“Sometimes failure is merely chasing you off the wrong road and onto the right one.” — Paul T. Jones
Today I want to talk about the worst mistakes I’ve made in apartment investing.
Trust me, I’ve made some doozies!
It’s been said that a wise man learns from their own mistakes, but a genius will learn from the mistakes of others.
You have a chance to be a genius today and learn from my mistakes.
1. Getting the Wrong Property Manager
The single biggest mistake I have made in my apartment investing career is getting the wrong property manager.
The reason why this is so critical?
The property manager is the number one thing that will make or break your deal.
You could have the best plans in the world…
But if you are not able to implement them, you will have some major issues.
Our team had this issue with a property in Little Rock, Arkansas.
We had a plan to go in and do all this work.
We were really excited about it!
We have this great property manager who we thought was a match made in heaven.
They performed well for us before when we used them on another market.
From the get-go, we started having major issues.
They can’t find their right staff.
They’re having issues finding contractors to work on the property.
Pretty quickly we go from 90% occupied in the property to only 65% occupied.
Then you’re at a breakeven point.
You’re not making cash flow.
You’re kind of treading water.
That causes issues, right?
You want to do more work but you can’t because you’re having issues with management.
In this particular deal we learned something important.
This property manager was a good property manager…
They just weren’t the right property manager for this particular property.
So what happened after we figured this out?
This isn’t a sad story, so put away your Kleenex box!
We call it our underperforming, outperforming deal.
We bought the property at around $49,000 per door.
We ended up selling it for $89,000 a door about two and a half years later.
Why is that?
Some of it has to do with what’s happening in the market with interest rates and asset prices.
We’re seeing the effects of those along with inflation and the global economy.
Real estate will always be affected by these things.
Thankfully, the deal is performing just fine and we’re excited about it.
But overall, this is a learning experience.
When you work with a property manager, it’s important that you ask the right questions.
Your quality of life is determined by the quality questions you’re able to ask yourself and others.
When working with a property manager, it’s important to ask a few specific questions.
Question number one: In this particular market, how many units do you have?
If the answer is a goose egg, so they have no units, that’s a deal breaker.
I don’t like that.
They may say they’re a great property manager in another market.
They could claim you’re their first deal in a new market expansion.
I’ve heard that story so many times.
I hear it from a lot of newer operators.
They’ll say they have a new property manager for me.
I don’t do that anymore.
There’s too much uncertainty in knowing how that particular property manager will perform in that particular market.
It’s really important you ask what kind of property manager you’re dealing with.
What type of properties are you working with?
If you are working with a large multifamily, what properties has the manager worked with?
Do they have thousands of units, but they’re all single families or commercial?
There’s many different types of property managers out there.
It’s really important to stop and ask the right questions.
If they’re working with Class A multifamily apartments, and you’re working with Class C, that’s probably not a good fit.
There are different issues that those types of tenants and managers deal with.
It feels good to share this story of struggle in this particular area!
Now let’s get to another mistake:
2. Getting the Wrong Type of Debt
The second big mistake I’ve made in multifamily investing is getting the wrong type of debt.
There are different types of debt out there.
You can get a long-term fixed rate.
That’s more agency debt that’s fixed for a long time.
You can get shorter-term bridge debt.
You can also get variable rate debt.
There are many different types of debt with all sorts of different parameters.
If you get the wrong type of debt, it can hurt you in performance and how the deal works out.
This deal will actually end up performing just fine.
But there’s still a big problem there.
The cashflow was delayed.
What our team did is obtain a long term fixed rate debt below 3%.
We got agency debt fixed for 10 years.
This is great because we’re in a time of inflation.
Inflation is getting higher.
We have less than 3% amortized over 25 years.
Sounds awesome, right?!
The challenge is when you start a deal, you don’t always know what’s going to happen in the deal.
You don’t know when you’ll be ready to sell or refinance this particular loan.
It makes it very difficult to be able to sell early.
There’s something called yield maintenance, which is a fancy term for having penalties if you sell early.
These penalties apply to whoever was a part of that loan.
If you have a $20 million sale and you sell early, you’ll have to pay around $1 million in penalties.
That’s a big punch in the gut.
