There are 1,001 potential mistakes in any purchase of multifamily assets that await the non-professional. My objective here is to highlight only a few, some obvious, some not so obvious. For this writing, I am referring to multifamily properties purchased in the prices range of $2-$10 million dollars. This represents a slice of multifamily investments where many people start; those with an interest in the asset class, but not necessarily full-time professionals devoting their daylight hours to running a multifamily business. Following are at the top of my list of common crash points
Crash point: when the issue at hand is greater than your ability to fix it with cash or practical experience
- Inexperience. Newby’s (Newby: someone who has read “books” and books only. i.e., an individual with no practical experience) ALWAYS under-estimate the level of labor required to run the business. While multifamily management is not rocket science there are multiple skill sets required for success. As with McDonald’s, whereas anyone can make a hamburger, there’s only one company making them by the billion. Why? Systems. They have systems in place that are reliable, transferable and highly structured. And their labor force is trained accordingly. Just this week I heard from a good property manager sharing the job she was applying for went to the “girl friend” of the owner. This is no way to run a multi-million dollar business.
Lack of Dedication. The multifamily business is not a “hobby” or part-time business. In fact, multifamily management can be a 24 hour business. No different from exercise (and I’m the last one to talk about exercise) seeing measurable results requires not only time, but dedication and effort.
- Under Capitalization. Having little or no cash on the balance sheet is a recipe for disaster. This topic should be a blog unto itself, a book, an encyclopedia of explanation. Business School’s teach ratios about cash as a percentage of sales. Consider not less than one months revenue for cash reserves. While income can be static expenditures can vary widely.
- No Capital Expenditure Planning. Capex is and will always be. Capital expenditures (CAPEX or capex) are expenditures creating future benefits. A capital expenditure is incurred when a business spends money either to buy fixed assets or to add to the value of an existing fixed asset with a useful life that extends beyond the taxable year (http://en.wikipedia.org/wiki/Capital_expenditures). This expense category must be planned and accounted for in annual budgets. Multifamily real estate is a fixed asset class with long operational demands and high capital requirements. Planning for Cap Ex means known “surprises” are not a surprise.
- Buying too small- no economies of scale. There’s just no meaningful method for running a 20 unit deal as efficient as running a 124 unit deal. The expenditures in every category are going to be higher (on a per unit basis) with a small property. Now, this is no reason to stay away from the boutiques (boutique: quality multifamily properties under 100 units). This is just a note to remind all to measure apples with apples at time of acquisition
Reprint from Multifamily Insight .net by John Wilhoit Jr.