How to Avoid the Top Mistakes First Time Multifamily Investors Make
Do you know which real estate deal is the most difficult one to make? Simple answer: your first one. It’s a pretty easy answer, because on your first deal you really don’t know enough to avoid the pitfalls and mistakes that most investors tend to make.
The good news is that the multifamily market is doing quite well. Vacancy rates are down thanks in part to a new group fueling the rental market: baby boomers. Many are choosing to sell their homes and rent, deciding to forgo the work and effort involved in maintaining their single-family homes. Another strong group that prefers renting over buying Millennials; a generation that emphasizes flexibility and mobility over settling down in one location, and renting an apartment allows them this desired lifestyle. Also, rents are up, thanks in part to savvy property managers and owners who are capitalizing on their tenants’ demand for new, state-of-the-arts technology and amenities that justify rent increases.
While it’s a good time to invest in multifamily properties, there are some mistakes first-time investors make that can hurt them financially. You can’t just sit and wait until you’re completely ready and knowledgeable, or you’ll never get into the market. Plus, there are many different ways you can passively invest in real estate. So, if you’re a first-time investor, pay close attention and learn from the mistakes of others.
Going it On Your Own
Making the decision to invest in multifamily properties is a huge first step, but a good one. The mistake most new investors make is deciding to go all in on their own. After all, if it’s their deal and they do all the work, they’ll reap all the rewards. You can almost predict a bad outcome if this is the approach a new investor takes.
Here’s why: investing in multifamily properties is more of a group effort - a “team sport” if you will. Sure, you’ll “reap all the rewards” by going it alone, but you’ll also assume all the risk and lose all of your money if the deal goes south. It probably will.
As a passive investor on your first deal, you probably don’t have an extensive knowledge, or time to do carry a deal on your own; evaluating, negotiating, managing – all require vast experience. The other issue is having enough money or borrowing ability to purchase a multifamily property on your own. In order to buy a property, you’ll need net worth equal to the loan amount, and that could be an issue for many investors.
What’s needed is a syndicator, or sponsor, to assume the role of lead investor. Sponsors bring experience and expertise to the table, often acting as a mentor, a guide and a knowledge bank at the same time. Good ones have a successful track record in multifamily property investments, knowing how to locate a good property and properly vet the numbers. They also have other investors that they work with, which help to make the deal attractive to lenders. They earn fees and take on a portion of the equity, but the money spent to have a sponsor at the helm is well worth it. There are several ways to find a good sponsor, from referrals from friends to listening to podcasts and going to meetups. Do your homework, and you’ll be well on your way to successfully investing in your first property.
Failure to Stick to Your Budget
Some new passive investors let emotions get in the way of good judgment. When a sponsor brings an attractive deal to the table, the excitement overtakes the practical aspects of investing and the budget is the first to go. Instead of doing proper due diligence, which includes researching the market conditions like rents, resale values and surrounding areas, the new investor is ready to jump at the chance to invest. Even though there was a budget in place initially, the emotion overtakes those original numbers and the investor looks for ways to find additional funds.
Hurrying into participating in an investment is a common mistake of new investors, and one that can have negative consequences. Properly doing your due diligence takes discipline and a lot of time. Take the time needed to analyze the deal, review the numbers. It may take five or ten deals to analyze before the right one is presented -and that it’s one that works within your original budget. Do what is necessary to review each deal, and never rush your decision or feel pressure to do so. There will always be another opportunity available.
Counting on Future Appreciation
Don’t fall into the trap of “fortuneteller” property buying. Nobody can look into the future, and hoping for future appreciation won’t do anyone any good. Long time investors will tell you their philosophy was to acquire a property under value, hold it for a period of time and then sell it years later after it appreciated significantly.
Unfortunately, nobody can predict “future appreciation,” and if you hold a property waiting for it to happen you may be holding it for a long, long time. When the market is hot and values are rising, you can certainly use this approach and hope for the best. But nobody can tell you when the market will do one of its infamous turnarounds (and honestly, it will do this!), so the appreciation you were hoping for goes out the window. What you end up with is a property valued less than what you paid.
This is not to say that appreciation should not be taken into consideration; it definitely should, but you should be conservative and expect selling the property in a down market. If the numbers work when you sell in a down market – then it’s a strong sign that the deal is solid. My team normally underwrites deals assuming a down market when we sell, to account for a moderate appreciation. If your investment in a property is based on a “hope” or a feeling that it’s going to appreciate in time, you may be headed for failure. Toss the fortuneteller! Base your decision on the numbers - on cash flow. If you don’t see sustainable income based solely on the cash flow, walk away.
Not Having Accurate Costs and Expenses
It’s really up to the sponsor to provide you with proper cost and expense estimates on the property under consideration, but it’s your responsibility to do your due diligence to ensure those estimates are accurate. If you’re working with someone you’ve worked with before, this shouldn’t be a problem. But if this is your first investment with the sponsor, pay attention!
The mistake most first-time investors make is they forget that they have to pay for rental expenses from day number one. In a slow market, renters may start asking for (or even demanding) nicer units and amenities. That means the sponsor may come back and report that major upgrades and repairs are needed to bring the property up to current market standards in order to keep and acquire new tenants.
If it’s a hot market, renters may want the top amenities available or insist on major building system upgrades. To avoid those type of problems, make sure you analyze the property in relation to other properties that are available in the market you’re looking at before making an investment It will provide you with an accurate rental expense estimate and provide an estimate of the potential return on your investment. Otherwise you may be in for a negative surprise down the road.
Focusing on the Wrong Market
Most first-time investors think that investing in a local property is safer, simply because they know “the neighborhood.” This is a huge mistake! Remember the old saying about real estate? “Location, location, location!” Well, the profitable location might be halfway across the country! Local investments do not guarantee success.
Your sponsor will provide you with a market analysis that includes information on the cap rate of rental properties, area job growth, employment and unemployment numbers and more. This is the information you need to ensure you’re investing in a sound market. The information and data you receive will help you decide on the best investment decision you can make, so be sure you review the numbers you receive.
Just because you’re a first-time investor doesn’t mean you have to repeat the common mistakes made by other investors. Find a sponsor with a successful track record and a good reputation, do your due diligence on the property that’s offered to you and avoid the pitfalls outlined in this article. That way you’ll be on the road to a successful property investment.
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 brings the true stories behind the deals, from the most successful real estate investors around the globe. Ellie 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.