052: 7 Challenging Risks in Apartment Investing and How to Handle Them
Most of you already know Nan and I nerd out a lot about apartment investing and real estate. 🏢 It’s almost like we dedicated our whole lives to literally talking about it.
Some people call it an obsession, we call it a passion. 💓 And you gotta be passionate about some things, right? Some people have ComicCon and we have conferences about multifamily apartment syndication. Cosplay is not encouraged.
It’s not a secret we love what we do, which is why when it comes to knowing the ins and outs of this industry we’re just as dedicated as our friends who spend months planning and perfecting their ComicCon costumes.
So with all this obsessing we couldn’t help but ask ourselves: what were the first types of multifamily homes to ever exist? Fun fact, they were not called apartments at all, but Insula’s, and they can be traced back to Roman times. They were about six to seven stories high and had shops and common areas throughout the building. Because these buildings were built so high with not a lot of safety measures, the higher the floor, the cheaper to rent.
Fascinating, right? The more luxe apartments first made their appearance in— no surprise here— Paris France and were reserved for the ultra-wealthy. Which left those living below the poverty line looking for housing.
Real estate has never been without its obstacles and challenges but through it all– wars, famine, economic crashes, and global crisis– it’s stood the test of time and proven to be resilient and reliable. Which is more than some of us can say for our exes.
As long as humans have existed, they have needed shelter. 🏠 It’s the most basic of human needs according to Maslow’s Hierarchy of Needs. But as we all know, sometimes life has a way of… life-ing. And by that we mean, stuff happens and you never know what is coming around the turnpike.
That’s why today we’re covering some of the most common challenges facing real estate today and what you can do about it. Because even though things can–and will–happen, you’re as prepared as you can be to navigate whatever move you need to make next.
See? Our obsession comes in handy every once in a while, especially when it comes to how we can support you and your passive income journey best.
First up, the good ol’ market. We know you hear about it all the time in the news, but for good reason. Every real estate market experiences fluctuations as it moves through its economic cycle and affects your investments. Booms and busts are inevitable real estate markets are impacted by the economy, inflation, and interest rates.
Oh, and worldwide infectious diseases.
If you want to mitigate the risk of a potential economic downturn, it’s important to understand the market you’re investing in. Which, yes, does require a little bit of homework.
But! For good reason. You know the three rules of real estate, location, location, and location. And that includes the local economic factors at play, not just if it’s a beachfront property.
#️⃣ 1️⃣ What major employers are there? There was a reason people were freaking about billionaire Elon Musk moved his Tesla headquarter to Texas. That was a huge loss of jobs for California folks, but a major win for the Texas market.
#️⃣ 2️⃣ What is the unemployment rate? Knowing the majority of the population is employed means a better chance of good, loyal tenants.
#️⃣ 3️⃣ What economic anchors are there? Look around the town and see what opportunities are available in that area. Good schools and universities? Tourist sites and locations? It’s important to take inventory of it all.
#️⃣ 4️⃣ And finally, what is the population growth rate? Beyond young families and birthing babies, what is bringing people to uproot their lives and move to that location– or not?
For us, the Kitti Sisters, we look at this data, and more. Other factors to consider include different economic drivers from major tech industries, manufacturing, and medical centers. Examine the answers to these questions diligently. The answers will give you an idea of the economic health of the market.
We can’t stress this enough: Understanding the market you are investing in is a critical part of determining the risk.
The Sponsorship Team
Next up, find your A-Team, also known as the Sponsorship team. Even though Palm and I are introverts, we’re still big on people. The people who make up our sponsorship team, more specifically. Why? Because the team in charge of your apartment investing plays a major role in the success of your investment. 🤝
Think about it, when your house catches on fire, you’re calling the pros. Firemen, and women who have trained for years to try to keep your valuable assets safe. You’re definitely not calling the volunteer fire people team, you need the experts.
Experienced real estate investors know how to oversee a property management company’s performance, how to negotiate with lenders, and what to do in case of a market crash. This is why finding the right investors, the right team, is nothing you should gamble with, it’s your number one job.
On Tuesday’s episode, we talked about our mantras, and one of them was about finding your Who people, not your How-To people. Your Who people are what can make or break your investment. That’s why you need the best Who’s to Do.
Okay, we’re done playing Dr. Suess so we’ll leave you with one last nugget of wisdom on this topic. In EP007 of the Cashflow Multipliers Podcast, The Exact Strategy We Use When Vetting an Apartment Investment Deal we shared the most important step in beginning your passive income journey.
It’s not crunching numbers or finding the perfect market to invest in, it’s all about finding the right people and enlisting them to your A-Team. That episode is filled with strategies we use to vet the perfect people– it starts with a glass of wine and ends with being aligned with your dreams and goals. So if you haven’t already, go back and listen. 🎧
The Asset Class
Third, we have to choose the right asset class. Lately, there has been so much surrounding what type of investment and assets people need to start investing in to get ahead in this economy. Is it confusing Crypto or a nonfunctional token, an NFT?
Regardless of where you stand, there will always be people who have an opinion on the type of asset you should invest in.
But as we mentioned earlier, the real estate asset has lasted almost as long as Father Time himself. However, there are so many types of real estate out there, how do you know which one is best? The real estate asset class you invest in can also determine how much risk you’re facing as an investor.
