The Top 3 Surprises I Faced When I First Started Investing in Real Estate

Top Surprise #1: People Are Willing to Overpay to Get a Deal Completed

Yes, I know, we’ve all heard that at this stage of the cycle, investors tend to overpay; yet I am always surprised to find out how much others have been paid for properties I either passed on or bid on. When it comes to multifamily properties, it seems that the sky is the limit regarding prices. Over the past several years, prices have soared way above the asking price. The reason: availability. When the great recession happened in 2008, construction of new apartment complexes came to a halt. That meant inventory was dwindling, and the prices of existing properties began to skyrocket.

However, there are other things in play. A lot of too eager or inexperienced investors have started buying these properties, and are willing to overpay just to get a deal done regardless of cost. When you begin bidding on a property, be prepared to see people bidding up the prices just to be able to say, “I got it!”

Another issue is that there is a huge demand. Both retirees and Millennials are postponing the purchase of a single-family home. Baby boomers who are retiring are choosing to rent after selling their home. It’s a trend that’s happening all over the country. And Millennials are choosing to wait on the purchase, because they’re planning to have families later in life. They also have a huge amount of student debt, and they want to live in core urban areas, which drives the price of a single-family home way up.

As both a syndicator and a real estate investor, I take a conservative approach when evaluating a property. I’m not relying on fees as syndicator in order to survive, so I have the freedom to choose the right properties and buy at the right price. I look at the numbers, and make sure that the net operating income (NOI, which is property income minus expenses) can support the debt payment on the property. If it can’t, I walk away. There are other deals out there to explore, even if it takes more time to find them.

To avoid surprises on these high-priced properties, remember that there are ways you can avoid joining the frenzy and overpaying. Be conservative in your underwriting and plan for a moderate rent increase. Even if your current submarket enjoys a 5% rent increase today, and objective professional projections are for a 4% rent increase in the next few years, lower your expectations to 2% or 3%. Focus on the deal’s upside, but be conservative.

Here’s another idea to consider: make sure that the exit cap (the cap rate at which you project to sell the property at the end of the hold period) is higher than the cap rate that is in place when you buy the property. After all, there’s no guaranteed that you’ll meet your forecast of future cash flow, which may pose a risk to investors.

Top Surprise #2: Raising Money is Harder Than You Think

If you think that raising money for your real estate investments will be easy, because you know wealthy friends and family members, you will probably face a different reality. The truth is, raising money is hard when you first start, even and especially if you’re counting on family and friends as your source of capital. There are many things that you can do to make raising capital easier.

When I was starting out, I was convinced it'd be easy to raise money from family and friends. I was quite surprised at some of the objections I encountered. The biggest problem I found was that most of my family and friends weren’t sure what real estate syndication was all about. So I started educating potential investors about how the process worked.

The biggest surprises came from people who I assumed would be a part of the investment who chose not to participate at first. One family member didn’t want to mix business and family, but I actually respect that.

Another surprise that may come up is not having enough funds available when the deal presents itself. Determine how much money your family and friends are able to come up with. Provide adequate information on how the funds will be used, the amount needed, funding milestones and when the funds will be distributed. That way, there won’t be any confusion.

For my first deal, I ended up raising capital only from 1 family member and 1 acquaintance. The rest were investors that reached out to me after I’d built my social media and online presence.

My advice when soliciting family and friends: walk in with your eyes wide open, and don’t assume it will be easy. Don’t count solely on them when you're first starting out – leverage the power of social media to attract investors and increase your reach beyond the people you know today. Another piece of advice: always try to raise about 20% more than you estimate you’ll need, because some people do back out of the deal for any number of unforeseen reasons.

Top Surprise #3: There are Always Surprises

As prepared as you think you are when investing in real estate, the truth is you’ll always run into unexpected surprises. Every deal is different and new things will come up, so be mentally prepared to have some deals go well and be a smooth sail, but for others to have a rocky ride.

One investor I know bought a property and later discovered a severe mold issue. It was so well hidden in the property nobody could have discovered it, but he was left with a hefty bill to mitigate the problem. With one property I bought, I discovered the landlord stopped all regular maintenance efforts months prior to the sale.

Something else to consider is the 30-day due diligence period of time you have after agreeing to the purchase. As shown in the previous two examples, it can take time to find hidden problems. So a good practice is to always ask for a 30- day extension to the due diligence period. It’s a fairly common practice; so don’t be afraid to ask.

Another example of a surprise I never expected was when I purchased a multifamily property from a man who was also self-managing the property, instead of hiring a professional third-party property management company. Shortly before taking over the property, all employees got up and left.

Other surprises that may pop up with multifamily properties have to do with costs and budgeting. Investors have to take into account the unforeseen expenses that may come up, such as an HVAC system that is supposed to last for 20 years but breaks down after only 12. If there wasn’t a contingency fund to handles such unexpected expenses, your investment could face some serious problems.

Another area where surprises can come up has to do with operating expenses. Investors may think that they’re making a profit based on cash flow, only to be hit with an unexpected tax bill that puts them in the red. Always know the amounts of all operating expenses when investing, including utilities, property taxes, taxes on rental income, maintenance and insurance. If you miss any category, you could end up with financial problems.

One other area where you can get hit with an unexpected surprise is the costs involved in upgrades and repairs. That’s why it’s critical to have a professional assess the condition of the flooring, appliances, counters, and plumbing prior to signing a deal. Just one unexpected renovation can cost upwards of $10,000 and more - a surprise nobody wants to have.

Summary

I am a “challenge junkie” but still face new and creative surprises every time. But hey- this is real estate. You’re going to face some unexpected surprises when you invest in multifamily properties. It’s a fact of life in this business, and if you’re prepared for it you’ll be in a position where the surprise won’t hurt you financially. It starts with buying a property, where you may run into people overbidding a property and driving up the price solely for the reason of “winning the deal.” Don’t get wrapped up in the bidding wars - have a plan in place and walk away if the numbers don’t work. The other area where surprises may pop up is when you’re soliciting funds from family and friends. Not every relative or friend will embrace your request with open arms, so be prepared to hear a lot of people saying, “no, thank you” before you acquire some investors. Finally, be prepared for surprises when having to deal with maintenance, renovations and repairs, or expenses. As prepared as you think you may be, you never know when an unexpected expense will pop up. Having a contingency fund in place will help handle any of those problems.

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