3 Keys to Buying Multifamily Right

Discover the 3 keys to buying multifamily, right. We have been advising people on multifamily investing for 20 years. You’re about to learn what to do (and what NOT to do) when buying multifamily real estate.

3 Keys to Buying Multifamily Right

At Commercial Property Advisors, we mentor people from all walks of life to build profitable multifamily portfolios that produce a steady stream of rental income, while maximizing the appreciation potential of each multifamily investment. Our success rate over the last twenty plus years, has proven that there are 3 keys to buying multifamily the right way.

Key #1: Comprehensive Financial Analysis

The first key to buying multifamily is to conduct a comprehensive analysis of the property income and expenses and that begins with having the correct data. Many people rely on the information in the property brochure, but the income and expenses in the brochure can’t be trusted. In commercial real estate there are very few consumer protection laws so it’s caveat emptor, or buyer beware! Which means, if you buy a multifamily property and discover that the numbers were misleading, there’s really nothing you can do about it. Rather than relying on the property brochure, you need to need to obtain the seller’s actual income and expense statements going back 12 months year to date to base your calculations on.

Verify the Seller’s Numbers

However, you can’t rely solely on the seller’s income and expense statements. You also need to compare these numbers against a third party to ensure accuracy. We provide our protégé students with comparable data from their specific market to verify the seller’s numbers because without that data, you have no way of knowing if the seller’s numbers are true. The seller may have left something out by accident or even on purpose.

Don’t Overly Rely on Online Data

Another mistake you can make when conducting your financial analysis is to overly rely on online data. You may think you can raise the rents and increase your NOI, but if you are relying on online sources only, you may be basing your pro forma on false information. Online is a good place to start, but you can’t end there. You need boots on the ground to see the property, the condition of the interiors, the neighborhood, and the amenities to confirm the information given to you online. Then use property managers as a resource to find out what the property can do.

Calculate New Property Taxes

Property taxes are one of your largest, if not the largest fixed expense you will have on a multifamily property. So, to get accurate projected expenses, you need to calculate what your new property taxes will be. The current property taxes are based on the seller’s property taxes. Do not use the seller’s property taxes in your calculations! The reason is because the seller may have purchased the property twenty years ago for $100,000, which means their tax base is extremely low. Now, twenty years later it’s worth a million dollars and your taxes are going to increase considerably.

So in your cashflow calculation, make sure that you’re using your new property taxes because it can make a big difference. If you’re off by $10,000 a year because you forgot to calculate your new property taxes, that’s about $800 a month in cashflow and $160,000 in NOI value because you miscalculated. You don’t want to make that mistake.

Key #2: Thorough Due Diligence

Before you buy a multifamily property, you need to conduct a thorough analysis of the property and verify every aspect of the deal. This process of due diligence will help you avoid any hidden pitfalls and know exactly what the risk are. Due diligence for commercial real estate is broken up into 3 areas:

• Physical Due Diligence or a physical review that includes building inspections and market research.
• Financial Due Diligence which includes examining profit and loss statements and leases for the property.
• Legal Due Diligence which consists of examining the legalities of the property like title, zoning and land use.

Property Inspection

After you sign your contract, you have a specified amount of time to complete your inspections. Often the agent or the seller will want you to do your inspections in 7 to 14 days. Do not agree to this! It is not enough time to conduct a thorough inspection, get the inspection report back, examine it, call other vendors if there’s issues, and then go back and renegotiate with the seller and amend the contract. At least 30 days is needed, so don’t fall for a shorter time. There’s too much pressure in 7 to 14 days and you’re going to miss something. So get a minimum of 30 days upfront in the contract.

The second mistake people make when buying multifamily and conducting the physical inspection is to only inspect some of the units. Let’s say you have a 24-unit apartment building and the seller or agent doesn’t want you to inspect all 24 because it’s disruptive to the tenants. Not inspecting all the units is a big mistake because the units you don’t inspect will be the units with the meth lab, or the pit bull, or that have something the seller is trying to hide. The seller will cherry pick the best units to show you and then after you close on the deal,  you’re in for a big surprise. Always thoroughly inspect all the units.

Audit All the Leases

When you get your property under contract, the seller will give you all the leases to review. This is when you will audit every lease by comparing them against the property’s current rent roll. A rent roll is a register of all the tenants, the date they moved in, what they pay for rent and when their leases expire. You need to compare the rent roll with every lease to make sure everything lines up. Usually you will find 5 to 10% of the leases don’t match up.

