Multi-Family Investments: What's the Risk?

[Geoffrey]

Okay so another addition to my little odyssey here as it seems like there so much to learn just when you think you know something. So looking into multi-family it leaves me woundering why is there so much trepedation about these? The bank qualifies the property, the returns can easily be great, there is normalizing the value, there shouldn't be much risk if you research it thoroughly. What's there not to like? Is it the big numbers that scare people off: what if the building has structural problems costing hundreds of thousands, for example. To the veterans, what is the big risk here? What am I missing?

 

[Cory Sperle]

The risks, unlike single family is one small error could leave you bankrupt as a heavily levered or poorly performing property will eat your breakfast, lunch, and dinner. Yes entry level is in excess of 500k. The largest risk is overpaying, especially in today's flat to falling rental market in the west, exasperated by poor government policies in many areas. Most projects also have some form of very costly deferred maintainance.

 

[Alvaro Sanchez]

Risk is that you write big cheques, you lose big cheques... If you overpay buying a building, it might take you years to come back. So you need to get educated the best you can to minimize risk.

 

[Thomas Beyer]

There are a number of risks in multi-family investing that have to be weighed and mitigated on the path to possible / likely success:

A) you pay too much
B) you underestimate vacancies
C) you under estimate expenses, both small and large
D) you over estimate revenue
E) the overall market deteriorates ( like we saw in AB the last two years, albeit better now)
F) new apartment buildings draw customers and prospects away from your old apartment building
G) you can't get the mortgage you anticipated ( usually a function of A but also B-D)
H) you run out of cash while holding, before you can sell or refi
I) your onsite manager steals money
J) your onsite manager is the key drug distributor in the area
K) you go bankrupt because the bank calls you on your personal guarantee
L) you stress out and/or lose sleep over A to K, and your health and marriage deteriorates

All these can be overcome, of course, with proper due diligence, the right team, impeccable property management, clever marketing, life & business experiences and plenty of cash.

Loads more in my book 80 Lessons Learned on the road from $80,000 to $80,000,000.

 

[Willyboy]

There are a number of risks in multi-family investing that have to be weighed and mitigated on the path to possible / likely success:

A) you pay too much
B) you underestimate vacancies
C) you under estimate expenses, both small and large
D) you over estimate revenue
E) the overall market deteriorates ( like we saw in AB the last two years, albeit better now)
F) new apartment buildings draw customers and prospects away from your old apartment building
G) you can't get the mortgage you anticipated ( usually a function of A but also B-D)
H) you run out of cash while holding, before you can sell or refi
I) your onsite manager steals money
J) your onsite manager is the key drug distributor in the area
K) you go bankrupt because the bank calls you on your personal guarantee
L) you stress out and/or lose sleep over A to K, and your health and marriage deteriorates

All these can be overcome, of course, with proper due diligence, the right team, impeccable property management, clever marketing, life & business experiences and plenty of cash.

Loads more in my book 80 Lessons Learned on the road from $80,000 to $80,000,000.

Let's say all the bad things in your post happen but you have cash back up so as an example for a 1.5 million small apartment building how much cash minimum you would need to be able to overcome all the bad stuff in your opinion? $50k, $100k, $200k, $500k? How much?

 

[Thomas Beyer]

Depends on the city and property condition.

A large city is more resilient than a small town with one employer that goes bankrupt.

Assuming Fraser Valley, GTA (incl Hamilton), Kamloops, Kelowna, Calgary, Edmonton, Regina, Winnipeg or Saskatoon or Red Deer region $1.5M gets you an 8 plex to a 16 plex. If roof is leaky that is about $50,000. New hallways carpets, lights and paint $20,000. Each suite $4-12,000 ... per. Boiler around $10,000. But a 60 year old building needs perhaps brand new plumbing and electric wires which will exceed $120,000. Or 30 new windows for $100,000. So price the asset accordingly. Most cash-flow is eaten up in upgrades. Do a realistic 5 year budget and don't overpay for an old ugly asset as the seller knows where all the warts are but you do not usually. As such, a thorough property inspection is a must before you waive conditions.

