In recent years there has been talk of a possible recession for a variety of reasons. But there is always a risk or a reason not to invest in real estate. Should that stop us? Simply put, no.
In fact, it is better not to have a deal at all than to get involved in a bad deal. But that doesn’t mean there aren’t any deals. You just have to be patient and wait for the right ones.
Yes, the competition is tough and the prices are expensive. That is why you need to be even more selective when investing in apartment buildings and pay attention to the fundamentals. Unlike single-family homes, there are unique multi-family risks if you don’t pay attention to specific needs.
There is no way to completely avoid risk. With all of the variables that are beyond your control when investing in real estate, anything can go wrong at any time. But when it comes to investing in apartment buildings, it’s even more important to be aware of these risks and to manage them effectively. To prepare, check out the most common types of risks and ways to mitigate them below.
1. Asset risk
This type of risk is about the value of an asset and its general risk in the marketplace. Basically all assets have this, and it’s important to understand how much it is in relation to the property you are interested in before invest in real estate.
In all honesty, there is no way to completely eliminate this risk. It’s pretty much integrated with the world of investing. But in order to deal with it as little as possible, it is best to learn everything about the asset. Make the best informed investment by doing your research and making sure the risk is worth it. Ask yourself these questions to get started.
- How much is the investment?
- Do I have to renovate and if so, how many?
- How much will these renovations cost?
- In which neighborhood do I plan to invest and where do I see the future?
This last bullet is very important. A bad market will ruin even a great investment property. But when you invest in properties within the same asset class, you can meet the expectations of multiple locations at the same time.
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2. Manager risk
A property is less likely to perform well if it is not well managed. Whether you manage the property directly or hire someone to do it for you, if the job is not done properly you will most likely see a decrease in the income from the investment.
Save some money to reduce this risk. Healthy cash flow is essential to keep your investors happy. An apartment building usually generates an upper limit of 6%, which corresponds to the net operating income divided by the original purchase price.
You may not have that 6% minimum cash flow initially depending on where you’re buying, but you should get very close to that number after some renovations. By the way, renovations also cost money.
In terms of upkeep, you also need to have a handle on the repairs that are required for the house. These can become very expensive very quickly if you don’t react to them quickly. Having around $ 10,000 on hand just in case something happens while you have tenants is a great idea. But getting everything in order before placing your place in the market is also a smart move.
If you let your property develop all sorts of problems it will become less valuable to people trying to move in and if they do they may not stay.
Never rely on cash flow to fund your home renovation expenses. This restricts your capital and slows down the growth in value. It is also risky if the cost turns out to be higher than budgeted.
In addition, you should never budget just enough money for the renovation. Increase an additional 10 to 15% of the given budget, because the building is full of surprises. Things like multi-family loans can be an option, but these type of lenders can take it very seriously to repay the money on time. If for some reason you are unable to make payment, it is likely that you are not getting any assistance from the lender.
However, this does not mean that you should forego renovations altogether. This is exactly what gives you a competitive advantage in the market. The right changes will attract a lot of potential residents. This means, in addition to expected rental growth, you can ask for even more per tenant over time.
3. Risk of over-indebtedness
This type of risk is about being over-indebted compared to the value and cash flow of your property. Basically, the risk of over-indebtedness is very high if a property is in such poor condition that refurbishment is not worthwhile.
Sometimes it’s not bad to take this risk as people can see the potential in projects. And if you are planning on converting the property, you can save a lot of money by living in a unit, repairing it, and renting out the vacancies as soon as they are ready for tenants.
To avoid this, be sure to go into your investment with a plan. Have a set budget on how much you want to spend on a property and then how much you want to spend on renovations. So many landlords love a good project and fixer-upper, but if your money isn’t managed effectively, the multi-family risk here would be too high and turn the house into a money pit.
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4. Economic and local market changes
As investors, we all know that market conditions never stay the same for long. This is why it is so important to research the area you are investing in beforehand.
Think about which industries will be hardest hit during the next downturn and avoid cities that are heavily dependent on those industries. Part of this multi-family risk is having multiple families living on your property. If each of them work in the same field and this industry goes down tomorrow, you are out of luck.
Cities with great employment diversity are far more economically resilient than a city that is heavily dependent on just one industry or company. You can attract many different types of people to your apartment building, reducing the need to keep looking for tenants.
5. Difficulties in funding
Getting into the real estate industry can be difficult, but even more so with apartment buildings. For example, many states, such as New York, require investors to pay three to four times as much down payment on an apartment building compared to a single family home. It can also be more difficult to get a loan or investors.
To counter this, you need to save even more money to cover the cost of down payment, renovations, marketing, and more. At least $ 100,000 for a property of three or more units should be enough to get you started, but also keep in mind that a lot can go wrong with apartment buildings. The responsibility to take care of all of this is yours. If you don’t have the money to manage all of this upfront, you will easily run into debt that you cannot get out of.
No reward without risk
Even if we are discussing avoiding risks as much as possible, that doesn’t mean that the risk is not worth taking. Making the right decisions with the right risk can ultimately mean a great outcome for you.
Ultimately, every real estate investment is a game of chance because we never know what the future will bring. Adding the additional concerns about multi-family risk only makes things a lot more stressful. But having knowledge of all of these topics will make it as easy as possible to get involved and help you make the best decisions possible so that the more likely you will be able to cash out.