How do I avoid making a bad investment or buying a bad property? This is the question many investors (active or passive) ask as they encounter new investment opportunities. In today’s quick snippet, we seek to provide our view on a few items to consider to help mitigate that risk.
1. Know your investment criteria. With so many opportunities available, how do you choose the one? This is where having definitive investment criteria can help narrow down the pool of opportunities. Are you looking for cash flow or appreciation? Are you looking with properties with a heavier value add or stable value add? Class A, B, C, or D? 20 units, 50 units, 100 units, 200 units? Target returns – e.g. min Cash on Cash return, IRR, Average Annual Return, Equity Multiple? What asset class are you focusing on?
2. Know and understand the market and submarket. I often like to say you can do a lot of things to improve a property but you cannot move its location. The underlying market forces are the tail winds that can help you execute on the business plan or the cushion that can help you weather the storm. Knowing the market trends such as population growth, job growth, income growth, job quality and diversity, etc. is key in helping you determine the above. The submarket is just as important. We discussed our approach to selecting markets and submarkets in a recent article.
3. Know and vet the deal team/the operators. You will often hear the phrase: “Bet on the jockey and not on the horse”. This is very much true in the commercial real estate investing space. A good operator can successfully turn a bad property into a profitable investments. Conversely, a bad operator can hamper a great property in a great market. For helpful questions to ask, please refer to our recently published article.
4. Know and understand who the key partners are. There is an old African proverb that states: “If you want to go fast, go alone. If you want to go far, go together.” This cannot be more true for multifamily investing, which is rightly described as a team sport. In addition to the Management Team (aka the General Partners or the GPs), there are multiple other partners involved that are key to both the due diligence process prior to purchase and to the execution of the business plan post purchase – lender (your largest capital contributor, are their terms competitive and do they have proven ability to close?), property manager (the PM is the one responsible for daily operations, tenant screening, maintenance, etc.), asset manager or PM consultant (the one who works with the PM to ensure the business plan is executed timely and in the most optimal manner), CPA (essential not only for book keeping but also for the K1 reporting and real estate advisory), cost segregation specialist (who helps maximize the permissible tax deductions), attorney (real estate attorney and SEC attorney who not only draft the documents and PPM but also help the syndicator stay compliant with SEC regulations), broker (essential in helping find the property and working through the closing process with the seller). You want to understand who these key parties are, what their background and experience is, and whether they are the best fit for this market, property, and property/business plan. For example, hiring a PM who has only worked on 20 unit assets to manage a 120-unit property might not be the best fit, even if their fee structure is lower. Or working with a CPA with no prior real estate experience might cause not only book keeping issues, but also create a situation where the maximum permissible deductions and tax management strategies are not implemented or at least explored.
5. Know and understand the financing. Making sure the right financing is selected for the particular deal and business plan is a key responsibility of the sponsor. As a passive investor, however, you may want to ask questions to gain comfort that the operator has done just that. Is short term or long term financing or fixed or floating debt right for the subject deal? It depends. What are the loan tenor and other key loan terms such as covenants, recourse, interest rate, fees, etc.? Do the projections match and remain in compliance with such terms? If a refinance is projected, is it realistic based on the financing landscape?
At the end of the day, unforeseen events could and often will happen. However, how one performs the vetting and diligence process coupled with having clear investment criteria can help mitigate such risk or at a minimum ensure the right people are in place to help navigate the ship through stormy waters. We hope that with the top five questions above you feel better positioned to avoid buying a bad property or making a poor investment decision and smoothly sail through the investment selection process with a peace of mind.
Should you have any questions or want to learn more about real estate investing or for an overview of our target markets, please reach out to firstname.lastname@example.org.
Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.