7 mistakes made by Multi-Family value add investors
Multifamily real estate investments are lucrative opportunities with promising returns. However, it comes with a fair share of risks which if not taken care of can end up killing the returns and lead to losses.
Let’s discuss a few mistakes that investors tend to make and should avoid:
Overestimating rental rates, appreciation and refinances: It isn’t uncommon to be overly optimistic about the post-renovation rents, however, it is necessary to also have this estimate be based upon the data-driven comparison with competitors. Investors also often assume that the rents will grow in a straight line which is also incorrect. There may be some years where the rent stays constant and some years where it even declines. Investors often get aggressive when they build refinances into their underwriting modeling, but refinances may or may not happen. They must also not bank too much on appreciation as the sale of a multifamily property is dependent upon the NOI and the cap rate, and if the NOI doesn't increase as expected, it will hamper the sale price of the asset.
Underestimating Expenses: It is critically important to estimate the operating expenses accurately. It is imperative that the investor considers looking at the property’s previous performance for reference when estimating the operating expenses. The success of a value-add strategy is highly dependent upon accurately estimating the cost of renovating the property. It is common that investors underestimate the time and cost required to complete renovations.
Not reviewing the rent roll: When evaluating an apartment complex, an investor should not focus only on the current rent but also on lease expirations. Tenants will usually either renew or lease or they won’t. Finding a new occupant takes time which reduces the income for the property and the loss in income is further increased if a group of leases expires at the same time.
Not stress-testing the pro forma: A Pro-forma is an estimate of the future income and expenses. Who is to say that the actual performance will be close to the pro-forma estimates? Hence, it is necessary to stress-test the pro-forma and take a data-driven approach to underwriting by considering a variety of possible outcomes before engaging in a transaction.
Assuming you don’t need any partnerships: Investing in a multi-family property involves a lot more work as compared to a single-unit property. Sometimes, the investor might try to wear multiple hats and manage all the work on their own, which will not only burn him out but also reduce efficiency. Involving a partner, however, can help divide the work among multiple people and make it easier to efficiently manage the investment.
Disregarding Diversification: “Never put all your eggs in one basket.” An investor needs diversification in his/her portfolio to reduce risks. It is best to own different types of properties preferably in different geographical locations. This minimizes the risk if one area or property does not perform well.
Not aligning the renovation timeline with lease expiration: Oftentimes investors do not take into account if the time at which the renovation is carried out coincides with the time the lease expires in which case the lack of planning can cause disruption in the process of renovation and also cause discomfort to the tenants. Hence, the renovations should be planned in a manner that the property is empty owing to lease expiration.