With a tight multifamily real estate and little inventory, knowing how to pick a market to invest in is crucial. Here are five things you should be looking at to select a market.
1. Demographics; Who lives in the area today? Is there a migration of people moving into the market? What is driving the movement?
2 Rent Rates; What are the average rents in the area? Is it a A, B, C or D area? How much are houses renting for (and competing for apartment dollars)?
3. Employment; Are there jobs in the area? Are companies moving in (or out) of the area?
4. Available Inventory; How many buildings are for sale? What is the average cost per door by class? How quickly do they move?
5. Exit; After you get a deal under contract, how many people are also chasing the deal? If you understand this, you just found the people that will buy the deal from you when you are ready to sell.
You can lose a lot of money in real estate if you don’t do your research. You need to learn all you can about multifamily real estate so you can become an informed investor or a master syndicator. It doesn’t matter if you are working on your first deal or your 100th – staying sharp is important and being engaged with the market is key! Know WHERE you are buying and WHY you are buying.
Another thing to note is that multifamily real estate investing is a team sport. Go to live events and network with others. Who knows…you may even find your next deal at your very next networking event!
Getting into your first multifamily deal can be exciting and nerve-wracking at the same time. If you do it right, getting into good multifamily deals will allow those involved to get closer to achieving their financial goals.
For some, realizing true financial freedom, is an illusion without the right way to get there. If you are serious about obtaining more wealth without the risk and hassle of building a portfolio one single family home at a time, then multifamily is the answer. When it comes to cash flow, multifamily apartments are by far, the most lucrative way to get that stream of income that is within the reach of private investors like you.
Here are my 5 benefits of getting into your first multifamily deal:
1) Steady Cash-on-Cash Returns
Higher cash-on-cash returns compared to single family homes make multifamily a solid winner. Getting $300 of monthly cash flow on a single-family home is a good starting point for many investors, but with multifamily investors can realize multiplied cash flows. This is you are multiplying the number of units. If one deal works, why not multiply it by 50 or even 100? Even owning a single multifamily deal with 12 units will put two or three thousand in your pocket. It may not be enough for some of you to change your life, but it would certainly help cover some of your bills.
2) Plenty of Demand
In case you hadn’t noticed, the is a ton of demand for multifamily. Aside from Baby Boomers and Millennials moving to renting rather than owning, it’s less expensive to live an in an apartment than maintaining a single-family home. For investors running their properties correctly, it means high occupancy. The large cost of multifamily deals compared to single family homes are enough to keep many investors away. So this market has considerably less competition. For those that are not afraid of the numbers, they are charging ahead.
3) Low Risk
If you are familiar with how banks lend on multifamily, you know that their rates are usually low and have a high degree of flexibility and leverage. This is because they see multifamily as a low risk investment. If your single-family home goes vacant, you need to worry about having cash reserves to sustain it. If you have a mortgage on it, you are pulling that cash out of your personal reserves. The benefit of having many units in one building is that if one goes vacant, there is still cash coming in from the others to keep it running. If banks like low risk and you can leverage their money, you should take advantage of it.
4) Leverage Professional Property Management
The cash flow of a properly run multifamily deal enable you as an investor to hire professional property managers to handle maintenance, tenant concerns and problems if they arise. The incoming cash flow generated by a multifamily property allows you to use your time to source more deals or spend it on what you enjoy doing. What’s more, having a professional property manager will allow you to scale your business if you like as you can lean on their expertise.
5) It’s a Business
Many investors favor multifamily properties because of the consistently strong market and the significant return on investment. So, like any business, there are many tax benefits and ways to increase cash flow. Aside from depreciation and interest deductions, other expenses like insurance and ongoing maintenance are spread over the number of units in the deal. You can force appreciation and Net Operating Income in more ways by offering benefits to your tenants. This drives valuation up and creates value in your multifamily deal.
Anyway, this is just an outline for you to consider the benefits of multifamily properties. What do you like about multifamily deal? Let me know in the comments.