Sometimes shorter term bridge debt can be really helpful.
There’s a lot of bridge debt available at the time of this post that is shorter term and fixed.
They do have higher rates, but the loan allows you to have flexibility.
There are no penalties, which sounds pretty amazing!
This particular debt is usually extendable another year or so.
It gets you to about the five-year timeline.
That’s pretty amazing!
Particularly if you have a syndicated deal or if you’re in a syndicated deal.
Being able to refinance or sell when you want to can be really helpful.
Now, let’s round out these tips with our third and final mistake:
3. Being Too Aggressive in Projections
Being too aggressive in your assumptions when looking at a deal can be very harmful.
If I’m too aggressive on the front end before I actually get the deal, it can cause a lot of problems in the future.
During my first multifamily deal, I went from having a small single family portfolio to 225 units.
That sounds pretty outrageous!
Well, I was a part of a team and I had my contribution to that being a part of the management.
So I didn’t do all of it, but I was a part of this amazing team.
I went to a property in Texas and walked around a bunch of units.
There were some issues with the Class C, working class type properties.
We felt like we had a great business plan to improve things.
Everything was all set up.
It was going to go perfectly with a bow tied on top.
Spoiler alert: It didn’t go that way.
After we closed on the property, we realized there were some plumbing issues.
There were some foundation issues that did not come up on the inspection.
We did have some cash reserves, but we obviously didn’t plan for all these issues.
This was a substantial expense and our cash position got low.
We were a little bit aggressive in certain ways.
We assumed certain things would go well that didn’t necessarily go well.
I think we all know the saying about what happens when you assume:
When you assume, you make an ass out of you and me.
That’s exactly what’s happened.
We learned that you have to really make sure you fire test things.
Obviously, there’s really no substitute for experience.
Maybe we could have gotten a different property manager.
Maybe we should have hired another contractor to make sure we knew what was going on before we got into the property.
To round us out, I wanted to make a side note about what it means to be conservative in your underwriting.
People use this term a lot and they’re not always conservative.
Sometimes they have wishful thinking.
Very few people are trying to deceive people or deceive themselves.
It’s still really important that we are conservative.
I wanted to mention a few important things:
Firstly, from this story, we can learn that cash reserves are really important.
We raise more money than we need to ensure we have cash in a deal.
The second thing is your cap rate at exit.
If you’re buying something at a 4% cap rate, it’s considered conservative to raise the cap when you sell to a 4.5-5% rate.
So you’re raising it higher.
That causes the numbers to come down and makes them look less sexy at the end.
So you’re trying to say if things don’t go exactly how you want, you make sure you underwrite.
There is obviously a balance in underwriting deals.
If your expectations are too rosy, you might be disappointed.
It could not go that way.
On the other hand, I’ve known people who are too conservative and don’t do any deals.
It’s a challenge to find that sweet spot of not being too conservative or too aggressive.
Finding that happy medium and staying there is not easy.
It’s really important to slow down and take a look at what happens if things do slow down.
Right now rent growth is going crazy!
At the time of this post, we’re seeing 10-15% national rent growth, which is huge.
It’s going absolutely nuts right now.
But we also have to assume that things may slow down.
We’ll never underwrite 12% rent and growth in a deal.
We have to write maybe 3-4% in a particular market.
Even though we’re seeing a lot of growth, we want to be very conservative on what we think will happen in the future.
We can’t assume we’ll go to the moon and not come back down.
My hope for you with this post is that you got some takeaways.
Whether you’re new to real estate in multifamily investing, or you’ve been doing this a while, you can say you grew from not only your experiences, but also the experiences of others.
Hopefully you’ll walk away feeling more like a genius because you learned from my mistakes!
There’s power when we share these stories.
When you meet other people and operators, ask about these kinds of stories.
If someone doesn’t have stories like these, they’re either inexperienced, which is fine, or they’re just not being fully forthright with you.
I’d be very cautious to invest or partner with anybody who is not sharing those things.
Now I want to hear from you!
What’s your biggest real estate investing mistake?
I read all the comments and would love to hear from you!
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Disclaimer: I am not your investment advisor. This is for educational purposes only. I am not giving specific advice on what you can do. I am simply giving my opinions.