In prior articles I discussed how one can get started in real estate and how an initial $50K investment can provide a good head start towards achieving financial freedom. However, having that excess liquidity does not mean you should jump into every or any investment opportunity presented to you. In today’s quick snippet, I will address key questions to think about before you decide whether to invest in a deal or not. You can also reference these questions as a checklist later on when you come across multifamily investment opportunities.
1. What are the market dynamics and is the market conducive to the business plan? For example, projecting a 10% rent increase for several years in a market with moderate population growth or projecting monthly rent of $1,700 in a market with median household income of $40K that realistically supports maximum rents of $1,100 is not a realistic assumption. At a minimum, it should cause you to pause and ask questions or ask the operator to substantiate their projection rationale.
2. What is the track record of the operator running similar projects? What is the track record of the sponsorship team? Who is the extended team, especially the property manager (and if applicable the day to day asset manager), and what is their background?
3. What is the property and its condition and do the numbers align with that? Class C properties generally require more maintenance due to their age – is that reflected in the repairs and maintenance number? Is the property a heavy value add or a light value add? Do the capex projections align with the nature of the value add required to generate positive returns? Does the hold period align with the nature of the value add strategy?
4. How conservative is the underwriting and does it align with the market fundamentals?
5. How does the debt structure align with the business plan?
6. Does the return align with the level of risk? For example, a lower IRR may be appropriate for a stabilized or a light lift property. A heavy value add or turnaround strategy should yield higher returns. What is the return on investment, i.e. lift in NOI (due to increase rents driven by improving the property) relative to the valuation increase?
7. Does the opportunity align with your own investment objectives (cash flow, appreciation, tax shelter, etc.), target returns, investment horizon, and liquidity position? Generally speaking, unless this is within your own risk tolerance, you should not be investing your last dollar into a deal. These investments have a medium to long term horizon and cannot be liquidated overnight, in the event of a personal emergency.
Needless to state, as with any investment, there are risks involved. There are exogenous events, outside of one’s control or foresight (especially when one is projecting 3-5 years out), that could adversely impact the investment – high and continuous increase in interest rates, high inflation, a recession or depression, a natural disaster, regulations, etc. In extreme circumstances or in events where the risks were not mitigated upfront or there was not sufficient cushion/margin of error built into the numbers, the business strategy may pivot from generating the projected returns to preserving capital or minimizing losses.
Our team does this deep diligence upfront. Thus, usually by the time you are presented with an investment opportunity by me and my team, the deal and the sponsorship team have been vetted. That does not mean that you should not ask questions or do your own diligence and analysis before you wire these hard earned dollars you have saved. At a minimum, however, our vetting process serves to provide that first and second set of eyes, to prescreen the deal, and take away some of the guess work and anxiety on the front end, so you can focus on your diligence process first and then safely continue on your journey to achieving your personal freedom.
Download The Busy Professional’s Quick Guide To Investing In Multifamily here.
Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.