Take commercial properties such as shopping malls for example. They aren’t as essential as housing, and e-commerce, aka online shopping, is taking up a major reason why people aren’t so keen on visiting the malls as much as we used to. Hotels are similar, they rely on travel and tourism, therefore also making them risky to invest in when compared to the stability of an apartment complex.
At the beginning of the pandemic, the world was ordered to “stay at home.” Talk about an essential service– housing! Housing is something that people will always need, it’s at the core of what we need as humans to function properly in this world.
So when it comes to putting your investment dollars into something that matters and is essential, it doesn’t get clearer than multifamily living.
Understanding government policies in the location you want to invest in is crucial. And we know it can be tedious and a little annoying because as we all know, the government never made a plan they didn’t like to change.
Government policies are a risk factor you need to be aware of as passive investors. State and local governments may pass legislation that impacts real estate in more ways than one. And oftentimes, they do it right under your nose so you have to be on the lookout.
Let’s look at Section 8 housing, if your real estate deal is under that classification, that means the government will be covering a part of the rent through subsidiaries. Which, great, at least you’ll have a stable rent income, right? However, if Section 8 housing legislation ever changes, this could significantly impact your cash flow.
And when has the government changed anything without warning? We’re rolling our eyes over here. 👀🙄
You’ll also want to be mindful of whether or not a state is landlord-friendly. If your property is in a state where the tenant is favored, it can be more challenging for your team to evict a non-performing tenant, thus hurting the bottom line of your investment.
No one wants to live near anyone giving them a bad vibe– so you want to make sure you’re investing in an area where your voice is heard and opinions are taken seriously.
Here at The Kitti Sisters, we avoid the states that have what we consider a cuss word— rent control. States like California, New York, and Washington we steer clear from when it comes to places of investing. In those states, our ability to force appreciation of a property through higher rental premiums will be limited.
On top of that, the government could also change property taxes, which would impact the overall cash flow. There are plenty of other risk factors we take into consideration when it comes to investing, so knowing state policies can help us eliminate areas we know may not be the best fit. 🧐🧐
The building you invest in could be a potential source of risk for real estate investors. Knowing the current condition the property is in will determine how much capital and time is needed to make sure the building is performing at its best.
And by performing we mean aligning with the desired rental rates the real estate investor would like to see the apartment rent for. So how do you know which apartments will meet that goal?
Enter the ABC’s of multifamily apartment syndication, also known as the grading scale of apartments. Literally. We prefer to go after Class A and or Class B multifamily asset classes in promising areas with a great rentability track record. And scoping out those locations starts with your sponsorship team.
They’re the ones out there doing the due diligence of having the financials, rent rolls, and other crucial details to make sure the property you’re investing in is a success. For more on this topic, listen to EP025 Stay Classy: The Grading Scale of Apartments – on classifying your apartments. 👈
The Business Plan
Buildings and the Real Housewives actually have more in common than you think.
Because they both require a facelift? 😜
Yup! But unlike the housewives, buildings refer to their work being done as value-add not a BBL.
It’s crucial to understand why the business plan for each investment opportunity can also add to the risk you’ll face. Value-add investing involves forcing the appreciation of a particular property by improving the condition, increasing rent, decreasing operational costs, and/or improving overall efficiency.
Whew– that is a lot of work to be done! A more distressed property that needs major renovations does bear more risk. I mean, that applies to anyone who chooses to go under the knife. But, it can also mean a greater return on investment. However, there is plenty to consider before making this decision.
There is an opportunity on both ends of the spectrum for an investor to lose and make money. By taking on a distressed property and drastically improving its conditions, the return on investment is greater than if the property only needed moderate renovations.
It’s the difference between pulling out the sledgehammer and having a demo day vs installing trendy new backsplash tiles and a fresh coat of paint.
Another common strategy used amongst apartment syndicators is something referred to as turnkey investing. Turnkey investing involves buying a property that requires little to no renovations, such as Class A since it’s newly built. Class A properties are mainly built for the promise of cashflow because there isn’t much work to be done, or rather, there isn’t much room to force appreciation.
The amount of leverage you have on your real estate deals also determines how much risk is involved. The more leverage you have the more risk.
At the same time, the more leverage you have, the more capital you can use to speed up a project and generate returns for yourself and your investors.
However, being “over-leveraged” in your real estate deals can be dangerous. Remember when you were younger and discovered the magical power of a credit card? It was all fun and games until that statement hit at the end of the month. 😁😁
The same can be said for overleveraging. If your returns aren’t enough to cover your interest payments, you can find yourself in a tough position. In moments like this, we look to those who have gone before us. Many savvy real estate investors will tell you to have cash reserves on hand, just in case.
And there have been many cases to watch out for– economic downturn being the tip of the iceberg. In case an economic downturn occurs during the hold period of your asset, cash reserves will help you cover operational expenses if revenue decreases significantly. Think of this as your “rainy day fund.” ☺️☺️
While these may have been just seven of the challenges facing apartment investors today, we know that every market, every building, and every investor is different. That’s why covering these foundational topics will make you a better passive investor in the long run.
Now you’re better equipped to ask questions to your sponsorship team and lookout for the best policies and markets to invest in– and you no longer have to worry about the sixth or seventh floor being too dangerous to live on thanks to modern architecture. 🧐🧐
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