There are countless books, blogs, podcasts, and other media that depict the advantages of investing in multifamily communities. But it would be naïve to presume that investing in apartments is a way to “get rich quick,” as some have declared. The most prosperous investors only became so by learning the in’s and out’s of the business, including the fundamental concerns to examine before investing in a particular property.
Here are four critical apartment administration matters to watch for when considering an investment opportunity:
1. Unforeseen maintenance.
Many multifamily investors miscalculate the costs of unanticipated maintenance at their properties, and as a result, do not keep adequate reserves on hand for emergency repairs. This can be especially calamitous to first-time investors who may already be stretched thin from meeting the costs of closing on the property (e.g., a 20-25% down payment, closing costs, and more which can total tens or even hundreds of thousands of dollars).
Apartment investors should have at least three months’ worth of total property costs (principal, interest, taxes, insurance, and routine maintenance) set aside as resources from which to pull on in the event of impromptu maintenance needs, like a leaky roof or HVAC systems that unexpectedly die.
It’s also crucial for apartment investors to build a Rolodex of trustworthy and dependable contractors that they can rely on with short notice. When a pipe bursts upstairs and is flooding your units in the middle of the night, you don’t want to be looking through search engine pages or needing to ask Alexa to help find a reputable contractor. Having strong relationships with clutch multifamily-credentialed contractors is vital for any apartment investor, as it ensures they get a fair deal for the work and can trust that the job will be finished correctly the first time around.
2. Renovation work.
Anyone familiar with HGTV knows that renovations rarely go according to plan. Apartment investors should plan for unpredicted costs to climb when doing any improvement work. It’s not unusual to start pulling out walls to find things like asbestos or mold, which will drive prices up, notably when exposed brick is the finished surface.
There are two keys to managing renovation work. First, be sure to conduct proper due diligence before investing in any multifamily deal. Have a competent contractor walk the property with you to identify the inherent risks. They should also be able to give you a rough approximation as to a realistic remodeling budget.
A second way to mitigate unexpected renovation costs is to budget accordingly: at a minimum, set aside 10% of your total renovation budget as a contingency fund to cover any surprises.
3. Easy value-add opportunities.
Many investors evaluate properties based upon their value-add potential: can additional units be added to phase two? Could oversized units be converted to smaller units to add to the unit count? Can you charge for parking, or build in storage lockers and charge a premium to resident for this amenity?
But many investors overlook some of the more accessible value-add opportunities. For instance, there could be a leak in the water system. Go through water bills with a fine-toothed comb and see if there are abnormal usage patterns. A small leak could be driving down your bottom line. Consider a property with a 5% cap rate. If you can repair a leak and save $5,000 a year on the water bill, that’s effectively adding $100,000 in value to the property – just by fixing a leak! That’s much more effective than renovating units.
Another strategy is to implement what’s known as a “RUBS” system, or ratio utility billing system. This involves separating utilities and billing the costs back to the individual unit. If independently metering each unit isn’t practical, another option is to charge each apartment separately as a proportion of the usage. For instance, in a 100-unit apartment building, the owner might charge each unit 1/100 per unit. Some companies implement RUBS systems for property owners for a fee. Every cost that can be passed back to the resident sequentially increases the value of your property.
Since the mid-Nineties, valet trash has been a safe, cap-ex free, Cap Rate booster. The typical property value increases $750k - $1.2M based on a Cap Rate of 6-8%. It makes sense to enhance community curb appeal and realize higher rents.
4. Tax considerations.
One frequent mistake we see is investors who overlook changes in property taxes. Many first-time investors and real estate developers run their numbers on a deal using the current property taxes. Many forget that county assessments change after the property is sold. Most municipalities will re-asses the property upon sale, and in many cases, the property taxes go up as a result.
It is shocking how few people fully understand how taxes are levied on a property. Taxes can be one of the most significant line item costs in a pro forma—undervaluing those fees can be catastrophic from an investment perspective. Whereas you can pay down a mortgage, property taxes are a cost that never goes away. The county, in effect, is a silent business partner.
While apartment investing can be highly lucrative, it’s an asset class that’s far from infallible. For those just getting started, contemplate partnering with someone who’s more experienced and can guide you through apartment administration issues such as these.