. But the rent increases, the onsite manager has been able to bump the rents anywhere from $50 to $100.

Wow.

Now, it's not just because of that microwave, but, you know, in that particular market, we're one of the few buildings that's set up like that. And what that does also for the tenant is that it saves up countertop space in their kitchen. So now they don't have to, you know, plug in that extra microwave and take up countertop space.

That's a really good idea. Hood replacement is going to cost you about as much as a microwave these days, which is kind of amazing to me. That a lot of people probably don't even think about that, but a simple change that can make a big difference. Are the things to discover. They're not always really easy to discover either because they vary from location to location, and sometimes the smallest things can make huge differences. This one apartment owner, they were actually townhome-style apartments next to a garden-style apartment. They just put up a privacy fence between the townhome and the apartment buildings made a huge difference to the townhome dwellers. And a fence is next to nothing, but made a big difference in revenues there. So those are definitely some great things to discover there. Before we go here, we need to find out how we can get in touch with you. So share with our— Viewers and listeners how to get in touch with you.

Yeah, absolutely. So if anybody's interested in getting involved in apartment investing or even just learning about it, my blog is on my website. The website is www.larueinvestments.com. You can go to the Contact Us page. You can send me a message through there and we'll get back to you if you want to get involved in something. And if you wanna learn more about it, go to my blog there. They're all personal blog articles written by myself.

Well, great. Well, very terrific information today, Omar, and I certainly appreciate you being on the show. We'll have to get back together and continue this conversation because I think we're just getting started. Thank you so much for being here today.

Absolutely, Allen, and thank you for having me.

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