By Mark Lemmons I August 12, 2022
When it comes to investing in real estate, multifamily properties provide an excellent opportunity for high returns. Ongoing high demand for affordable housing brings a sizable target market. The need for apartments and opportunity for investors isn’t going away any time soon, especially with our current real estate climate.
There are many tax-deductible expenses involved in multifamily investments that provide large savings for investors, enabling them to get a high return on investment (ROI). But I’ve learned a few costly lessons while investing in multifamily real estate. And – I’ve watched others make some, too. I know from experience that if you’re not careful, your multifamily investment property can become a financial disaster.
Here are 5 mistakes to avoid if you are looking at investing in a multifamily property.
The number one mistake an investor could make is underestimating or miscalculating renovation and repair costs. Investors need to be familiar with the vintage of the property and comfortable with lender and insurance required repairs. Unless you are purchasing with cash, you will likely be forced to do some upgrades and repairs on the multifamily asset. Knowing what these are in advance and having budgeted for them will help make the purchase a smoother one. Be sure to partner with a construction professional who can give you real numbers – don’t guesstimate.
In multifamily in general, there are some electrical panels that are considered unsafe and very costly in multifamily to replace due to the sheer number of panels:
These electrical panels are a typical example of an issue in multifamily that you wouldn’t think much about in single family housing because there’s typically only one electrical panel – but there could be hundreds in a multifamily asset. Other issues that buyers should be aware of are issues with aluminum wiring if the property is built from around 1965 to 1972.
Lender-required repairs typically fall in the category of safety issues, but I’ve also seen them requiring other issues that aren’t related to safety at all. I’ve had lenders require parking lots to be resurfaced, rebuilding retaining walls, replacing stair treads, updating fire extinguishers, changing out door knobs and handles, etc.
Because lender-required repairs don’t typically drive income and don’t help you boost rents on the property, you need to recognize that you’re spending money but probably won’t be getting a return on that investment. Be sure you’re comfortable with the lender requirements or shop around a bit.
Accurate estimates for repairs and renovations is crucial to underwriting, but so are a few other things. It’s best to be conservative in underwriting, whether it’s giving yourself some padding with your renovation budget or using a modest forecast for the future.
For example, you may assume that the market will appreciate at a rate of 6% for the next 6 years. But, that’s being overly optimistic. It’s always better to err on the side of caution and use a more modest forecast. Appreciation is not guaranteed, and if your underwriting is depending on that, you’ll be in trouble.
You also get into trouble when you assume you’ll be able to make a large increase on rental prices because of the renovations you are adding. In reality, you’re probably going to need to charge less than you think. You want to give a realistic picture of what you’ll be able to charge based on the market, not just on your renovations. Use good market comparables that correspond with your property to get good estimates.
Getting the proper insurance coverage for your multifamily property is crucial to protecting your investment. One oversight in this area could cost you thousands – if not millions – of dollars. Be sure to work with an insurance broker you trust to get you the best carrier that fits your lender requirements. Yes, you want to get the best premium, but even more than that, you want to ensure you have the proper coverage.
It is best to have an insurance team in place prior to your investment so they can help you determine what coverage you need for your location and how much your coverage will actually cost. Having an accurate estimate will help you with proper financial plans for your investment. You also want to look at the trailing 12 months (T12 or TTM), which is a financial statement showing the multifamily property’s previous twelve months of operations. Look at any previous insurance claims, ask the current owner about it, and speak with your insurance broker.
Your lender has a vested interest in making sure you get the correct coverage, because until the loan is paid off, they are on the hook for the property. They will help you get the insurance you need, but some of your choices regarding coverage will come down to risk tolerance. For example, earthquake events have happened in Texas. They don’t happen often, and whether or not you get insurance for that is up to you.
Your property management company can make or break your investment. You want to be incredibly careful with the people you put in charge of managing your property. Your property manager is in charge of filling vacancies, performing maintenance, and dealing with tenant issues. If these things are not dealt with properly, it can result in major costs such as vacancies month after month or expensive maintenance repairs that could have been avoided.
Your property management company also plays a large role in the marketability of your property. If your property has bad online reviews due to poor management, you could miss out on filling your units with quality tenants.
If you’re ready to invest in a multifamily property, avoid these 5 mistakes like the plague. Multifamily real estate can be a great investment, but if it’s not properly done, you can end up losing a lot of money. If you’re interested in getting in on one of my next multifamily investments, contact me!
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