5 Multifamily mistakes to avoid (How to avoid them)

Foreign guys. So today we are diving into five multifamily investing mistakes, all right? And how to avoid them. My team and I represent over 4,000 doors in multifamily real estate. And we have experienced a lot of mistakes. So, you know, we've acquired a lot in just the past few years. And. And as many of you know, there's been a lot of ups and downs in the market. So with that being said, it's absolutely imperative that you know what's going on in today's market. If you are looking to scale to start a real estate portfolio or to scale your existing portfolio, do not do anything before watching this because we've also been able to coach many clients and see their real estate portfolio scale. But these mistakes will trip you up. So let's get into it. Number one is shooting too high in the pro forma. All right? So shooting too high in the performer. This is something everybody wants to do, especially when they're new. But if you don't understand pro forma, it just. The performa is essentially projected performance of the property made up of projected expenses, income, debt, and cap X in the time period you are planning to hold the property or execute the value add strategy. Okay? And so I give an example right here, just to give you some numbers and be a little overwhelming here, but the broker, pro forma, right? The broker sends you the deal, and this is what he says is the projected numbers. Okay? So let's just walk it step by step. The income on the property is $120,000, okay? That's what the broker is saying. It can reach 120 grand. And then expenses are 60,000. Okay? So all the rents, 120. All the other income, 120. And expenses, all the things that you have to pay for management taxes, all the different things, 60,000. The NOI is $60,000. So 120 minus 60,000 gives you a net operating income of 60,000. So your profit margins, and this is really how you value an apartment complex, which we'll talk about in just a second. But your debt, again, it would just say. We're just guessing here, but it's a $20,000 debt payment, right? Per year, and then your cash flow is 40,000. So given those numbers, and then we move over into the actual. Right, we can't just take the broker pro forma. We actually look at what are the numbers in real time. We go in and we look at the T12, the trailing twelve months of expenses and income. We look at the rent roll, what rents have Actually came in. And then we look at the market rents, all right, we go to apartments.com or we go to costar. We go to different things and go look at what the actual market rents could be. What are properties nearby actually experiencing in terms of rents? Properties that are fixed up, right? Not the property 20 miles away. That's way nicer than, than your property or way nicer than your property could even be. Has a pool, yours doesn't. Whatever. You got to compare amenities and look at what is the actual market rents. Okay? So, so in this situation, we find out that the income is actually the market rent, the market income. And what you could get at the Pro Forma is $110,000. And the expenses, after really analyzing everything, what's realistic is going to be 65,000, okay? So that means your NOI now is actually $45,000 as compared to the 60,000. All right? And that means. And then your debt, still 20,000, that didn't change, right? Your cash flow is now $25,000 instead of 40. So that's a big discrepancy. So big thing here is the keys you have to understand is that is $15,000 less, which means in the valuation, because like I said, the value of the property is based on the price profit, all right, Based on the noi. So it's the noi divided by a cap rate. Right. The cap rate may be just say 6% in that market. And that cap rate, just to give you an understanding of that, it's simply the way any business is valued is the profit times a multiple. And that multiple is based on market factors. Right? How nice of the area. Right? The condition of the property, how it's ran, all these kind of different things. And so that cap rate equals what your, your value is. And so in this situation, $15,000 less. If you divide that by just say a 6% market cap rate, that means you've got a $250,000 drop in the price that you can now pay for this property. So essentially, if you pay based on the broker's numbers, you would be losing a lot of money, right? You'd be paying based on unrealistic pro forma numbers. Okay? And I mean, just so you understand, the this happens all the time. People acquire a business or acquire property and project that, it's going to be a lot more and it's going to be worth a lot more than it actually becomes, and then they lose a lot of money. You know, one example I was reading about the other day, hp, I don't know if any of you know, HP acquired a software company called named Autonomy. All right? They acquired it for like $11.5 billion. Well, they projected that it would be worth so much more it didn't happen. They lost billions of dollars. Okay? So this is a very costly mistake. You don't want to be paying on the wrong numbers. What you're. If you do that, you're going to create the inability to pay your investors, the inability to pay your mortgage even and be able to refinance at the proposed plan or sell the property at the proposed plan. So then it creates a lot of headache. Okay, so let's go on to other mistakes in the pro forma. Okay, I'm just going to do one more slide on this because again, number one thing to protect yourself is you've got to be realistic. You got to project for conservative numbers. Okay, so other mistakes in the pro forma. All right, so this slide, you know, we're talking about, the market cap rate to sell is too low. All right? So like I said, some markets there's a 6% cap rate based on the property based on the market, some there's 7%. You need to know what that is. All right, and how do you find that out? You typically find a mortgage broker or you look at past sold comps in the area. Right? So you know, basically how, how you understand what a good market cap rate is for your area is you look at other properties that's been sold. So again, the market, the cap rate is determined on the income divided by the, the, the purchase price