A severe recession like AB just had with rent contraction of 20-25% and vacancies going from 0 to 20%+ will eat deeply into your cash-flow, usually negative if highly levered.

So assuming 30% down or maybe $400-450,000 and a mortgage of $1-1.1M or so you should have $50-100,000 handy in addition to all known deficiencies (i.e. if you know the roof leaks then that is 50K on top, plus cash for suites assuming 25-33%/yr turn over and need work).. in a LOC or cash to sleep well at night and bunker all cash flow for 5 years and/or re-invest it. If you have less leverage, say 40-50% down you need less reserves as your cash-flow is far higher. Most REITs have 50% or less leverage and many do not pay even 4%. Not a slam dunk like it used to be. More on this here http://myreinspace.com/threads/what-is-better-cash-flow-or-higher-roi.26596/

 

[Willyboy]

That would be a huge repair and fix up bill so I guess if one doesn't have more than enough cash it could be pretty risky. But I was wondering if a really good inspector was involved wouldn't this minimize the risks substantially?

 

[Cory Sperle]

Let's say all the bad things in your post happen but you have cash back up so as an example for a 1.5 million small apartment building how much cash minimum you would need to be able to overcome all the bad stuff in your opinion? $50k, $100k, $200k, $500k? How much?

There is no amount of cash that can compensate for this level of negligence. I have seen folks go under only making one or two of these errors, when they were incredibly successful at single family.

 

[Geoffrey]

I like J:

"J) your onsite manager is the key drug distributor in the area"

Hahahahahahaha.

 

[Geoffrey]

But I digress,

Truth be told, that list shut me down pretty quick. It's what I love about this forum -- it can save a huge amount of time in research.

Not to say an apartment building couldn't work without deep pockets, but it just isn't advisable. Too much to go wrong.

 

[Thomas Beyer]

Plenty of light among the shadows.

Any business worth doing has risks. Any.
The upside has to be judged in light of these risks.

Do you not cross the street although you might be hit by a car ?

Do you drive a car although accidents may happen ?

Do you fly in planes although they might explode or crash ?

Do you love although you might get hurt ?

Do you live although you will die ?

 

[Cory Sperle]

The largest factor keeping folks away from MF isn't the risks, its the massive amount of cash required.

 

[Geoffrey]

It's doable for the average middle-class, but also very risky. No matter how detailed the research, there's too much that can go wrong, and without a big cash back up, that could just take too long to recover from. It's worth investigating further, but not with much enthusiasm.

 

[Cory Sperle]

It is totally worth doing as you get value lifts that are not possible in single family. Yes there are risks, but properly mitigated the benefits are enormous since value is tied to the income of the property, every dollar of income you can raise increases the property value by a factor of 200. A $100 rent increase on one unit increases value by $20,000, so on 20 units that's $400,000. Tell me that's not worth doing. I've now purchased 6 buildings and it's not rocket science.

 

[adriano]

I totally agree with Cory , I own 8 buildings and I appraised 1 of my buildings and only had it for 8 years and it has over doubled in value. I had over a $900,000.00 lift in 8 years. If that is what people call "too risky" I will do it all day long. Well worth the so called risk IF done right.

 

[Cory Sperle]

Very impressive! Were you able to purchase this many on your own through refinances, or did you use co-venture partners?

 

[adriano]

Thanks Cory. I own all my properties on my own and I bought them all through refinancing. Working number 9 right now if it makes sense and if I can come to an agreement on price.

 

[Cory Sperle]

Awesome, living proof that one doesn't need partners to acquire many assets in a reasonable amount of time. Careful planning, and correct purchases, value adds and refinance is a proven method to adding to your portfolio.

 

[Geoffrey]

Okay, that's impressive, but what were your sources, what literature did you use to educate yourself? Any advice would be appreciated.

 

[Thomas Beyer]

Okay, that's impressive, but what were your sources, what literature did you use to educate yourself? Any advice would be appreciated.

The school of hard knocks. Now in a book.