Updated: Mar 7
There’s always some uncertainty when purchasing multifamily properties. I’ve been syndicating and buying real estate for years, and if there’s one thing I’ve learned is that real estate investments always have an aspect of uncertainty when you acquire a property. Of course, this shouldn’t surprise anyone. After all, it’s impossible to predict what the future may bring with respect to the real estate market and even with your specific properties. However, there are some measures you can take to make your investment analysis and assumptions as accurate as possible.
As a word of caution, even though there are ways to deal with uncertainty when buying real estate, you have to make sure you don’t try to accurately predict every little detail in your analysis and get caught in what we call “analysis paralysis”. Yes, there’s a healthy way to deal with uncertainty without going crazy.
I invest in value add properties, making improvements and renovations with the assumption that I’ll be raising the rents and increasing the net operating income (“NOI”) once those renovations are completed. Sounds pretty intuitive, but assumptions equal uncertainties, since there is no way to 100% guarantee you will get those premiums (rent premiums are the difference between the current rent for non-renovated unit and the projected rent that’s expected once the improvements are made to the renovated unit).
How to Deal With the Uncertainty:
It’s always best if the current owner has already renovated some apartments and is already receiving premiums. In this scenario, I am more confident I can renovate the units to the same scope and get similar premiums.
If the current owner hasn’t made the renovations yet, I look at comparables - properties that are in close proximity to the property I’m investing in (usually within 1-3 miles). In addition to proximity, the comparables should have similar amenities and the property should be of similar age (up to 5 years older or newer). I have my team call different properties and ask about rents as well as the scope of the renovation that was done. However, regardless of projections, I always use a conservative estimate on the rent premiums when evaluating deals, so my tendency is to assume lower premiums than the comps are receiving, just to be on the safe side. So, for instance, if comps are receiving $150 premiums, I will assume $120 and see if the deal still works with lower premiums.
Looking at expenses and where cuts can be made is critical to increasing income and profits. However, you can’t be 100% sure how much exactly it will cost you to run the property, since sometimes there are unexpected expenses (HAVCs that break, insurance costs go up due to market conditions, etc).
How to Deal With the Uncertainty:
As a rule of thumb, expenses should be about 40% - 55% of income, so that’s a great place to start. You can also take the property’s historical expenses and market expenses into consideration. That will help when analyzing numbers.
Another way to assess the property’s expenses is to have the property manager walk the property and provide us with a detailed operating budget, so we’ll have a good idea of how much it takes to operate the property each month. We also like to have a capital expenditure (CapEx) budget so we’ll know which one time items will require replacement. A CapEx budget can include roofs, HVAC systems, flooring, appliances, driveways and other large ticket items.