When it comes to reviewing multifamily investment opportunities, ultra-high-net worth individuals, serious investors, and family offices are quite astute at spotting flaws in the investor package that a sponsor or JV partner puts in front of them. While the obvious “red flag” flaws are easy to spot, like unreasonably high returns, risky debt structure, or a bad location, there are more subtle flaws that are sometimes overlooked, even by experienced investors.
In my experience as a syndicator and investor, I’ve seen these flaws on many deals. I began my career in real estate working as a commercial real estate lawyer in 2007 and later transitioned to a property manager role. After I received my MBA from MIT, I started Blue Lake Capital and became a syndicator. My company purchases Class B multifamily value-add properties in Texas, Georgia, Florida, and the Carolinas.
The flaws I see are often apparent in the investor packages, which generally contains a summary, a description of the opportunity, an overview of the market, a business plan, and an overview of the financials, or a proforma. While there are several to watch for, there are three flaws in particular that are of great importance, so I’ll discuss each one in detail.
Flaw #1: Business Plan Assumptions
One of the items usually found in many investor packages are beautiful photos of the property, often showing what the project will look like when fully renovated. Part of the business plan talks about value-add renovations of the units, but what isn’t always apparent is when the renovations will begin and how long they’ll take.
The renovation timing and length is something investors should pay attention to because renovating 200 units in 1 year may not be a reasonable assumption, unless the syndicator has an entire team that can renovate quickly. During COVID, the renovation length assumption has been put to the test, because sponsors may not be able to renovate that quickly even if they have the right team in place. When my team underwrites a deal these days, we assume no renovations in the first 6-12 months, just to be on the safe side; after all, tenants may not be able to pay the premiums for the renovated units in the near future due to COVID.
As a passive investor, I’d advise you to investigate whether the syndicator has the systems and experience in place to renovate the number of units they are committed to renovate, and what was the thought process behind their assumption. This is an important question to ask, and one question that you don’t want to skip over.
Another business plan assumption that may contain flaws is the cash reserves. Does the syndicator indicate how much he or she plans to have in cash reserves to cover major unexpected expenses? Unfortunately, most investors don’t ask how much is planned for reserves, but it’s an important question to ask.
As an investor, you want to be sure that there is enough money placed in reserve for one-time capital expenditures, such as a new roof or replacing an HVAC system. During COVID, lenders were asking syndicators to have 9 to 12 months of debt payments in reserve. Syndicators would either have to raise this additional money or take it from expenses and move it into reserves. However, if you have to use all of the reserves to pay for an unexpected expense, there won’t be any money left to pay investors.