10 biggest mistakes made in multifamily real estate investing
Investing in multifamily real estate can be a great way to generate income passively and build wealth. However, if you aren’t careful, there are more than a few potential pitfalls that can be costly and investors should be aware of them. This is a major hurdle and a big reason as to why people don’t invest into multifamily real estate. Whether you are a seasoned professional or if you’re just starting out, mistakes happen all the time. After evaluating countless deals, we’ve definitely seen a thing or two. So in this article, we will discuss the 10 biggest common mistakes to avoid in multifamily real estate investing such as failure to do due diligence, over paying for your property, insurance, and more.
1. Not doing your homework before you invest
If you’re thinking about getting into the exciting world of real estate investing, there’s one important thing you need to do first: due diligence. Due diligence is the process of investigating a property before you buy it, in order to make sure it’s really as good of an investment deal as it seems. And before you invest, it’s important to do your research and understand the market you’re entering. What are the potential risks and rewards? What is the competition like?
There are several different aspects of due diligence that you’ll need to look into. Here are some of the most important things to look into:
Inspection
First, you’ll want to have the property inspected by a professional. This will help you identify any damage or problems with the property that could have ended up crushing the profitability of your investment.
A professional inspection will also give you a better idea of what kind of repairs or renovations the property will need. This is important for determining the value-add possibilities as well. You can then use that information of needed repairs to renegotiate a lower purchase price or credit with the seller.
If you’re not sure where to find a qualified inspector, your real estate agent or broker should be able to recommend someone. Once the inspection is complete, you’ll have a better understanding of what you’re getting into and can make an informed decision about whether or not to buy the property.
* One thing many novice investors forget to do is to also inspect again right before closing. Many times sellers make promises about transferring the property within certain conditions or parameters; such as ensuring that a construction job is completed or promising a certain vacancy rate is met. Inspection also means that right before closing you walk through the property to ensure all promised conditions and parameters are met.
Financials
When you’re looking at a potential real estate investment, understand that you are looking at a business. Just like you wouldn’t buy a business without looking at the financials, you’ll want to make sure that the financials of the apartment are in order. This includes everything from the cap rate, to their rent roll, their past 12 bank statements or T-12. You’ll want to make sure that they’re making the money that they say they are making on their pro forma. In addition you want to find out where the opportunities are. Are they paying too much in utilities or other expenses making their expense ratio too high? Dig deep into the income and expenses on the balance sheet to uncover where the opportunities lie.
Legal Issues
You’ll also want to make sure that there are no legal issues with the property. This includes zoning and easements. If there are any legal issues, you’ll need to have these resolved before you can close on the property. If you end up buying a property that has any legal issues, you will be the one responsible for them, so you’ll want to check with your local government offices to make sure that there aren’t any outstanding liens or other legal problems with the property and the property title. The last thing you want is a bad title to haunt you later at closing.
Operations
If this is a large multi family property, you’ll also want to take a look at the property’s operations. How do they collect rents? How do they handle utilities and other operating expenses? Do they collect trash for tenants? You’ll want to find out if operations are running smoothly and if not how can you make it so.
Employees
For larger apartment complexes, you’ll want to check into the buildings employees. This is the property management team or property manager of the building. Ultimately this information will reveal itself as you are uncovering operations, but you’ll want to make sure that they’re qualified and that they have the right skills for the job.
If not, you will want to seek out a good property management company for the job. Ideally you will want this service to be recommended to you from a reliable source.
2. Overpaying for a multifamily property
If you’re not careful, you can end up paying way too much for a property. This is something that even experienced investors often do. The problem is that they get caught up in the moment and don’t take the time to make sure they’re getting the best deal possible. Luckily we are in a cycle of the real estate market in which sales are starting to slow due to interest rates beginning to rise. Therefore you can use that to your advantage by taking your time, making your seller wait just a bit longer than they expect, ensuring that you purchase a property at a good price or even under market value.
Make sure you understand the valuation process of multifamily property. Use the biggerpockets calculator to help with your calculations. Find out, what are renters paying per unit? What are the property taxes like? What is the rate of occupancy in the apartment? How about in the area? You have to crunch the numbers and understand how much the property cash flows in order to determine what is a proper offer.
3. Neglecting to get the right financing
One of the biggest investing mistakes made when purchasing multifamily property is not taking the time to get the right financing for a property. Whether you’re going with a hard money loan or conventional bank financing, you’ll want to be sure about your financing before you buy a property. There are many different financing options available, and each has its own unique set of terms and conditions. Fannie Mae is a great resource to seek a non-recourse loan for a commercial property.
It’s important to work with a lender who understands your goals and can offer you the best possible solution. Talk to other real estate investors and seek referrals. The best service providers are typically found that way. Taking the time to find the right financing can save you thousands of dollars on your mortgage payment.
4. Not having enough cash reserves
This is a common mistake made in multifamily investing, and it starts at the capital raise. It is much much better to overestimate your capital needs than to underestimate. The solution is to raise more than you need. This way you don’t have any issues at closing incase an investor backs away from your deal. Worst-case scenario in a situation where you raise too much money is that you have to rebate some back to investors.
However, you should make sure to always have 5% to 10% of the properties income inside of a capital expenditure account. This will allow you to handle any problems that come up, such as repairs or renovations that are needed. A capital expenditure account is typically required by your lender anyway so this is a good rule of thumb to live by.
You need to be prepared for anything when it comes to owning a rental property. Not having enough money to cover repairs It’s possible that the roof could leak or you may have a plumbing issue that needs to be addressed
5. Failing to research the market and location
Location is the most important factor in real estate investing. After you know that the property is located in a good area, the next most important thing to consider is its potential for appreciation. Properties that are expected to increase in value are generally the best investments. However with multi-family homes, the value of the property is based on the net operating income (NOI). So the idea is to pick a location where you can force an increase in NOI.
