7 Mistakes to Avoid When Investing
in Multifamily Real Estate
“It’s good to learn from your mistakes. It’s better to learn from other people’s mistakes.”
Failure is a powerful teacher. But, as Warren Buffet reminds us in the quote above, it’s much better to learn from other people’s failures so that we don’t repeat their missteps.
That said, here are 7 common mistakes I see in rookie and experienced investors alike:
Not Carefully Building Your Team
Real estate is a people business. Your success greatly depends on who you surround yourself with. To that end, I advocate building yourself a team of competent, reliable professionals to work with on a regular basis.
When you fail to identify the best people to work with, you’ll often find yourself saddled with misinformed real estate brokers, sketchy mortgage lenders, and unscrupulous property managers.
From my own experience and that of other investors I’ve coached, these people can harm your business in a number of ways—from sheer incompetence to willful fraud and embezzlement.
Take your time here. Run your due diligence on the people you work with as well as the properties you buy. Lean on fellow investors and experienced partners in the market to help identify the very best people for your team.
Buying the “Wrong” Properties
Investors often go astray when they wander outside their target market to buy a property they otherwise had no business looking at. This usually happens when a broker or another investor emails over a ‘hot’ opportunity or a ‘sure deal.’
When these kinds of opportunities spring up, FOMO (fear of missing out) will kick in and propel you down the wrong path. Before you know it, you’ll be outside your area of expertise trying to breathe life into a flailing property in a market you don’t understand.
To steer clear of this mistake, you need to develop well-defined investment criteria. Stick as close to your stated goals as possible and let everything else pass by.
Neglecting Due Diligence & Rushing Into a Deal
Properly executing your due diligence takes discipline and time. If you’re going to make sure a property is truly up to speed, you have to be willing to go through the paces of dotting every I and crossing every T.
No matter how promising the deal looks on paper, take the time to see the property in person and run through every step on your due diligence checklist.
If you’re interested in how I do this, join us in the closed Facebook Group MultifamilyCommunity.com and check out my Live video I shot in Kentucky performing due diligence on a 48-unit apartment complex.
Overlooking Economic Vacancy
Evaluating vacancy is a crucial part of your due diligence process. If a property is underperforming, you want to know exactly why so that you can judge whether or not you can improve the situation after closing.
A huge mistake I often see here is when investors evaluate physical vacancy without going on to consider economic vacancy.
To further flesh out how economic vacancy works, consider this example:
You’re looking at a 50-unit complex that rents out at $600 per unit per month. That puts its annual gross potential rent at $360,000. Consider the owner has that property 100% rented out, but they offer a free month’s rent with each year-long lease signing. That drops effective rent collection down by $30,000, which puts economic vacancy at about 8.3%, despite a physical vacancy of 0%. If there are any delinquent rent payments, economic vacancy will drop even further.
Similarly, if a unit is being used as a model/leasing office or one has been given to the onsite property manager to use, these factors affect economic vacancy as well.
Physical vacancy is an important indicator, but it won’t give you the entire picture. Make sure you look at the property’s income statements—not just the rent roll. That’s the only way you’ll get the whole story.
Skimping on Cash Reserves
Failing to hold enough cash in reserve when you purchase a property is a great way to ensure you find yourself struggling when unexpected maintenance expenses wreak havoc on your balance sheet.
When it comes to future property expenses, there are two things you need to account for up front: capital expenditures and maintenance reserves. The former refers to the major systems and appliances that effectively increase the value of the property. The latter refers to those recurring expenses which keep the property on an even keel.
To fund maintenance reserves, you’ll need to set aside a fixed amount per unit per year. This relegates maintenance expenses to its own line item in your budget.
Funding for capital expenditures on an ongoing basis is accounted for by holding funds in reserve, but it’s difficult to do when you first buy a property, unless you raise these funds with your equity when funding the deal.
In either case, the best way to anticipate and plan for maintenance costs and capital expenditures is to thoroughly inspect the property prior to the purchase, price out anticipated repairs/replacements, and re-evaluate your numbers to make sure the deal still makes sense.
Hoping for Appreciation
I call this the ‘crystal ball approach’ to buying and selling real estate.
In what used to be the standard method of investing, the crystal ball approach boils down to this simple slogan: buy low, sell high. Acquire a property under market value; then, turn it around a few years later for a quick and easy buck.
Without getting into its many logistical and financial pitfalls, I’ll point out the most obvious flaw in this approach: you can’t predict the future! No one can.
In a rising market, you may be able to get by with this approach for a little while. But, when the market turns (which at some point it most certainly will), you’ll find yourself in serious trouble.
If your sole reason for purchasing an investment property is a hunch that it’ll appreciate enough for the numbers to make sense, then you’re planning to fail. Instead, focus on cash flow. If the property can’t bring you sustainable income, then don’t buy it.
Betting on Future Cash Flow
Closely related to the previous mistake, investors get themselves in trouble by purchasing a property with negative cash flow without sufficient operating capital. They do this with the expectation that they’ll be able to get the property back into the black shortly after closing.
You may be able to get away with this risk, but once again you could be setting yourself up for a fall. More likely, you’ll get into the property and find increasing occupancy and/or rates to be a much heavier lift than you anticipated.
Then, you’re stuck with an underperformer that’ll drag you down or the rest of your portfolio.
Instead, go for cash flow on Day 1. If you can’t make the numbers work in your favor on the day of closing, then it’s time to either renegotiate or walk away from the deal.
In this post, we’ve looked at several of the most common mistakes I’ve seen in multifamily real estate investment. In summary, here are 7 positive reminders to keep you from making any of them yourself:
- Build a Team
- Stick to Your Criteria
- Take Your Time
- Pay Attention to Economic Vacancy
- Plan for Capital Expenditures and Improvements
- Aim for Cash Flow, Not for Appreciation
- Make Decisions Based on Today’s Income, Not Tomorrow’s
If you’ve found this helpful, I’ve included a special bonus section in my Lifetime CashFlow Academy course to cover these mistakes and several more.