Are you ready to make the jump?
I have been interacting with my network here on MultiFamily Intelligence. And they do talk about making the jump from single-family to multifamily properties and other commercial investments. But they have no idea what uncertainties come with it.
Though multifamily property investing earns great passive income it is not always easy. Firstly, Managing multifamily property is an intensive process. Secondly, it is expensive which makes it really hard for investors with little investment to enter the multifamily market. Finally, it is a highly competitive market which makes it tough for new investors to jump into multifamily property investment.
Does it mean you should give up on multifamily before you even started?
The answer is NO.
If you are thinking about making the jump. You need to look for these things no matter if you are an active or passive starter. The purpose is not to scare you, the purpose is to educate you and help you minimize the risk on your investment, and help you create a steady passive income source. Here are 19 things to look for when you are planning.
Cash Flow vs. Appreciation
The goal is to be wealthy. And being wealthy means having assets that generate consistent income. In Multifamily property cash flow is the primary income source and appreciation comes as a bonus eventually. On the other hand, if your cap rate is compressing and the value is not going up and your cash flow is less than average, it might do considerable damage.
Dependence on Interest-only Debt
Everybody loves interest-only debt. The attractive thing about interest-only debt is, it gives that boost to the cash flow in the beginning. But, if unfortunately the income shrinks on your property and you are running on interest-only debt for a few years now. And then principle payment hope in, you may find yourself in a really difficult situation. Most people do not agree with me on this but do you know what has been in New York recently?
Debt Coverage Ratio
We do not recommend any of the points here to be the basis of your decision, but we do allow you to use this one to play a vital role in finalizing a deal.
Debt coverage ratio or DCR in short will help you measure the safety of the deal you are diving into. Min requirement is 1.25 DCR. For example, if your cash flow is $25,000 per month and your interest and principal sums up to 20 grand. You are eligible.
But we consider 1.50 to be the minimum threshold to start with. To really push the limits and take that stress off of your head, take this to 2.0 plus and you will sleep like a baby at night.
Let us assume your occupancy is 86% and you are optimistic about it and think of a 95%. But let us consider it drops instead. It drops down to 77% or even less.
Consider the worst possible and calculate your DCR now. Does it cross the red line of 1.25? If it drops below that, you are entering the red zone. You are not safe anymore. This is why it is really advised to not rely on physical occupancy only as it does not show you the full picture. You need to consider economic occupancy and do the math for the worst to see if you still are in the safe zone.
Economy vs. Physical Occupancy
Physical occupancy refers to the percent of units that are occupied by tenants physically. While economic occupancy refers to the payment in percentage. That means these can differ. You may have a 100% physical occupancy and still have 80% economic occupancy because of concessions offered for marketing purposes or staff occupying a unit for free. That adds up and as a result, your economic occupancy drops.
Relying on pro forma which is based on hypothetical scenarios based on assumptions is a bad idea. Brokers and sellers show you a bright future hoping to cut a deal with you. It might come true in the future but you are not paying in the future. You are buying the property now and you are paying now. So you need to pay attention to what is instead of what could be. There is no guarantee you will be able to cut the expenses and raise rents quickly.
With that being said, when you are observing the rents don’t look at the lists where they only mention the highest rents. Do your research and find out about the minimum rents as well. As there is no guarantee the property you are buying is in the condition to charge the highest rent on the market.
A careful review of the neighborhood is considered to be very important among the key points. This may prove to be a deal killer if the neighborhood failed the test. You can use different services like Google Earth and NeighborhoodScout. Remember, you can not rely on these soft tools. Driving through every street in the neighborhood is still the number one method to observe the surroundings and look for the signs of drugs, crime, neighborhood, and suspicious activities.
You can ask the local cops for their honest review of the surroundings of the property you are looking to buy. Remember, this may change with time. The situation of a neighborhood can improve that is why don’t rely on outdated information you read somewhere on a forum or a website.
After you buy the property, who will take care of it?
Who will manage the property and how sure are you that they will take care of the property just as you will?
You need a property manager that can manage your property independently. If you have to manage the property manager, it will take you the same time as you would spend managing your property yourself.
What are you investing in? is it in good shape?
To thoroughly inspect the property, you need a team of at least three people. A maintanance professional, an expert on buildings and construction and another one for taking notes.
Inspection is not an easy process. Each and every unit need to be carefully inspected for different kind and level of damages. Sellers usually deny damages and will try to hide damages and will not tell you about the required maintanance. Never hesitate to walk away if the property have damages that were not mentioned in the offer.
While setting up budget for maintance and repair work, do keep an extra amount just incase an unexpected expense kicks in. It could be anything from a pipe burts water damage to a fire damage. If the damage reaches multiple units, it may significally increase the repair cost. That is why it is advisable to have sufficient budget for unexpected expenses.
No matter at what point you are in your investment journey, you will always face changes. Eventually we learn to handle changes and adapt according to the market and use the odds to our benefit.
Learning is a life-long process. We continue to learn from our experience and from the experience of the people in the same field. That is why we tend to network with like-minded people in different events and online. Join our exlusive membership and become part of the conversation.