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The Due Diligence Guide for Entering a New Market

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Apartment owners and operators discuss best practices for new-market expansionism. 

Expansion into a new market: It’s an issue almost every apartment owner-operator confronts at some point. Sure, the chance to increase the geographic reach and revenue-generating power of a portfolio is an appealing one, but growing just for growth’s sake, without a thorough preparation process and a carefully considered strategy, can lead to serious mistakes.

Stay Disciplined 
Since its founding more than 40 years ago, JVM Realty Corp., an Oak Brook, Ill.-based owner-operator, has followed the same strategy: Acquire and manage Class A and B apartment communities in secondary and tertiary markets in the Midwest. Adherence to that strategy has allowed JVM to expand over the years at a sensible and methodical pace into markets such as Kansas City and Indianapolis, JVM President and CEO Jay Madary says.

According to Madary, owner-oper­ators can get into trouble when they begin pursuing markets and commu­nities that fall outside their traditional investment criteria, a temptation that may prove especially powerful in today’s healthy apartment housing. “I think equity is plentiful, and sometimes there’s a lot of pressure for groups to acquire properties,” he says. “Maybe they will deviate from their in­vestment criteria or their target markets because of those pressures to buy. It’s important to remain disciplined.” 

Prepare, Prepare, Prepare 
Once an owner-operator has identi­fied a city as one that it’s interested in entering, there is no shortage of due diligence to undertake. 

For companies looking to acquire communities in a new market, they need to track transactions in that locale to learn the identities of the major buyers and sellers, as well as the typical sales prices and cap rates, says Ernie Heymann, Chief Investment Officer for Rockville, Md.-based CAPREIT, which owns and operates communi­ties throughout the United States and entered the Raleigh-Durham, N.C., metro area last year. 

Developing relationships with the primary local brokers is absolutely critical, too, Heymann adds. “A lot of preparing to enter a market is getting to know the two or three top brokers in that particular market,” he says. 

Taking tours of a potential new market with brokers is a great way to perform due diligence, Madary adds. “Brokers are very happy to meet new potential buyers, so you’re typically welcomed with open arms,” he says. “They’ll take you on a tour, show you the lay of the land, maybe show you some product they have on the market and then remain in contact with you.” 

A lack of due diligence often is apparent when companies that have focused on primary markets enter sec­ondary and tertiary areas and arguably overpay for communities, according to Heymann. 

“We see that happen frequently, where we’re like, ‘They just paid $120,000 a unit for that? You can build it new for $110,000 per unit. Why would they do that? "

Taking time to really understand the demand drivers of a metro area's individual submarkets and the scale of its new construction are imperative, too, Madary and Heymann noted.

“Everything may look good and balanced today, but you’ve got to look at that construction pipeline to make sure a market’s not going to get 10,000 new units this year when it can only really support 2,500,” Heymann said. “You have to make sure you have your hands around that.”

Finally, apartment companies need to consider what competitive advantages they would enjoy in a new market, says Dave Miskovich, CEO of Bethesda, Md.-based ROSS Companies, which owns and manages apartment homes in the Mid-Atlantic.

When considering the recent expansion of its third-party management services into the southern Virginia markets of Richmond and Hampton Roads, ROSS leaders realized the firm had an opportunity to deliver superior returns because of the relative lack of sophistication of other apartment operators in the area, according to Miskovich.

ROSS would potentially have an advantage in those markets because of its use of pricing, budgeting and operational software, as well as its digital marketing and reputation management efforts, the company concluded.

“We felt if we could bring our level of multifamily operating sophistication down there, it could be a huge success for us,” Miskovich says. “The owners there really see the value of the systems and the models that we bring.”

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