Investing in Multi-Residential Real Estate – 5 Don’ts

Don’t under estimate the importance of the due diligence process.
This is where most investment strategies go astray producing less than optimal returns and a negative outcome. Remain centered, pragmatic, unyielding and skeptical.

Never rely on the sellers or brokers operating expenses, guarantee of rents, statement of improvements (with or without receipts) market assessment, cash on cash return on investment, cash on return (factoring in the building of equity), capitalization rate (CAP) or gross rent multiplier. These often reflect the current owner’s income and expense not the new owner’s income and expense.

Confirm the factors used to calculate these metrics.

  • Whose property tax base is being used?
  • Who is managing the property, the current owner?
  • What maintenance has been deferred allowing for positive metric for the sale?
  • Is the insurance coverage under quoted?
  • Is there an on sight manager and what are they paid, really?

Don’t under estimate the amount of operating expenses required.
Overestimate expenses and reserves required and underestimate anticipated revenue when assessing anticipated cash flow. Identify the large capital improvement projects for the coming years and allocate a monthly reserve in anticipation of these reserves.

Large operating expenses that can challenge the success of an investment:

  • Roof with a four year life expectancy
  • Galvanized pipes in an investment over 35 years of age
  • Paving
  • Major operating systems such as water heaters and heaters
  • Appliances
  • Pool refinishing
  • Concrete repair or replacement
  • Garage door or carport repair or maintenance

Do not get emotionally involved. 
Emotional strength, centered, well-grounded assessments are a requirement for all investors.  Once you have defined your balcony strategy do not let emotional short term influences impact your decisions.  As much curb and metric appeal as an investment may have if it does not meet or continue to meet your investment strategy, move on.

Don’t let your rent levels fall below market value.
Not enough emphasis can be placed on this practice, particularly in rent control areas.  It is very common for owners and managers to want to minimize the turnover of their investments by keeping their rents low.  They often state proudly that they maintain a low vacancy rate.

Rather than a benefit this strategy creates breakdowns. It makes raising rents challenging for a new owner. Tenants who have enjoyed low rents for years reject any large increases and often move with resistance and delays, leaving an aged vacant unit that will require money to rehab before releasing.  To prevent a mass exit a new investor has to spread out the increases in units over a long period of time.  If there is rent control it can be years if not decades.  This is a huge burden to an investor.

As well, the overall value of the investment remains challenging for lending purposes, maintenance and re-sale.

Consider the following:

Building A –   Gross annual rents of $120,000 with a gross rent multiplier of 10.5 for the area makes the building value $1,260,000.  ($120,000 x 10.5%)

Building B –    Gross annual rents of $95,000 with a gross rent multiplier of 10.5 for the

Area makes the building value $997.500.  ($95,000 x 10.5%)

If two businesses were offered for sale at the same price and one had gross revenues 21% higher than the other which would you choose?

Don’t not employ your tenants
This is an absolute DON’T.  Don’t allow tenants to do work on the property and specifically in exchange for discounted rent. It is so innocent with so much exposure to the owner/manager.

Imagine a call regarding the following:

  • Smoke detector is beeping the batteries are out
  • The garbage disposal is leaking
  • A light in the foyer is out
  • The hinge on the side gate is broker
  • The screen on the sliding glass door is torn
  • Maintenance person neglected to place the garbage receptacle on the street

A tenant performing any work for compensation creates an employer/employee relationship with the resulting requirements for reporting and providing the appropriate withholding, W-2’s/1099’s and workers compensation coverage.  If the tenant incurs any injury during the course of performing activities on behalf of the owner this can expose the owner to serious liability.