How to Avoid Investing in a Bad Multifamily Deal

Avoiding a bad multifamily real estate deal requires careful due diligence and a comprehensive understanding of the market, property, and financials. In this blog post, we will cover some things to keep in mind when analyzing a deal to avoid losing money. Whether you’re a seasoned real estate veteran or just getting started, the ideas in this post are practical and intuitive to a certain degree. I’ll note that I won’t mention some of the more obvious things to do prior to purchasing a property like reviewing the financials, underwriting the deal conservatively, knowing your exit strategy, and more. Some of the topics I just listed have either been covered in other blog posts or will be covered in future posts. That being said, let’s jump into the post!

1. Thorough Market Research: Always make sure to research the local market and be on the lookout for trends that indicate signs of economic growth in the area. For example, if you see that there are several new developments in the area or perhaps new homes being constructed, it’s safe to assume that the area is experiencing population growth. More so, it’s critical to understand the neighborhood dynamics, including crime rates, schools, amenities, and proximity to transportation and employment centers. In short, you should try to gain a pulse or feel for a market which will then help you make an informed decision. Conducting market research is as simple as spending time in the area and talking to the people. While CoStar data and the news provide good info, there is no replacement for actually being in a market and getting a feel for the people and pace of life.

2. Property Inspection: This is almost needless to say, but you should always conduct a detailed property inspection to identify potential issues like structural problems, maintenance issues, and necessary repairs. For every property we’ve acquired, we’ve hired a third-party company to do a property inspection which has helped us narrow down/confirm our capital expenditures (capex) budget. The last thing you’d want is to acquire a property and be surprised by costly deferred maintenance that could’ve been avoided.

3. Understand the Demographics: While conducting market research, you should pay special attention to the type of people in the area. Understanding the feel of your future potential tenants is essential to understanding a business plan for a property. For example, if you’re investing in an area with class C properties, it might be a good idea to prioritize section 8 tenants. Furthermore, understanding the demographics gives you a feel for how you should communicate with your tenants. My rule of thumb is that the property manager should try to ‘blend in’ with the tenants so to speak. For example, if you’re purchasing a class A property, you’ll want to be highly professional since your tenants are likely business professionals themselves.

4. Market Rent Analysis: In order to narrow down your business plan, you should compare a property’s rental rates with similar properties in the area to determine if they are reasonable and competitive. For example, if comparable properties and unit types are going for $1200 on average, it’s a good idea to assume that you’ll cap out at the same rent. Being biased or overly optimistic in your thinking can and will crush you.

5. Financing Terms: In today’s economic environment of increasing interest rates, you must understand how it is that you will pay off your debt. I understand this point is obvious, but considering the number of real estate companies that purchased properties with variable-rate loans and without interest rate caps, this point was necessary to bring up.

6. Trust Your Gut: If something doesn’t feel right or you’re encountering too many red flags, it’s okay to walk away from a deal. Trust your instincts and don’t rush into a decision. About a year ago out team toured a property that seemed promising considering how much capex was put into the deal and how the property was being run. After touring the property, something just didn’t add up. The deal was somewhat underpriced compared to other deals in the market. When contacting our loan broker, he told us that one of his clients was under contract for that deal but stepped away during the due diligence process for a reason that he couldn’t quite remember. Long story short, we put in an offer and went back and forth a bit with the owners but ultimately backed away and went with our gut feeling. At the end of the day, there is no harm in backing away from a deal.

Conclusion

We’re all on the hunt for good deals. Like anything in life, the shinier the object it is that you’re chasing, the more work you’ll have to put in to get it. Finding a good deal is rewarding, yet what might be just as rewarding (or dare I say more rewarding) is avoiding a bad deal. If you’re a sponsor, avoiding a bad deal can save your reputation. This is especially true if your company is small and has a long way to go. Your company’s reputation is what makes it easier to raise capital and do more deals. If you’re just starting out, investing in a bad deal can save you from never seeing how far you can go in the world of commercial real estate. I trust this post will help guide you in the right direction and avoid investing in a bad multifamily deal.

If you have any questions regarding the terms and concepts in this post or previous ones, don’t hesitate to reach out to either me (tedi.nati@jpacq.com) or someone on our team so we can help explain what is causing the confusion. If you’re interested in investing with us at JP Acquisitions, you can contact us via email (contact@jpacq.com), LinkedIn, Instagram, or our investor portal to set up a meeting.

As always, I hope you enjoyed reading this post as much as I have writing it. Best of luck!