Not having a solid understanding of the local market can lead to making poor investment decisions because Investing in real estate is all about having a firm understanding of the market. You need to understand the landscape of the particular area you are investing in. If the area that you chose has an oversupply of the type of property you’re investing in, you may have issues with vacancy rates.
Ask yourself important questions such as: What is the area like? What are the typical renters in the area like?
Keep in mind that if you invest in rentals near a local university your tenants will most likely be students. So you must cater to this type of tenant based on this location; write leases which include specific line items prohibiting alterations and extra roommates. Also be aware that your tenants may not be long term, and vacancies in rental units will rise during the summer. Location will determine the type of tenant that you have so be sure to pay close attention to the market.
Do the research in determining if the location you chose is rising or falling. Is there job growth in the area? Use websites like www.bls.gov to determine the trend. What is the percentage of household formations year over year? Is it trending up or down? Have you gone to a chamber of commerce meeting to determine what business trends look like? If you know what jobs are coming, you have an idea of what people are coming and how many. These are major determinants of whether or not your location is one that will be profitable over the long term.
6. Not properly screening tenants
Tenants can be a nightmare for real estate investors. Not properly screening tenants can be a huge mistake for investors. This is why excellent property management is important as they should always screen the tenants thoroughly before allowing them to move in. This includes doing a background check and making sure that the tenant is able to pay rent. Otherwise, the landlord may end up with a tenant who is not able to pay rent or who causes damage to the property. Or even worse, causes other tenants to move out!
You never know who you are dealing with in the world. If you happen to mistakenly accept a tenant who is a registered sex offender, they can scare off new potential tenants who actually do the due diligence of finding out about their neighbors. That is not a safe environment for women and children, so it would only make sense that they want to move out. However there is no law that prevents you from not renting to criminals.
So to save yourself from losing thousands of dollars in physical vacancies or even physical damage from unruly tenants, do yourself a favor; retain tenants and ensure proper screening. If your property is not big enough for property management then make sure you follow a checklist for screening tenants properly.
7. Not having the proper insurance.
If you’re not properly insured, your real estate investment could cost you a lot of money. Make sure your entire portfolio is properly protected with the right insurance policies.
There are a lot of different types of insurance for real estate investors, and it can be confusing to know which ones you need. But failing to have the proper coverage can be very costly if something goes wrong.
For example, if there’s a fire at one of your rental properties and the damage isn’t covered by your insurance, you’ll have to pay for repairs out of pocket. Or if one of your tenants sues you for damages and your liability policy doesn’t cover the full amount, you could be on the hook for thousands of dollars.
Don’t let a lack of insurance ruin your real estate investing business.
8. Not having a good attorney
If you’re going to invest in real estate, you need to have a good attorney on your side. There are a number of reasons.
For one, a good attorney can help you navigate the often complex legal landscape of real estate transactions. They can read documents and clauses and catch things that you may not catch. They can also help you avoid potential pitfalls and protect your interests in the event of a dispute.
Additionally, a good real estate attorney can provide valuable strategies, insights and perspectives on property values, market trends, and other factors that can impact your investment decision-making.
For example, in one of our mid-west real estate deals, we were referred to a lawyer that introduced us to a strategy that allows us to save money on property tax increases by purchasing the LLC of the seller in the transaction. This clever strategy prevents the county from being alerted to a real estate transaction, allowing us the buyer, to keep a lower tax rate based off of a previous assessment.
Investing in real estate is a major financial decision with significant risks and rewards. Having a good attorney by your side can help increase the chances of success and minimize the chances of costly mistakes.
9. Not having a solid exit strategy.
You must make sure you have a solid and methodical exit strategy on your multifamily real estate property. Will you be keeping the property for long term as a buy and hold? How about refinancing to buy out partners or to reinvest into a new property? Make sure you have a plan to sell the property before purchasing the property.
This is why knowing your investment numbers is so crucial upfront. If the investment can’t be justified on paper simply with calculations, then there is no need to go through with the investment to try and force it to work.
If you do not enter the investment with the end in mind, you may find yourself in a difficult situation when it comes time to sell your multifamily real estate property. Without a proper plan, you could end up selling your property for less than what you paid for it. Real estate investing is for making money, not losing it.
10. Doing it alone
Many new investors make the mistake of thinking they can handle all aspects of their real estate investing business on their own. This is a huge mistake that can lead to financial ruin. Real estate investing is a complex business with many different facets, and it takes a team of experts to successfully navigate it.
The most successful real estate investors understand this and have built a team of specialists who handle different aspects of the business. From finding and evaluating properties, to negotiating deals, to managing repairs and renovations, to marketing and selling the finished product, there are many moving parts in a successful real estate investing business.
Investors who try to go it alone quickly realize that they’re in over their heads and end up losing money on bad deals or taking too long to turn a profit. Real estate is a team game and the key is to create a winning team. Or simply join a winning team.
Conclusion: Summarizing these multifamily investing mistakes to avoid
Going into a multi family real estate deal can be daunting, but being equipped with information is how you avoid mistakes. Make sure you have a clear plan before investing. Don’t know the market well? Make sure you get to know the market. Haven’t set a goal? Set one! Be patient on the buy, don’t over pay. Do the proper due diligence and market research. Consult with your team and win together, this is a team sport.
DO YOU WANT TO INVEST INTO OUR REAL ESTATE DEALS?
Register below to get first opportunity to our deals, news and other information from Gold Grade Capital.