What Makes Multifamily Investments Fail?
Lately, there has been so much talk going on about the hot multifamily market and how strong the market dynamics are. This has led many new investors into the market who are driving up prices around the nation. Sometimes the prices are being driven to almost ridiculous levels where its hard to see how the new owners can make money. Because of this driving up of prices and very aggressive evaluations, I think it’s important to look at the top reasons multifamily investments fail.
Don’t get me wrong, historically, multifamily real estate investments are one of the safest bets you can make with your investment capital. Multifamily investments have some of the lowest foreclosure rates of any asset class because they fill a basic human need, shelter. In retail and office investment properties, businesses don’t necessarily need to open a new location to expand their current one. Technology now allows workers to work from virtually anywhere eliminating the need for office space. But, people still need a place to live no matter what.
The filling of a basic human need is definitely one of the reasons we choose to invest our own capital into multifamily properties. While they are very safe in comparison to other investments, some multifamily investment properties do fail. Usually it comes down to one of four big reasons that if not corrected quickly could doom your investment and it’s important that you are aware of these before you invest.
4 big reasons multifamily investments fail:
- Bad Property Management – Multifamily assets are very management intensive. You need a good property management company to enforce leases, bring in quality tenants, take care of maintenance issues, and protect the property. Poor property management is a major reason properties fail.
- Bad Market/Bad Asset – Sometimes investors don’t do their due diligence and pick the wrong asset in the wrong market. Typically these fail because they pick a property in a market with very poor quality tenants or high crime and cannot attract the tenants you need to keep the property operating correctly. This can also happen by choosing a property that functionally doesn’t meet the demands of the market. For example, a complex with only one bedroom apartments in very family oriented area or vice versa.
- Incorrect Underwriting/Over Leveraging – These properties fail not due to them being in a poor market, bad property management, or even because they are bad properties. These properties fail because of poor underwriting or financial analysis during the purchase. If you overpay for the property and over-leverage it by taking out a loan that the property cannot afford, you can lose it if the property or market takes even a minor downturn. Do not over-leverage your properties and they will make you wealthy. Over-leverage them and you can lose them.
- Under-capitalized – Properties that fail due to being under-capitalized happen when something goes wrong on a property and the owner does not have the funds available to take care of it. This can happen from not collecting enough rent or having a large capital expense like a roof that must be replaced. If you don’t have capital set aside for reserves or a “rainy day fund” you could be in big trouble if a big expense item is needed.
Multifamily investment properties are one of the safest investment vehicles available to protect and grow your wealth. You must invest conservatively and do your homework. To minimize your risk, it’s important to avoid poor property management, challenging properties in difficult areas, do not over leverage your asset, and be sure to factor in extra capital or a reserve fund in case of unforeseen expenses. If one of these challenges does occur, it’s important to adjust quickly to correct the problem.