Here is a question that comes up in conversation: How to I make the jump from single family to multifamily. As subtle as the differences look, the contrast between single and multifamily properties can be big. If you are looking to take down a 5 unit or greater, the additional units under the same roof will impact the financial terms, time to close, budgets and many other items related to the property. Sometimes getting into the deal can be easy, but at times it can be frustrating. It just depends on the personalities involved and how committed you are to be easy to deal with. Despite all this, the process is generally the same – whether it be 10 or 100 units. Investing in multifamily may seem intimidating, but if you learn and partner with experienced people, it doesn’t have to be. Before you decide to take down your first $10MM property, I’ve outlined the 5 biggest differences that you need to know:
1. The Numbers – The biggest difference in single and multifamily properties is with the numbers. On a single-family home rental property, you look at projected rents and maybe lean on the neighborhood to tell you if you have a good deal. In a multifamily deal, you will look at this info and much more. And the bigger the deal in terms of units, the more data you need to rely on. You will be looking at the T12 (or Trailing 12), rent rolls, maintenance costs, net operating income, vacancy drivers and other material info. Not only do you need to know what all this means, you need to account for every dollar. When you are starting out, trying to decipher the terms and numbers can be confusing. But if you analyze enough deals and are diligent, it will become second nature.
2. More Docs – It may make sense that a 50-unit building will require more due diligence than a single-family home. Along with the number of units, there will be more paperwork and degree of order required. You will want to review all the leases and look for “heads on beds”. Meaning, is the seller just placing anyone in the units to drive occupancy up. You need to look at rent rolls to see where the rents are to market and if there are any dips in occupancy. You will want to look at major repairs that were made and what warranties are in place on such items as the boiler, roof and water heater. Anyway, just understand it will sometime take time to get your hands on all the paperwork not only for your own review but for the bank as well. In addition to all that, the lender will want to look at the deal appraises. Unlike a single-family homes that are appraised on comps and listings, a multifamily property is appraised by how much cash they generate because it is a business. In order to put both the buyer and seller at ease, putting these deals together takes more time. All this means is that it will take more time to close. The good thing here is that the bank is your partner. If the documents you are sending do not make sense to the bank and they don’t like it, it means you shouldn’t buy it.
3. More Capital – This is the part that many people get hung up on. But here’s the thing: if the deal makes sense, the money will come. So, there are a few ways to look at expenses in a multifamily deal: If you own a smaller deal, all the expenses are under one roof. If you need a need roof, dryer or furnace, you typically need one for all the units. When you looking at bigger multifamily deals, you need to make sure you have reserves to handle the unexpected. One big mistake that new multifamily investors make is not setting aside enough capital to renovate or cover incidentals. For example, the closing costs on a multifamily deal are more than a single family. If you are syndicating, you can expect to pay an SEC attorney anywhere from $8,000 to $12,000 to prepare the paperwork. Between legal, environmental and other lender costs, things can add up quickly. A good starting point for a class C property is setting aside $1,000 per door, but that may vary on your location.
4. Bigger Team – For many in real estate, landlords that handle a single-family property may feel that one property is difficult enough. Suffice it to say, the more units you have, the more difficult it is to manage everything. If you plan on making the leap to multifamily, I advise people to get property management when they hit 16 units. If you bought it right, there will be enough cash to cover their cost and still provide a healthy profit while allowing you to focus on buying more deals. In addition to a property manager, you need to find a good accountant and a handyman. You want to surround yourself with a strong team to help you scale. This includes a bank, property inspectors, attorneys and more. I covered more of this in another video. If you do it right, you will be spending more time finding deals and less time managing properties. First thing, start with an experienced property manager, explain your vision and leverage their experience when speaking to brokers and looking at potential deals.
5. More Due Diligence – It may take a couple of hours to research a single-family deal. On a multifamily it will take much longer. Of course, there are tools out there to quickly analyze a multifamily deal in 20 minutes, but if you decide to commit to the deal, you are in for some work. Getting the paperwork together, running the numbers and making sure everything adds up can be tedious at times. This is the part where you are looking for reasons NOT to do the deal. If it passes muster, you continue through the due diligence phase to close. Due diligence on a multifamily deal is not easy, but necessary. Make sure you understand everything related to the deal. If you can’t commit the time, partner with someone or hire a professional underwriter that can do it.
There you have it. When done right, investing in multifamily deals give you many more options and is an amazing and proven way to build wealth. Whatever the reason: to build your long-term portfolio, increase monthly cash flow or leave a legacy for generations to come, there are differences in the deals and your methods of execution. Understanding what to do will make you successful.