An example of that could be the security deposit. The tenant may claim to have given a $2,000 security deposit, but the lease doesn’t show it. So what are you going to do? The rent roll may show it, but the lease doesn’t. If you didn’t audit it during your due diligence, you don’t have any protection and you owe that tenant $2,000. So your best bet is to compare all the leases against the property’s current rental to find any inconsistencies.

Title Search

Another common mistake during the due diligence process is to simply glance over the title search report because it’s too complex. As part of your financial due diligence you will hire a title company to do a title search. When you get the title report, your job is to go through it and ask questions. Anything you don’t understand, or any question that you have, the title company can answer. Understanding the title search report is important because it contains all the recorded documents against a property’s title to determine ownership and any liens or encumbrances. Some common issues a title search can reveal are:

• Creditors that have a lien against the property.
• Inheritance disputes; there could be a family member on title that didn’t sign the contract and has no idea that the property is for sale.
• Zoning restrictions that you weren’t aware of.

So thoroughly review the title report and get clarification from the title company to avoid potential issues with liens, disputes, or zoning restrictions.

Key #3: In-Depth Understanding of the Market

The third and final key to buying multifamily right is to have an in-depth understanding of your market. And that starts with paying attention to the supply and demand for different types of units in your market. For example, if you are planning to buy a 24-unit apartment but all 24 units are one bedroom, you might want to reconsider unless you are in an area with a higher demographic of single people, like downtown or near a college or university. This is because the average tenant of a one bedroom tends to be transient which means you will not have a steady income base. On the other hand, a building with one, two and three-bedroom units is ideal for most neighborhoods and will provide a steady income base. So, when buying multifamily properties, it’s best to have a unit mix.

Crime Rate

Often investors will run the numbers on a property, and they get blinded by the cash flow. What I mean is, on paper the property cashflows so well that they ignore the red flags, like a high crime neighborhood. It doesn’t matter how good the cashflow looks, if the property is in a high crime area, don’t buy it. The tenant pool in the area won’t have reliable jobs and can’t be depended upon to pay the rent. To find out the crime rate in a prospective market, go to crimemapping.com. You can enter the address, and it will show you what crime is in that area.

Rent Trends

You also need to check the rent trends in the area when buying multifamily. If you think the rents can be increased, you need to verify that yourself. A great tool to find out the rent in your market is rentometer.com. Simply type in the address and it will tell you what the rents are for that area. If your rents are below market, you may be able to raise them.

Transportation

More and more, people want to live where they can easily access public transit and walk to stores and restaurants. walkscore.com will tell you what’s within walkable distance of your apartment building.

Population/Job Trends

Is the population growing or declining? If it’s declining, you will have less population to draw from as tenants. And with less demand, you won’t be able to raise the rents. And what are the job statistics? No jobs or a struggling economy means less tenants and lower rents. So look for growing markets with stable job numbers.

A great resource for general demographics is neighborhoodscout.com. It produces a phenomenal, comprehensive report that will help you better understand your market.

Rent Control Legislation

The last market factor to consider is whether the city that you’re investing in has rent control laws or pending rent control legislation. If the city has rent control measures, you won’t be able to increase your rents because your rent is controlled by the city. And if the city is discussing passing rent control laws, that could affect you in the future and totally derail your exit strategy. So when buying multifamily property, check to make sure there are no rent control laws that will restrict you.

Review of the 3 Keys to Buying Multifamily Right

Key#1: Comprehensive Financial Analysis

• Obtain the seller’s actual income and expense statements, rather than relying on the property brochure.
• Compare these numbers against a third party to ensure accuracy.
• Don’t overly relying on online data.
• Calculate new property taxes.

Key#2: Thorough Due Diligence

• Allow a minimum of 30 days for inspections.
• Inspect all units, rather than just a few.
• Audit every lease by comparing them against the property’s current rent roll.
• Thoroughly review the title report and get clarification from the title company to avoid potential issues with liens, disputes, or zoning restrictions.

Key #3: In-Depth Understanding of the Market

• Pay attention to the supply and demand for different types of units in your market. Have a good unit mix unless you are in an area with a high demographic of single people, like a university area.
• Don’t be blinded by the cashflow: research crime rates, rent trends, population trends, local job availability, and transportation access.
• Check to make sure there are no rent control laws or pending rent control regulations.

If you have any questions, post a comment below or text PETER to 833-942-4516.

Every Successful Multifamily Real Estate Investor Has a Mentor

Every successful commercial real estate investor has a mentor. Get your mentor here:  Commercial Property Advisors Protege Program