or the value of the property. Right? So the noi divided by the purchase price gives you. Your, your cap rate. And so you can look at that for other properties in the area and what they sold for. All right? And you can compare how renovated is that property? How nice is that property? Is that similar to yours? Okay, so that's number one. And a mortgage broker ultimately is getting in there and looking at it appraisers, you know, so you can connect with a commercial mortgage broker. So they're going to help you with that. But again, that could be a catastrophic difference between what you're buying it for and what you can sell it for. And then the market rents are too high. Like I already mentioned, you want to go into apartments.com and look at what are properties actually renting for in the, in the area, and then other income is too high. Listen, I see this all the time. People will go and purchase or underwrite a deal. That's class C property. And don't even get me started on class D, right? Like class C properties. You're not putting a sauna or a gym in a class C property. Right? They're not gonna, that's not gonna, they're not going to pay for that. They're not going to. There's not going to be other things that you can add. You know, people want to put in valet trash and, and, you know, all these different things, right? You're not going to be able. You got to think about your tenant base. Are they willing to actually pay for extra services? So, you know, once you get into nicer properties, class B and A properties, then you can start thinking about those things. But other income being too high is another thing that you got to be realistic about. And then expenses unreal. Realistically low. Look, I mean, you know, the, the. I don't want to give you too many, like, actual numbers because you know, everything's going to be dependent on, on the property you're looking at. But if you tell me you have a property that's built in 1970 and you, the, the person's telling you that it's, it's got a 35% expense ratio, I'm telling you they're lying. That's not real. Right. In these apartments, you can assume a 50% expense ratio for most properties. You know, now if you have a class A, really nice property, yeah, maybe we can operate at a lower, you know, 40% expense ratio or if you have smaller units, you know, less than 10 units. And yeah, maybe we're there. But if you're, if you're looking at underwriting a deal that needs value, that needs to be renovated or needs to be changed, and, and the expenses are, they're telling you it's 40% or below. It's probably not real. So you got to be realistic about your expenses. Typically it's around 45, 50, sometimes even 55%. And then last point here, guys. You got to operate it with a mindset of you've got to kill the deal if you want to protect yourself in today's market. You want to be safe, you've got to operate from a mentality of, I've got to do everything I can to investigate this deal and see if I can kill it. If you can't kill it, you've got a pretty good deal, right? Or you have something that you can now present and be confident in. And so that's the number one thing. Okay, now next slide. Value add or distressed properties. Here's a big mistake. I believe in today's market, okay, if you can't afford to lose it, don't risk it. Right? So, you know, make sure the property is cash flow positive at the purchase, okay. And there's many reasons for this. Have people bring a 30% occupied property and say, yeah, let's, let's, we can make this so much more valuable. Sure, that's fine, but you're risking a lot more. Whenever you think about the lag time, you're, you're obviously taking a much bigger risk that there's no underlying issues. What are the reasons it's 30% occupied or. Right. What are the. That's a bigger lift. So in today's market, I encourage you be cash flow positive out the gate, okay. And same thing with new construction, right? The lag time there makes it a more risky investment. And so if we're thinking about decreasing risk, you know, Warren Buffett's rule is never lose money, right? Number one rule, never lose money. Number two, refer to number one. So you, you know, the lag time for new construction and renovating an entire complex before generating income creates a higher risk. Think about it. Day one, you take over the property, you immediately have to be injecting money, right? Every single month you're bleeding, right? We don't want to risk that right now, especially if you're a newer investor. If you're a seasoned investor, you have money, that's maybe fine. But for newer investors, I recommend do not get into value. Heavy value added stressed properties. More than 50% vacant is a no go for us. More than 40% of tenants not paying is also a no go. You know, and the other thing about that is renters talk to other renters, right? If, if you have 40% of a tenant base that's not paying, the other 60% is probably going to talk to the 40% and they're going to stop paying. So you can immediately have a snowball on your hands where you lose a lot of money. So look for light to moderate value add. You know, an example of that would be you need some renovation or management to be changed out. I think we just put out a video about our 88 unit. We just bought that. Really. We created about $2 million in equity within two years of purchasing the property. And all we had to do is go in and change out the management company, right? No renovations needed, just improve the management. The operations make tenants feel like this is a nicer property just based on operations, right? So that's the kind of play you want to do now. Renovations are still fine, but light to moderate. Okay, all right, High cap rate deals. This is number three. All right, we're moving along. High cap rate deals. If you don't have all the money or want cheaper debt to make the property work, you know, high cap rate deals obviously is a, is a situation here where the issue with these deals is bad properties and bad areas. Right. I see so many people go on LoopNet, they say, oh, this is a high, this is a 10% cap rate deal. Well, typically that means that it's a, it's a not a very good area and it's a not very good property. And so you're going to be in a situation. Again, this