Evaluating a deal varies from property to property. My focus these days are Class C and Class B deals, so it really depends on the business plan for the property which drives the underwriting process. This includes gathering the expense and income data, building a financial model, performing rent and sales comps and in-person visits. All this can take anywhere from a few days to a week. Then, once you negotiate the fine points and get it under contract, you will have 30 to 60 days to perform due diligence to confirm your underwriting assumptions and build out your business plan according to what you find. When you consider the costs of both the underwriting and due diligence process, deal evaluation becomes an investment of both your time and money. So, the sooner you can find any deal breakers, the better.
Here are my 5 tips on potential deal breakers to look for when you are checking out a multifamily deal:
1) Mistakes in the Offering Memorandum
The offering memorandum is a marketing document created by the sellers’ broker that summarizes the deal. Note that I just said “marketing.” The purpose of the OM is to support asking price the sellers’ broker. All the photos will look very nice and the typesetting will be impressive. The intent is to sell the deal for the highest price possible – and yielding beefy commission check for the broker.
Typically, the OM will include a pro forma, trailing 12 month and a rent roll. You never use that data when analyzing a deal. At most, you should use it as a guide because most of this data will not be accurate. Sometimes they are even totally fabricated. Remember, this data is to pull in the highest offer.
I have looked at many deals where the rent roll in the OM and the actuals from the property manager were off by over $100 a unit. If you are looking at an 80-unit deal in a 9-cap market, it could mean the value is pumped up by $500k to $1MM. They also had occupancy at 100%. As soon as you see anything ending in a zero, you know it’s bull – especially when you see the rent roll historically showed 87%. I can assure you that they are not chaining tenants to the refrigerators! You must always use actual historical data and a current rent roll when looking at a deal.
Another time, I found they didn’t add the expenses up property and it made the deal appear like it had a higher cap rate. Other times. the internal rate of return was wrong. And other times when someone transcribed the rent roll from an 86-unit deal from paper to Excel and the numbers were all wrong. I know that people may make mistakes, how can you trust the numbers if there are so many errors in the OM? Again, understand that these numbers are all for show. Use them as a guide only when underwriting.
2) Unrealistic Pro Forma
The pro forma contains detailed information of the financial performance of the property. Generally, when you are looking at a deal, the T-12 is used to see if income and expenses of the property is stable month over month.
Here is an example that happened to me recently: I was looking at a 150-unit deal. The financials showed gross income for the previous 5 years starting at $780k and increasing by about $12k annually, which seem reasonable. The pro forma showed gross income for the coming year to be over $250k from current and it showed 100% occupancy. Additionally, the expense ratio was at 39%. Even the very best run properties with little to no maintenance run at a 40% expense ratio. While it is possible, the property would be a very well-run machine and those tend to be hard to come by.
On another deal, I found the expenses were super low compared to what they should be in the area. For instance, the annual water and sewage bill for a 30-unit deal was about $5k and the property was sitting on 1.8 acres of land with a lot of grass. Just doesn’t seem right.
The best way to overcome an unrealistic pro forma is to base your analysis on how you will run the property. If you are leveraging partners – like a property manager – ask them to prepare a pro forma of their own based on the seller data and knowledge of the area.
3) A Bad Area
One of the factors that tends to be an automatic deal breaker for me is the area it’s located. I’m looking for good deals in good markets. If there is no demand for people to live in the area or there aren’t jobs moving in, it may not be for you. If you are not able to raise rents or you need to worry about appliances getting stolen in the middle of the night, just don’t do it.
4) Unethical Property Manager and the Owner with a Bad Reputation
Let’s say the financial data in the OM was done by mistake or it was created by an intern not familiar with the numbers. We already decided we will not take them at face value. But, there are things far worse than bad numbers in a document and that is people that purposefully cloud the deal to hide expensive problems or even flat out lie.
I hold events on a regular basis with multifamily investors. One of our attendees discovered that the property manager was forging rent rolls, leases and other important data. The property manager also said they had 91% occupancy when it was more like 80%. The only reason my friend caught the property manager in the lie was because someone inside the company forwarded an email by mistake. He would have discovered it eventually because the numbers would not have balanced with what was in the bank, but he would have been further down the road.
