Updated: Aug 19, 2019
When you own a multifamily property, many times things go along quite smoothly. Tenants pay their rents; your property manager is on top of all the issues relating to the property, including maintenance, repairs, tenant issues or problems and more. Occasionally, however, problems come up and catch you by surprise.
When it comes to your multifamily property, the last thing you want to hit you are surprises. By knowing the warning sings of potential problems, you can proactively address those problems and act accordingly, rather than reactively when they hit you by surprise. I’ve put together some of the top warning signs that show your property may be in trouble, and ways you can act to avoid those problems.
Warning Sign #1: Dramatic Changes in Occupancy
The “health” of multifamily properties is usually measured by two benchmarks: occupancy levels and vacancy rates. Occupancy levels describe how many units are rented, and is expressed as a percentage of the ultimate goal of 100%. An occupancy rate of 95% means that 95% of the available units are rented.
Vacancy rates describe how many units are vacant in a multifamily property. A vacancy rate of 5% means that 95% of the units are available. Every market and submarket has different occupancy and vacancy levels. The average occupancy in the U.S. today is around 93%, which means that 7 out of 100 apartments are empty and not generating income for you.
If you suddenly find you’ve gone from a 95% occupancy rate to an 77% occupancy rate, you’re looking at a major warning sign of potential problems. Yes, I know, 77% sounds like a high number, but it’s still a significant decrease from a 95% occupancy. There might be a good reason for it, but this is not something you want to ignore. Along with the changes in occupancy, there also may be extensive rent concessions (discounts to lure new tenants) to fill vacant units, as well as a significant showing of bad debt (rents that have not been paid by tenants). If a significant number of tenants’ checks are bouncing, it may be that a major area employer closed their facilities or laid off a lot of workers. That spells trouble for multifamily properties.
How to avoid falling occupancy?’
The first step is to have weekly phone conversations or meeting with the property manager to discuss falling occupancy rates proactively, before they get out of hand. Monitor the numbers and address the warning signs as soon as they become apparent.
One way to lower the vacancy rate is by using concessions, such as “one-month free rent” for tenants who sign a one-year or longer lease. The problem with concessions is when they get to be excessive; you’re cutting right into the cash flow and income. If you have 10% of your apartments on concession, that’s a significant amount of money you’re giving away. Put a limit on how many units you’re willing to offer on concessions, and stick to it. Use concessions with caution; high concessions can hurt your bottom line.
Vacancy rates fluctuate monthly, but usually only on a small percentage basis. If they jump, you need to determine the cause. It could be one tenant is causing all types of problems, and if that’s the case, correct the problem or start the eviction process. If the vacancy change is due to a problem with the building’s maintenance or equipment, get it repaired or replaced - fast. Nothing is worse than a lot of tenants leaving and bad-mouthing your property.
Warning Sign # 2: Your Property Manager is no Longer Engaged
The first sign that your property manager is not engaged with managing your property is a clear one; if the property manager communicating less and less with you or you have stopped hearing from them in a while, which is, and there’s no other way to say it, a really bad sign. They don’t return phone calls, emails or texts. They may be negligent with property inspections, or have bookkeeping problems with the rent or don’t have enough staff to handle the property’s needs. Remember, they’re there to manage the property; if they’re not doing it, say good-bye.
Another sign may be extremely high maintenance costs. If the property manager doesn’t have a good network of vendors, they’re going to be paying the highest rates for work, even for basic repairs or inspections. If they aren’t responsive to tenants’ maintenance requests, they’re not doing their job.
A rise in risky tenants or those who don’t pay their rents on time may also show that the property manager is not engaged. And if there’s an escalation in conflicts or problems between the property manager and tenants, then this is the time to make a change and get a new property manager.
Another sign might be late or sloppy monthly reports. These are critical for cash flow and income statements, and there is simply no excuse for an inadequate job in this arena.
How to avoid disengaged property manager?
Before you hire a property manager, ask to speak with their current clients, and read online reviews. Since many property managers are large companies, their information will appear on Google and you’ll be able to read what tenants think about them (you can simply ask a potential property manager what properties they manage and Google the property name. the reviews will appear on the right side of Google search results).
As the syndicator or owner, you need to get the property manager engaged. Once you’ve hired a property manager, you can do this by having weekly meetings or phone conversations discussing the occupancy rates, building maintenance issues, tenant problems or anything else that could turn around and bite you without warning. Closely managing your property manager will make sure they are still engaged.
Warning Sign #3: Competition is Lowering Their Rents
The first two signs were easy: rise in vacancy and a disengaged property manager. They are easy to spot. The next one is more nuanced and requires you to keep an open eye on your competitors. You or your property manager should be monitoring the market and the competition to see what rents are being charged, and what other properties’ vacancy rates are. If they’re not doing this, or aren’t savvy enough to do it, you’ll need to do the research. Either way, you have to know what the competition is doing.
If your competitor is offering major concessions to potential renters, like two month’s free rent or a steep discount in rent for a longer lease, they’ll might attract potential tenants that will pass on your property.
How to avoid fierce competition?
