All investments carry a certain level of risk, and multifamily properties are no exception.
Historically, real estate has been considered one of the safer assets to invest in, but there are a number of factors that should be considered prior to investing in this asset class.
Understanding these risks are important whether you are an individual investor looking to purchase your first duplex, or you are joining a syndication. The difference however is that individual investors would have to mitigate these risks on their own, while passive investors in a syndication only need to ensure that the sponsor has addressed these concerns.
Let’s look at the most common risks you may encounter when investing in multifamily real estate.
Market conditions can have a serious impact on multifamily properties and should be evaluated carefully before making any investment decisions. Some local market variables that need to be taken into account include trends in population growth, vacancy rates, rental demand, supply of competing properties in the market, and current rental rates. Other macroeconomic factors such as interest rates, unemployment, and inflation can also affect the outcome of your investment.
Understanding the risk of a particular market can help you make better-informed decisions about selecting your target market.
The day-to-day operations of multifamily investment properties are typically handled by a property manager. Whether one person, or an entire team, these individuals are the face of the ownership group for tenants, vendors, and the community. They are responsible for showing available units, collecting rent, dealing with tenant complaints, and handling maintenance requests.
Poor property management can lead to tenant move-outs, unfilled vacancies, deterioration of the property and its systems, inaccurate accounting, and a slew of other problems that will ultimately jeopardize the success of your investment. Therefore, it is extremely important to hire knowledgeable, experienced and professional property managers with systems in place and top-notch people skills.
The characteristics and condition of the building you are investing in can also be risk factors. A property’s location, curb appeal, architecture, floor plans, and on-site amenities can all impact the occupancy rate and the monthly cash flow it generates.
More importantly, real estate deteriorates with age and therefore it needs consistent maintenance and occasional repairs. The older the property, the higher the likelihood that major building components such as the HVAC or the roof may be due for replacement. Such repairs can run into hundreds of thousands of dollars. If investors fail to set aside appropriate funds for such capital expenditures, these costs will impact the operating budget and consequently, the anticipated return on investment.
Investors sometimes over leverage their assets in order to finance a larger portion of the purchase. A property with too much debt and not enough monthly cash flow to cover both the operating expenses and loan payments could be exposed to financial risks. If the owner is unable to make the monthly loan payments, the loan will go into default and the property may be foreclosed on by the lender.
Despite these risks, investing in multifamily real estate can be a great opportunity to diversify your portfolio. With the appropriate due diligence and financial structure, you can most certainly mitigate potential risks on your investment.
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