Another time, someone sent me a 200-unit deal. Doing a quick search for the address on the Internet to see what the residents rated the property, I came across a video on YouTube where the landlord was shouting at a news crew! They were accusing him of providing no heat for the many of the tenants in the middle of winter. Something about paying a bill or a not repairing the boilers. I know that kind of stuff can be fixed easily with proper management, but if this is just one indication of one problem, I don’t want to see any more.
Regrettably, people don’t always tell the truth. If you get an inkling that something isn’t right, you walk away.
5) Issues Found at the Walk-Through
Even if everything looks good on paper you need to do a walk-through of the property before locking it down. There can be plenty of deal breakers that you can only see when you actually see the property.
For instance, if I see a lot of cars in the parking lot on a Wednesday mid-morning, it could be an indication of high unemployment in that building. Or if the surrounding area around a very nice prospect looks bad and run down, it could be an indicator of for crime.
Performing a site visit may impact your repair budget. Recently, I went to visit a 4-story property that looked promising on paper. When we walked around back, it looked like the back wall was splitting in two. From the very top to about the middle was breaking apart! Clearly the sign of an expensive problem. That would have cost a great deal of cash to repair and it killed the deal.
What’s your biggest deal breaker when you are looking at a deal? Let me know in the comments.
Let’s talk about getting loans for your multifamily deals. Here is a rule of thumb: the easier a it is to get a loan on a deal, the less money you will make. There are many different types of loans. The easiest one to get is a residential loan, which is 1 to 4 units and you must live in one of the units. For this discussion, a house isn’t considered an investment simply because it doesn’t produce cash flow. If we contrast a house, you will have a down payment, pay PMI or private mortgage insurance and an interest rate based on your personal credit score, your debt, employment and other factors. To get that loan, you have to prove that you personally have the cash flow to afford the debt on the house because the bank doesn’t consider it an income producing investment.
The opposite is true on an income producing property, like multifamily. Picking and investing in the right multifamily deal is one of the most important things you’ll do starting out. Structuring the right equity, debt, getting a good rate and cash flow on your deal is incredibly important. In this case, your biggest partner on the deal is the bank because they are usually putting up 60 to 80% of the debt on the deal depending on how you structure it. So, financing is extremely important. You need to know financing and the various ways on how to get the deal done because it costs you money. A difference of a only a quarter of a point in interest on a large deal can mean paying hundreds of thousands of dollars more per year. Many times a bank will offer an interest-only loan at a certain percentage above Treasury rates when financing these types of deals. You’ll need to compare rates to find the best one and length of term for your situation.
Another thing to make sure you line up the equity side, or your down payment. Unlike buying a house, you don’t want to pay the principle down. The objective is all about how much money you can cash flow on a monthly basis. As the land value appreciates and rent increase because you are driving appreciation in the property, you still get cash flow. The cash flow covers the debt payment and gives you passive income. There is no upside in paying more to bring drive the debt side down. With that said, I like to do long amortizations as I want to reduce the monthly payment and maximize cash flow. This will vary on the type of loan and what the bank is willing to do on the property. And if you are working on a larger deal, you should spend more time negotiating rates and terms with the bank.
Here are the 3 things the bank is going to look for when they are considering your multifamily deal:
1. First, they are going to look at your net worth, which includes liquidity and assets. 2. Then, they will look at your credit. They will be looking for lates, bankruptcies and other blemishes. 3. Finally, they will look at your track record and experience in buying and managing real estate.
To get started, you need net worth and liquidity. Whether you have it yourself or you lean on partners that have the liquidity and net worth. This means partnering with experienced syndicators that have done multifamily deals in the past or have a foundation in good sized commercial real estate.
Then, make sure your credit is in good shape. There are many credit repair companies out there that will work to get rid of the tradelines impacting your score. If you know your credit is lacking, I’d suggest you start on that today so you can be ready when you find a deal.
And for your track record, you can lean on your property management company. If you can find a company that manages many units, they have a good reputation and are easy to work with, you will be good.
Anyway, let me know what you think. Do you have any lenders, credit repair or property managers you’d like to recommend in your area? Leave them in the comments.