What Can Go Wrong In A Multifamily Deal?
What can go wrong in a multifamily deal?
I admit it — I don’t want to talk about this.
Can you blame me? I would much rather sing an ode to multifamily as a can’t-lose investment, where nothing ever goes wrong.
Why would I want to scare off potential investors with worst-case scenarios of what could go wrong — and possibly never will?
But, I’m committed to transparency and open communication. And plus, you know that no investment is without its risks and potential downsides. That is definitely true of multifamily real estate.
No apartment complex is problem-free. The successful investors take Murphy’s Law as their guiding principle — they do everything in their power to anticipate everything that could happen … and do their best to leave a cushion for anything unanticipated that might happen.
I’m going to lay all the cards on the table and describe some of the most common things that can go wrong with a multifamily investment. Some of these have happened to us here at Investor Boardroom; others have happened to partners or acquaintances.
This list is certainly not exhaustive — real estate is always full of surprises. There’s no way around that. But with experience, risk-management, and preparation, none of them have to be death-blows to a deal.
1. Mass Exodus
It’s the nightmare of every real estate investor … You buy a property full of rent-paying tenants, and wake up the day before closing to find out that every tenant has vanished, like the Rapture.
Of course, this is hyperbole … but a mass exodus of tenants is very possible.
Why? Because people don’t like change. They may be afraid of a rent increase, non renewal, or just having to deal with a new landlord when they have already attained a level of comfort with their current landlord. They may not want to wait for the shit to hit the fan — they may just duck out pre-emptively, leaving you with a vacancy issue.
This is especially a risk if you buy a multifamily property where many tenants enjoy a month-to-month rental agreement with the current landlord instead of one-year lease terms. Month-to-month tenants are at their liberty to leave whenever they want with few consequences.
But that doesn’t mean you should run screaming from every deal that has a lot of month-to-month tenants. Locking those tenants into a lease — or cycling them out for a better tenant base — could be a great value play.
But it does require proactive management. Don’t count on the tenants not to notice the change in management — the solution is to get out in front of it, reassure the current tenant base, and encourage them to stick around to see the amazing upgrades you have in store for the tenant experience.
2. Bad Tenants
Some tenants you bend over backward to get to stay … Others, you fall down on your knees and pray for them to leave.
One of the advantages of multifamily real estate is that one bad tenant may be offset by the other tenants … but a bad tenant can have an outsized impact on quality-of-life for other tenants.
You could have hoarder tenants whose apartments stunk to high heaven, becoming a nuisance and a health hazard for the neighbors. I’ve had tenants whose significant other was living in the apartment off the lease to avoid a criminal background check … and, surprise surprise, ended up harassing and threatening the neighbors. I’ve had tenants who skipped out on months’ worth of rent, only to skip on the lease and leave the apartment trashed — thousands of dollars in damage.
If you have a rash of non-paying tenants, it can create a significant cash flow problem. This can be an especially large risk in the early going when you’re trying to reposition a rough property with a rough tenant base.
Yes, you can evict a bad tenant under many circumstances, including nonpayment and bad behavior. But it’s not as simple as changing the locks. Eviction is a judicial procedure that can take months to execute depending on state and county laws … and the tenant may be able to fight the preceding and stretch it out even longer, stiffing you for rent the entire way.
The one upside is that finally evicting a bad tenant is cause to pop champagne corks. Few burdens feel better when they are lifted.
3. Going Too Big, Too Fast
We often talk about how buying a 100-unit apartment complex is not that different from buying a duplex — the numbers are bigger, but the business is the same. This is true … to a point. But it’s also easier said than done.
Some real estate investors try to go big when they aren’t ready. They don’t have the reputation or the investor base to fund a big deal … or they run out of money in the due diligence process. If they come up short on funds, the deal may fall apart and the investor is out tens of thousands, even hundreds of thousands in deposits, application fees, and inspection fees.
A large liquid firm can absorb such a black eye … but this can be a death blow for a novice apartment investor.
4. Rosy Projections
“Underwrite conservatively. Underwrite conservatively.” It sounds like a broken record, but we can’t possibly overstate the importance of underwriting conservatively — which means only buying a deal when it looks like it can survive even the worst-case scenario.
Still, projections are just that — projections. They’re barely better than an educated guess. Expenses could end up being higher than expected and harder to ratchet down than expected. It might be harder than you thought to get rents up to market. Initial repairs and repositioning have a way of going over budget.
Human nature is the enemy when it comes to projections. We want to believe the best-case scenario. But smart investors brainstorm the nightmare scenario … then try to make it even worse. Will the deal still make money? Fortune favors the pitiless and brutal underwriter.
5. Rogue Lenders
Real estate investing isn’t for control freaks. Yes, a lot of money is at stake; it would be nice to be completely in control.
But not everything is in our hands. The lender is one of the biggest X-factors in any multifamily deal. Last-minute lender decisions can wreak havoc on a multifamily deal.
