Written By: Joe Danza & Seth Ferguson
Multifamily Real Estate: As prices continue to rise, finding cash-flowing properties is getting harder to come by in the residential real estate space. That is also causing many first-time investors to make costly mistakes as they sacrifice cash flow for the hope of potential equity gains in the future. Equity is not a guarantee; it is here today and gone tomorrow. The same can be said for the multifamily commercial real estate space as properties are being sold well over list price and returns shrink. That fact can lead to multifamily syndicators taking more risks while making tradeoffs to secure the deal.
How do you determine if multifamily makes sense for you? Are you looking for an investment that yields high returns yet is passive? Are you looking for generational wealth? Do you not want to be involved in the day-to-day operations of these apartment complexes? If you said yes to those questions, multifamily real estate might be for you.
With over 20 years of real estate experience, we have made some costly mistakes resulting in some meaningful and valuable lessons, frequently learned the hard way. Here are our top 5 lessons learned in multifamily real estate:
Lessons Learned in Multifamily Real Estate
Lesson #1: The deal itself is not as important as the team (general partners).
The rookie mistake that we see with passive investors is that they focus solely on the returns instead of the team. Numbers on a spreadsheet are one thing; making it happen depends upon the team running the deal. General Partners are involved in the day-to-day operations. It is essential to understand their backgrounds, track records, and how they operate. Do they communicate clearly? How are they invested in the deal? They should invest in the transaction with their own money. More importantly, do you trust them? You will be married to this team for at least the next 5-7 years, depending upon the length of the deal. Just as you spend time with your potential spouse, you should do the same with any investment.
Lesson #2: Understand the Opportunity.
It is imperative to understand the business plan (new construction, value add, hotel conversion, distressed properties, etc.). How will they execute it? Does it seem feasible under the proposed timelines? Do they have multiple exit strategies? i.e., what is the plan if there is a downturn in the market? General Partners need to have a plan and a backup plan just in case. Are the General Partners guaranteeing or advertising refinancing to return your initial investment? It might be a red flag. No one has the crystal ball on what the real estate market will do over the next 12-24 months. No one can guarantee that a refinance can be secured. That is the reality. While it is okay to talk about a refinance and return of capital– you should not capture it in the underwriting. It is risky and also sets unrealistic expectations that investors can expect to get their money back. Nonetheless, it will be hard to backtrack once advertised.
Lesson #3: Underwriting.
Being able to understand the underwriting and the pro forma is an art and craft. It is not easily understood unless you have taken a crash course. For example, understanding the market analysis, employment forecasts, increasing or declining population, education, crime rates, etc., will drive up or down projected rents. Underwriting does not just understand the market–it is also about understanding how and what comparables were used to increase the projected rent. Were the comparables similar in size, age, square footage, and amenities? Comparables need to be apples to apples; they should not be apples to oranges. What expenses were captured, and how were their estimates projected? Can you genuinely recapture utilities—will the market support it? What stress tests will be done on the property? How many vacancies can there be before the deal is in trouble? What do the reserves look like, and how did they determine this was sufficient?
Lesson #4: Do not rush into a deal.
We have all experienced the “fear of missing out” to some degree in our professional and personal lives. “FOMO” can cause us to make costly mistakes as we make decisions without having all the facts. We can also experience the same as we look at potential multifamily real estate deals. It is important to pause, refocus and remember your end state– how does this deal help you achieve your financial goals? Additionally, review all the critical points (ex. syndication team, business plan, terms of returns, etc.) before rushing into any multifamily deal. Remember, there will always be another opportunity.
Lesson #5: Do not be afraid to ask questions.
It is in everyone’s best interests that you have a solid understanding of the investment opportunity. Good syndication teams will be sure to have multiple opportunities for you to ask questions to make an informed decision. When in doubt, ask. Rely on your support team of lawyers and accountants to look through items that may be unfamiliar to you.
Seth Ferguson is the founder and CEO of Multifamily Real Estate Investments Inc. A 13-year real estate veteran, Seth controls over $50 million of multifamily properties, has transacted over $150 million, and hosts a real estate TV Show and real estate investment podcast—Real Wealth Through Real Estat. He is also the host of YouTube Channel: Seth Ferguson – Multifamily Real Estate Investing and will be hosting the Multifamily Conference in Toronto 2022.
Joseph Danza is an Army Reserve Chaplain and Information Technology Program Manager. Since he was a child in his parent’s real estate business, he worked in real estate and has over 13 years of real estate experience with his own business. He is the CEO of a multi-million dollar real estate company focusing on multiple revenue streams, comprised of STRs, LTRs, Property Management, and Multifamily syndications.