The COVID-19 pandemic triggered a wave of changes in commercial real estate investing. Remote workforces and e-commerce trends have significantly impacted retail and office asset classes; however, the multifamily asset class has seen relatively little disruption. Since people will always need places to live, multifamily assets are probably the most popular and competitive real estate investment class. Whether you are investing in a small multifamily apartment building or a 200-unit apartment complex, to follow are strategies and insights to consider when evaluating your next multifamily investment deal.
Understand the Renter Profile
The tenant profile of a multifamily property can provide great insight into a property’s operating and turnover expenses and the overall stability of the property. For example, if an apartment complex is located in a college town and most tenants are college students, the building will most likely experience frequent tenant turnover. High turnover typically results in higher repairs, marketing expenses, and a higher loss of revenue due to vacancies. Conversely, a property with a large population of senior tenants will tend to be more stable, with tenants renewing more frequently and resulting in lower turnover and marketing-related costs. Understanding your renter profile can help determine your property management needs, assess whether your existing amenities are well suited for your tenant base, and define your target audience to market the property.
TIP: Ask the seller or the management company for as much information as possible on the current renter profile. For example, it is good to know:
- Where do most tenants work?
- Are there students in the building?
- What is the age demographic?
- Are there many families with small children?
Developing an overview of the market may help answer many of these questions and dedicating time to observing the property is always beneficial.
The Importance of Good Property Management
Having a reliable, reputable, and professional property management team is probably more critical with multifamily investments than with any other asset class. New tenants need to be adequately screened, tenant requests and work orders must be addressed promptly, vacant units should be marketed and turned over quickly, and all common area amenities must be maintained. The mismanagement or mishandling of any of these items can negatively impact a property’s reputation and increase potential risks and liabilities. When evaluating a new property, it is essential to understand how the seller has managed the property and how effective their practices have been.
In many cases, a property will be marketed with offering materials assuming “market management fees.” These fees tend to be different from the amount a purchaser will require to manage the property, and even different from the seller’s actual expenses. For example, the seller may be an institutional investor who owns several assets in the market. They may have shared property managers and staff, allowing them to manage the property effectively at a lower cost. Conversely, the seller may be a “mom and pop” operation whose family has owned the property for many years, and the entire family is on the payroll. In that case, there may be opportunities under new ownership to manage the property more effectively and inexpensively. The key is to understand how the property is presently being managed, what will be required to successfully maintain the property going forward, and to underwrite that actual expense accordingly. Trying to save or cut management expenses without cause may cost more in the long run.
TIP: Review the seller’s operating statements in detail to identify their management and staffing costs. Ask questions to ensure you understand how they manage and market the property. Then, compare that information with how you would anticipate managing the property. Consulting with a third-party management company in the area can also help clarify these assumptions.
Multifamily investors are always looking for opportunities to increase a property’s revenue and create value. While growth through rent appreciation is certainly advised where possible, there are many other ways to increase a property’s revenue. Some common methods are through strategies like charging extra fees for covered parking or reserved spaces, renting out common areas for parties or events, adding or increasing pet fees, sub metering utilities, and converting unused spaces into storage units that tenants can rent.
TIP: Ensure you understand any services that are included with tenant rents and the existing sources of miscellaneous revenue, if any exist. From there, potential additional revenue opportunities can be identified.
Unit Conditions and Renovations
Unless the property in consideration is a brand-new complex with new systems and appliances, it is critical to an investor’s forecast to understand each unit’s makeup, i.e. flooring, types of appliances, countertops, etc., and condition. Even if units are well-appointed and in good condition, reserves for replacing elements over time, such as floors and appliances, need to be underwritten. The more familiar you are with the building and its condition, the more accurate your underwriting will be. If an investor plans to create value by renovating units, it will be especially important to know the details related to the renovations and the overall cost.
TIP: Request an inventory of unit finishes, upgrades, appliances, and systems. For underwriting purposes, you will most likely want to reserve money per unit, either upfront or on an annual basis, to deal with the renovations and replacements. If you have any plans to upgrade and renovate units, research your market to make sure those renovations address the specific market needs and upgrades your competition may lack. When appropriate, inspect as many, if not all the units, as permittable.
If you are considering investing in a multifamily operation, please get in touch with us. The Innovative CPA Group provides services, solutions, and guidance based on our real-world experience in the commercial real estate industry.