The most leverage you can usually get for a multifamily deal is 80%; I’ve underwritten deals for 80%, only to have lenders come back and tell me they will only lend 65%, leaving us to scramble for a larger down payment and decide whether or not the deal still makes sense with less leverage.
It can get even worse. Lenders have a lot of leverage in their ability to call the loan due at a moment’s notice. I knew an investor group who was about to sell their apartment complex for a tidy profit, but when they disclosed the sale to the lender, only to have the lender come back with a bogus list of “mandatory repairs” — despite the fact that they had had the chance to make a list of mandatory repairs — and demanded an inflated repair escrow or the group would be subject to foreclosure.
The lender essentially tried to steal the property out from under this group when they discovered how much they were selling for. They had to accept a quicker closing at a lower price to avoid losing everything. Moral of the story — choose the right lender!
6. Property Manager Fail
Another potential point of failure in a multifamily deal is the property manager.
Yes, the deal sponsor is in charge, but much of the success or failure of day-to-day operations is in the hands of a professional property manager or property management firm. At least, you hope they are professional.
Sometimes no property manager can save a defective property … but there are certainly plenty of ways for the property manager to be negligent or even hostile. I’ve seen property managers hire incompetent on-site staff, be lazy with collections and maintenance, throw repair contracts to buddies for inflated costs … even flat-out steal from the investor group.
Good deal sponsors stay on top of their property managers with regular calls, surprise visits, and stringent reporting and transparency requirements. But there’s only so much a deal sponsor can do, and once operations have gone off the rails it can be expensive to right the ship. Switching property managers mid-stream can be a nightmare.
It pays to vet your property management company carefully — check reputation and references, visit other properties they manage, and screen them for good business practices.
It helps if you partner with a property manager early on in the process so they are in the loop about your investment strategy. They’re the ones who will have to execute it, so they should at least be confident putting their reputation on the line that they can do it before you close. But some companies will lie just to get the business.
But one of the benefits of being an experienced investment firm is that you build a relationship with a property management firm and then use them again and again.
7. Capex Nightmare
Big properties come with big bills. The physical due diligence process should include inspections of every major system — roof, plumbing, electrical, HVAC, etc. — to estimate their remaining useful life. That way, you can price major repairs and replacements, also known as “capital expenditures” or “capex”, into your projections.
But if a major system fails unexpectedly, you could be up Shit’s Creek — literally if a sewage pipe bursts.
One investor group I know bought an older building. As part of their list of mandatory repairs, Fannie Mae requested that one electrical panel be replaced. But when the electrician came out, he informed the investors that the remaining electrical boxes may have been good enough for Fannie, but not for the city. If he pulled the permit on one box, the city would require them to replace every box. Ouch.
8. Lawyer Up
One thing we know about landlords — they’re rich. Miserly moneybags with Scrooge McDuck swimming pools full of gold coins, with no concern for the plight of the little guy.
Am I right? Does that sound like you?
Of course, that’s a gross stereotype. Apartment syndications can be made up of investors with a diverse net worth. For one investor, that $50k buy-in may be a drop in the Scrooge McDuck bucket. For another investor in the same deal, losing $50k may set them back years in their financial strategy.
But see how far you get telling a sob story about poor, put-upon apartment complex owners. 99.9% of listeners will start playing the world’s tiniest violin — no sympathy whatsoever.
Bottom line — “rich” apartment complex landlords have a target on their backs in the shape of a dollar sign. In our litigious society, tenants and even non-tenants won’t hesitate to sue a “fat cat” real estate tycoon in hopes of a multimillion-dollar payout … so they can live the fat cat life themselves.
Slip-and-fall lawsuits, discrimination lawsuits, worker’s compensation lawsuits … Even if you win in court, these proceedings can be draining to fight, both in terms of money and prematurely gray hair.
That’s why every real estate investment group had better have a solid relationship with a good local lawyer. And I don’t mean a contract lawyer or eviction lawyer — I mean a bare-knuckle litigator, the meanest pit bull of an attorney ever to pass the bar, the guy or gal that every lawyer within 100 miles quakes in their boots when they show up to represent the plaintiff and see this bruiser at the defendant’s table.
One of the advantages of working with an experienced deal sponsor like Investor Boardroom is just that — our experience. We’ve cycled through several multifamily properties and made mistakes we will never repeat again.
No multifamily deal is perfect, but with an experienced hand on the wheel, the ship will stay upright even in stormy waters.
Reach out to us today to hear more about the problems we have encountered in our deals, how we handled them, and how we came out on top in spite of them.
Resources available to you:
If you’re interested in learning more about the kinds of private real estate investment opportunities I referenced in this blog, download my free ebook titled “The Rapid Millionaire Blueprint” by clicking the link HERE.
Follow us on Social Media:
Facebook Group (23k+ members): Click Here to join
Personal Facebook: Click Here to connect
Instagram: Follow Me on Instagram
Youtube Channel: Click Here
All the Best,