Well, there’s nothing much you can do about that, because you can’t control the competition. What you can do is to understand what’s going on. Find out why are they doing it? Is their vacancy rate high? Or is there another reason? (maybe the owner wants to sell and is determined to increase vacancy as much as possible to get the highest possible price). Is there a lack of new people moving to the area? By researching the reasons, you’ll be able to avoid a spike in your own vacancy rate and perhaps come up with a creative solution to the competition’s new strategy.
You need to conduct research on a regular basis to understand what’s going on in your markets. Go online and check the competition’s websites, and see what they’re offering new tenants. See if they’ve made any changes that could explain the concessions or lower rental rates that they’re offering. Most likely, they may be facing a high vacancy rate due to a building issue, market condition or a tenant problem. Knowing the reasons would be helpful in retaining your tenants.
Warning Sign #4: Your Property’s Income Can’t Pay the Debt
One of the worst nightmares for multifamily property owners and investors is not having enough income to cover the property’s debt service. When looking at income, be sure you’re looking at the net operating income (NOI), which is based on all property revenue minus all reasonable expenses.
If the property isn’t generating enough income, or the expenses are extremely high, there won’t be enough money left to pay the lender (principal and interest on the loan). That could put you in default, and the lender could call the loan. But that’s a worst-case scenario, and one you can hopefully avoid.
How to avoid inability to pay debt?
Start by looking at vacancy rates. If you’re property is running above 8%-10% vacancy, that could be why there’s not enough income available for the debt service. Are tenants paying their rent on time? Is there an excessive amount of bad debt? Anytime you’re seeing more than 3% of bad debt (bounced checks, failure to pay rent, etc.) you’re looking at a problem.
Always maintain a debt service coverage ratio (DSCR) of 1.25. A DSCR is calculated by dividing net operating income (income minus operating expenses) with debt service (yearly interest and principal payments). If the DSCR is too close to 1, then a minor change in cash flow could make it impossible to pay the debt. When it’s greater than 1, say 1.25, there is sufficient income to pay current obligations. A 1.25 DSCR means that the yearly income is 125% higher than the yearly debt payments. For example, an NOI of $125,000 with debt payments pf $100,000 = 1.25 DSCR.
One of the keys to avoiding overleveraging is to monitor the loan-to-value ratio (LTV). This is a good indicator of one’s ability to repay the loan. The LTV is calculated by dividing the total borrowed by the property’s appraised value, expressed as a percentage. A safe LTV is 65% to 70%. A high LTV is 85% or higher, and the higher the LTV, the higher the debt payments, which raises the risk of not being able to pay the debt.
Warning Sign #5: Property is in Disrepair
One of the keys to attracting new tenants and retaining the ones that you’ve worked hard to acquire is to have a multifamily property that shows well and one that tenants take pride in. If there are signs of neglect - poorly maintained or no landscaping, paint peeling from the exterior, outdated interior fixtures and carpeting - then your property has little to no curb appeal. This makes it hard to bring in new tenants, and your vacancy rate will rise.
Another issue is failing to make repairs when needed. Broken light fixtures, non-working sprinkler heads, and broken concrete on sidewalks - they all point to a property that neglects its tenants. When you have this type of situation, your property may be in trouble. Are there a lack of funds available to make the repairs, or is it simply a case where the property manager isn’t doing his or her job? Either way, this type of disrepair and neglect will cost you in terms of rent and operating income over time. Don’t think you are saving money and increasing your cash flow by not fixing what seemed to be “not urgent”. Your cash flow will shrink as tenants will start leaving.
How to avoid a despaired property?
You can avoid this situation by having key vendors available to make needed repairs in a timely and cost-effective manner. That’s up to your property manager to take care of, but if the property managers aren’t on top of this, it’s time to make a change. Be sure to tour the property often enough (announced and unannounced – here a surprise visit can be very useful) to ensure that you can get a firsthand look at the status of your property, and have regular phone or in-person meetings with your property manager on this topic. Ask for documentation, review vendor invoices and ask for copies of tenant requests or complaints about anything that isn’t working properly. That way you can be proactive in addressing the problems before they cost you tenants.
Multifamily properties shouldn’t be a burden; they should be a business that runs smoothly. You don’t want to be blindsided by problems that should have been addressed early on. There are enough warning signs that show up to alert you to the key problem areas, so you can take appropriate action as needed. Watch your occupancy rates, meet regularly with the property manager to ensure that he or she is fully engaged and on top of resolving any problem areas, constantly review the market to gauge competitive properties and what rents they are charging or what concessions they are offering, don’t overleverage your property to the point where you can’t pay your debt service and have a process in place to avoid having a property that is in disrepair. Do these things consistently and you’ll avoid those negative surprises that can hurt you.
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About the Author
Ellie is the founder of Blue Lake Capital, a real estate company specializes is multifamily investing throughout the United States. At Blue Lake Capital, Ellie helps investors grow their wealth and achieve double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.
Ellie is the host of Unbelievable Real Estate Stories, a podcast that shares true stories from within the industry, and the critical lessons learned, from the most successful real estate investors, innovators, developers, and more from around the globe!
She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations.
Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management.