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When you look at the prices of multifamily properties, you’ll find that they’ve skyrocketed over the past several years. In fact, there are often bidding wars that drive up the prices due to a limited availability of properties along with the desire for new investors to jump on the multifamily bandwagon. Will the good times ever end?
Before answering that question, let’s look at the reality of the market. While it appears that everyone is making money — 30–40% IRR at exit is now common — the reality is that not everyone is enjoying this profitability trend. (IRR is the average internal rate of return on an investment and is used to measure the potential profitability of an investment.) I personally know investors who’ve lost money in real estate recently. We just don’t hear those stories — only the stories of success.
I’ve collected these lessons from their stories and am sharing these with you, so you can benefit from other people’s experiences. Let’s take a closer look at the most common reasons why some investors are losing money.
1. Invested With Inexperienced Syndicator
While many new investors think the most important questions to ask a syndicator are about the property, the real questions to ask are about the syndicator’s experience and track record. I’m of the opinion that most people invest in people first, then the deal; but some investors’ main focus is the deal at hand. Investors who focused only on the deal, and not on the syndicator, are more exposed.
In one case, an investor I spoke with told me that he has invested with an inexperienced syndicator because that investor liked the high returns. On paper, the deal was supposed to yield 22% IRR, but failed to do so. The syndicator’s inexperience was overshadowed by the lucrative equity split of 90%-10% (the market is a 30%-70% split). But since they couldn’t perform, the enticing equity split wasn’t even relevant and investors lost their money.
Solution: Ask the right questions. Always ask about the syndicator’s prior experience and their past projections versus their actual returns. Most syndicators have this report available and can share it with you. If they don’t have one, that’s a red flag and you should walk away from that deal.
2. Invested In Bad Areas
When it comes to multifamily investments, it doesn’t matter how robust the economy is or how low the unemployment rate is; if you invest in a property that is in a high crime area, it will be hard for investors to collect rents or prevent some tenants from mistreating your asset.
It’s hard to reposition a property (when you make significant upgrades and renovations to the property) in order to bring in a higher demographic tenant if the property is located in a bad area. That generally means a C or D class property, and quality tenants don’t want to move into an area considered bad. It’s much easier, although not easy, to reposition a property when it’s located in a good area, considered an A or B class property.
I personally passed on many deals that looked great on paper but were located on the wrong side of town. One such deal was in one of the worst neighborhoods in Orlando. I passed on it because it was in a high-crime area. Later, I found out that the syndicator who brought me the deal was struggling to make payments to his investors because of a high vacancy that ate into the distributions.
Solution: Invest only in a solid area. For doing due diligence on a city, one of the best tools I’ve found is City-Data.com. There you’ll be able to get key information on neighborhoods, schools, employment, crime stats and much more. Before putting up any money, visit this website. It’ll save you a lot of headaches down the road.
3. Invested Based On Emotion
I’ve heard all types of reasons why an investor agreed to invest his or her money in a specific deal. They ranged from “the building was beautiful” to “it was located in the city that I grew up in” to “I travel to that city all of the time.” While liking the syndicator is important, it shouldn’t be the only reason to agree to invest in a deal.
I’ve heard many stories on how emotion comes into play on a multifamily deal, where investors start bidding up the price on a property just so they could say, “I got the deal!” The actual numbers went by the wayside, and that’s a terrible way to analyze a deal. When I analyze a deal, I always look at comparables, the net operating income (NOI), current rents and vacancy levels and many other metrics. If the numbers don’t justify a purchase or investment, I simply walk away.
Solution: Always do your due diligence, and take emotion out of the equation. You have to neutralize the emotion that got you excited about the deal and replace it with a legitimate analysis of the numbers. You have to ask, “Is this actually a good investment?” If it’s not, say goodbye. There are always other deals to be found.
Summary
I started by asking, “Is everyone making money in real estate now?” Obviously, the answer is no. But there is certainly money to be made, as long as you follow sensible investment guidelines.
Start by working with an experienced syndicator who has a verifiable track record and can demonstrate that he or she can show past projections versus actual returns. Avoid investing in properties located in bad areas. Do your due diligence on crime rates, schools, employment rates and other metrics that show a viable location. Finally, take emotions out of the purchase decision and stick to the numbers. That way, you’ll end up with a profitable investment.