is probably more like class D properties a lot of times. And we don't want to be in those areas. That's war zone areas. Right. You're going to get a bad collection percent. Right. You're going to get bad expenses, high expenses. And it's typically because these properties are older and they have bad tenants, like I already said, right. The tenants are lower income and they're not able to, you know, pay or they're not able to take care of the property. Right. They end up creating issues, right? So they end up banging up your property and you got to pay more in expenses. And then obviously with all that being said, there's bad returns. So high cap rate deal sounds exciting at first, but the idea of actually creating solid returns is not very good unless you're just willing to go in there and work it yourself and it's a smaller deal and you know, maybe then. But you don't want that headache, all right? Going on underestimate, underestimating cost, not doing thorough due diligence. Okay? So it's not just the purchase price, it's. And the reno cost, all right? You gotta understand, it's all the different things like acquisitions, related expenses, legal fees, broker commissions, loan closing cost. You need to think about all these things in your underwriting. We teach people how to bring all the money to the table through limited partners and bringing capital partners to the table. And we go into depth on that. But I've seen it where people underestimate these costs. They raise money and then they have to go back and raise more money. That is not what you want to do. That's so hard to do. So you've got to make sure in the beginning, you know, the acquisitions related expenses like legal fees and broker commissions, and then also your operating costs, taxes, insurance, these things are high, right? There's. And your taxes by the way is based on your purchase price or based on what you're going to get the property to. You got to underwrite the pro forma to not based on the current value, but based on the future value. Right. For your taxes. So there's all kinds of things. And you need to get insurance quotes, right? Because just because the you're currently paying the insurance at the rate you have or the seller owner currently has it doesn't mean that's going to be your or you would even get the insurance, right? You got to make sure you go in and get insurance quotes. Okay. So maintenance and management add up over time. So you got to remember that you due diligence issues. So one thing we stress big time with our clients, you know, and over our portfolio, our acquisition director is constantly thinking, you know, what's the operational, financial and physical property? Due diligence. So operational is, you know, the due diligence of the management company, of the team of the infrastructure of operations, everything to do with that, the financial, doing the due diligence on the T12 and everything in there, what's going on in the financial situation and then the physical property actually doing your due diligence on inspecting the entire property. And you typically want to have a inspection company come in and, and look through every single unit and we have a whole list on every single one of these situations. Right? Operational, financial, physical property. And then also you got to factor in your exit cost. Okay. So selling isn't free. You also think about the pro forma broker fees, potential capital gains tax and other transaction costs. Right? You got. I say refinancing is better, but still has cost involved. Okay, so let's move on. Last one. Being a solopreneur, I know I say all these are important, but if this, I mean the reason you're watching this is because you want to make sure you skip the mistakes, right? And so I would just encourage you find people who are where you want to be. Don't go at it alone. Find a community. It's the reason my partner and I, we started a mastermind because we get so much from other masterminds. We're a part of masterminds. I was just telling people today I have, I'm a part of so many other masterminds and I don't use anything on a lot of them, but I will come to an event every once in a while or something like that. And I do renew every single year. And the reason is because one connection can save you millions of dollars. One connection can add Millions of dollars to your portfolio or to your net worth. And so at the end of the day, get in the room with other people. Biggest mistake is doing it by yourself. You take on all the risk, all the work, all the capital, all the unknown, and hope to get all the reward. You know, great things in business are never done by one person. They are done by a team. Steve Jobs said that, you know, you can think about partners on your team being property management, financial and property advisors, capital partners, boots on the ground partners. If you're not local to the property, you might want to bring in someone who is local as a boots on the ground. You know, you want to think about your SEC attorney if you're raising capital. You know, we have a SEC attorney on our team. The securities Exchange Commission governs all the capital raising on private investments. Underwriter, advisory. You want to have an underwriter on your team. You know, most of the biggest firms have those underwriters and I would at least have a consultant on there and then a loan broker and obviously, you know, an advisor and a underwriter, you know, and all these things we can help you get connected with there. If you want to connect with us on a deeper level and be a part of our mastermind or get help one on one. Would love to do that. There should be a link in the description below, so just click that. We'd love to help you out and walk you through all these different nuances, but, you know, it's the idea. Elon Musk only owns 13% of Tesla, right. Jeff Bezos owns like 10% of Amazon. Right? Because you need people, right? People. And it's capital partners. It's people coming in and helping you scale your business. Biggest people do it as a team. So hope that helps. Guys, I want to see you win. I want to see you not make the mistakes we did and we see so many other people make in today's market. So God bless, guys, thanks for joining.