How to Reduce Risk When Investing in Multifamily Real Estate

Are you looking to invest in a multifamily property? Have you considered everything involved with owning a multifamily building or an apartment complex? Sure, you can get promising returns. There’s less chance of losing value in a down market than with a single-family property and financing might be easier. And you can quickly grow your rental property portfolio

But there are a number of risks involved with investing in a multifamily property. Luckily, there are a few ways to reduce risk with solid, diligent planning.

Reduce risk with smart planning

 

You should never go into a multifamily investment without a proper plan. You must prepare for the unexpected and have a solid idea about potential costs.

Below are a few tips for developing a solid plan for your multifamily investment:

  • Perform thorough property inspections and go over records with a fine-toothed comb. A property in bad condition or full of poorly screened residents is bound to give you a financial headache, one that you can’t afford. 
  • Have the right team. Gathering a good team of experts for property inspections allows you to predict the costs of:
    • Deferred maintenance (immediate cash needs)
    • Capital improvements (cash reserve needs)
    • Loss of income from vacancy and/or poorly screened tenants
    • Renovations and improvements
  • Conduct comprehensive market research at the micro level. Will improvements or new amenities result in higher rents? What do renters want and can you give it to them?
  • Buy the asset at the right price, with the right financing. You don’t want to find yourself over-leveraged and taking on too much debt, especially in a market downturn.
  • Hire a property manager. Having someone manage maintenance work, answer phone calls, offer customer service, and handle tenant reviews and complaints will make your life much easier. If you’re a new investor, expect your lender to require professional third-party management throughout your first year of ownership.
  • Create a budget. It’s important to put together a realistic look at property income and expenses during your first year or two of ownership. A pro forma budget analysis will help you avoid the dreaded cash call. Do this before you buy the property!

Risks associated with multifamily investing

 

Being a successful real estate investor involves many skills. It demands careful planning, thorough due diligence and a good dose of patience. Here are a few risks commonly associated with multifamily investments. Knowledge is power!

Vague exit strategies

 

Even before buying a multifamily property, it’s important to have a detailed exit strategy or multiple exit strategies in mind. For instance, you might sell the property, refinance it, exchange it, or convert it to another use as in a condo conversion. Timing a market is difficult at best but knowing you have multiple exit strategies equals peace of mind.

Although investing in a multifamily property can be highly profitable, the market doesn’t always do well. So what do you do when your multifamily asset underperforms? If you can afford to wait, do it! You can hold the property until the market stabilizes. As the market picks up, rent will begin to rise, which can mean large profits for you. 

Maybe your plan is to sell your property right away to avoid losing even more money and to reduce risk. Another option is to force property appreciation through strategic renovations and through the addition of inexpensive amenities. By renovating your property, and increasing income, you can raise the value of your asset. 

It’s always a good idea to perform a stress test on your property financials. What happens when vacancy increases? How much can you lower rent and remain afloat?

Regulatory issues

 

Government regulations may interfere with your profit margins. For example, rent control can regulate the amount you charge for rent (how much and how often you can raise rent), which could result in profit loss if the cost of rent goes down.

Other regulations like the Denver Green Roof Initiative could affect your multifamily property. The new ordinance requires that buildings over 25,000 square feet dedicate a percentage of a building’s roof to green, vegetative space, or other options such as “cool roofs.”

There are costs associated with installing new green or cool roofs, including more expensive insurance, which will greatly impact Denver multifamily unit owners. Preparing yourself for regulations like these is very important, whether you’re saving funds to cover certain costs or doing research on geographical areas before investing.

Changing social patterns and lifestyles

 

The multifamily industry is ever changing. The demographics of a particular area rarely stay the same. Baby boomers and millennials are constantly looking for homes that suit them, which means they won’t stay in the same multifamily properties.

This could affect you as a property owner. With shifting consumer tastes, you can lose tenants to other more appealing properties. To combat this and reduce risk, you could try creating common areas that appeal to multiple generations and keeping up with popular trends.

Properties with no resilience

 

Your property should be able to bounce back from different challenges like financial loss due to mismanagement, climate change, weather-related disasters, etc. The best way to properly reduce risk with these issues is to prepare for them. The more resilient your property is to disaster the less it will cost you and the safer your residents will be.   

You should thoroughly research the area in which you will make your investment. Some places are prone to hurricanes and tornadoes. Other areas experience blizzards, snowstorms, and fires. You might consider choosing an area with little risk of natural disasters. Doing so could save on repair costs in the long run.

Also be sure to ask the seller for copies of all insurance claims for the past 5-10 years. This is a great way to check for previous property damage.

Inadequate tax planning

 

You can’t forget about property taxes. High sales prices can make for some pretty high property taxes. Be careful not to underestimate property and income taxes at the time of purchase or sale. Mistakes could reduce your actual return. 

The best way to take advantage of the many tax strategies available to real estate investors is to hire a Certified Public Accountant (CPA) who specializes in real estate investments. 

Exposing property to legal issues

 

There are many things you can do to get yourself in legal trouble as a multifamily property owner such as:

It’s important to be familiar with the law and certain regulations to reduce risk and avoid such issues. Failure to do so could result in the loss of your property and even jail time.

Are you interested in real estate investing? Here at Theresa Bradley-Banta Real Estate Consultancy, we offer educational programs for aspiring multifamily investors. Contact us today to learn more!

Learn more:

 

Multifamily Property Owners – Don’t Skip the Inspections!

How (and Why!) You Should Track the Crazy Multifamily Real Estate Market

The Real Pros and Cons of Buying an Apartment Building

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Theresa Bradley-Banta writes about investing in real estate while avoiding the pitfalls that plague many new investors. She is a 2017 PropTech Top 100 Influencer and winner of 14 American and International real estate awards for her website and real estate investing programs. As featured on: The Equifax Finance Blog, AOL’s Daily Finance, Scotsman Guide, The Best Real Estate Investing Advice Ever Show, Stevie Awards Blog, Rental Housing Journal, and Investors Beat among others.

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