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7 Mistakes of the Newbie Apartment Building Investor

by Michael Blank on March 31, 2014 · 12 comments

  
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Apartment building investing is probably the most reliable, repeatable and teachable way to generate income and retire early. It’s not a get-rich quick scheme but with persistence and time it’s one of the best ways to achieve your financial goals.

Unfortunately, not all that glitters is gold. And not all apartment building investors are successful. If things go badly, they can be costly.

In this article, I review the top 7 mistakes I see newbie apartment building investors make, so maybe we can all learn from them!

Mistake # 1: Buying in the wrong area

You can fix a lot of things about a building: you can renovate, improve cosmetics, and control costs. But you can’t fix the building’s location. Don’t buy a building in an area that is declining. If you do, then your vacancies will rise and your rents will drop. Instead, buy in an area that is improving.

Related: Newbies Take Note: Why You Shouldn’t Buy Houses for $30,000

Mistake #2: Getting happy ears and rushing into a deal

Especially when we’re just getting started, we are eager to do our first deal. The temptation is even greater if we’re using our own money. We want to put it to use, and we don’t need to convince other investors that a deal is good. Be patient and take your time. Commit to looking at a lot of deals so that you can recognize a good deal when you see one. Analyze tons of deals to get practice.

Mistake # 3: Taking short-cuts during due diligence

Doing due diligence is a lot of work, and it can also cost money. I am always tempted to spend as little time and money on something as possible, but sometimes that can bite you in the butt. Make sure you have a good due diligence check-list and then stick to it. Don’t cut corners.

For example, one mistake is not to review the seller’s bank deposits. The seller is reporting a 5% vacancy rate, which is confirmed by the rent roll. Great. But how much of that rent is she collecting? What if she’s only collecting half the rent and the rest of the tenants are all behind and need to be evicted?

Fortunately, I didn’t skip this step when I bought my 12-unit building, and I discovered just that. I was able to negotiate terms with the seller that addressed this situation, but had I skipped this step, I would have been in a lot of trouble.

One thing I didn’t do (but was advised to do by one of the landlord/tenant attorneys I interviewed) was to check the public records for any court activity by the tenants. If a tenant is in and out of landlord/tenant court, then that tenant is familiar with the system and will be a management problem.

I did skip this step, and it created massive issues for me with two tenants who worked the court system to their advantage and to my detriment.

Don’t cut corners during due diligence!

Related: How Due Diligence Can Save You Hundreds of Thousands of Dollars

Mistake # 4: Not having enough cash reserves

You do a good job estimating repairs, income and expenses. Your building is doing pretty well. But then things start to go wrong. The roof you thought would last for another five years suddenly leaks and needs to be replaced. One of your tenants sues you. Several stop paying rent. Your boiler breaks. Officials discover you’re not lead paint compliant and force you to remediate. It could be one of many possibilities that are hard to predict.

For this reason, you should maintain a reserve fund that you can use for emergencies so that you don’t run out of cash. How much? I don’t have a hard and fast rule for this but I shoot for 2% – 3% of the purchase price.

You should also build up a reserve out of cash flow. The rule of thumb is $250 per door per year. This is slated to be used for capital expenses like replacing roofs, boilers, walk-ways etc.

From my own experience, had I not had a reserve fund there is a good chance I would have run out of money in my building because of all the troubles that one of my tenants created (read the whole grueling story in this Bigger Pockets article - brutal).

You never want to run out of cash.

Mistake # 5: Lack of cash flow

In our eagerness to do a deal, especially one where the potential profits after renovations are huge, we sometimes get into deals that don’t cash flow from day one. This is a dangerous situation and should only be attempted once you have experience. And if you do, you better have a much bigger reserve fund that can sustain you for longer than you think.

The best thing to do is to not do it. While you can get into deals where the cash flow is less than you want at first, make sure that there is sufficient cash flow to pay the bills with a good margin for error.

Mistake # 6: Poor property management

Your property management is so critical. You can do this yourself for better control and to learn. If you hire one, make sure you hire a GREAT property management company and then manage them carefully. Your life can be pure hell if you have a bad one and can be utter bliss if you have a good one. My intent here is not to write about what to look for in a good property management company (maybe in a later article if you’re interested!) but to highlight that this should be an area for you to pay particular attention to.

Mistake # 7: Some Day …

Many newbie investors never get the chance to make mistakes 1 – 6 because they sit on the sidelines and never do anything. They say “Some day, when I have the money.” Or “Some day, when the kids are in school. In college. When I’m retired.” Sure, they’ll buy books and seminars, but they never actually do anything with it. This frustrates me to no end! I would say this is probably the biggest rookie mistake. My advice? Go get some knowledge (start here with the Bigger Pockets!) but know that there is NO WAY you can know everything up front. If you want to get going with real estate investing of any sort, you’re going to have to DO SOMETHING at some point. Will you make mistakes? Absolutely. Be smart, manage your risk, but get started now.

Conclusion

While apartment building investing can be challenging, we are all fortunate here at the Bigger Pockets to be able to learn from each other, hopefully avoid some common mistakes, and speed up the learning curve.

What are some of your lessons learned?

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{ 12 comments… read them below or add one }

Adam Schneider March 31, 2014 at 6:58 am

Great post, Michael. Who does the tenant review of court activity?

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Michael Blank March 31, 2014 at 7:00 am

You do (unless you outsource it to a virtual assistant)! Normally the information is public record, and most jurisdictions have the info online. If not, you may have to make a trek down to court house.

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Bobby March 31, 2014 at 6:59 am

I am in the due diligence phase of my first 6 unit apartment building, and thank you for the articles! Gotta say, I think I am more prepared for the purchase than the seller, who runs the building like a hobby instead of a business and it’s a bit frustrating when he doesn’t have his paperwork together at all, but it also forces me to run the numbers myself instead of relying on his side of the story.

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Michael Blank March 31, 2014 at 7:02 am

So true … it was the same for my 12-unit building. It’s frustrating because you don’t have all the information you feel you need to make a decision. I’ve noticed that the larger the building, the more professional everyone is — another argument for going bigger as soon as possible!

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Denis C. Monahan March 31, 2014 at 7:41 am

Don’t forget to include a management company fee when calculating your numbers (NI, IRR, etc.) even if you plan to manage it yourself. If you are going to manage it yourself, you are buying an apartment and a job. The management fee will be your payment for the job. If you do not deduct it in you numbers, you are overpaying for the apartment component of the deal. Also, you may change your mind later and decide to hire a management company, in which case the cost is already baked into the deal. Finally, when you go to sell the apartment, the buyer is likely to include a management fee in their calculations – so you should to help you estimate your resale amount.

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Michael Blank March 31, 2014 at 7:52 am

Very good point, thanks Denis!

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Sharon Tzib March 31, 2014 at 9:30 am

Checking the court records for the tenants is an awesome tidbit – hadn’t heard that one either. I also received awesome advice from Amanda Han that a great way to verify the income is via a seller’s tax returns – they rarely inflate the income there (or under report expenses for that matter) Thanks, Michael :)

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Michael Blank April 4, 2014 at 7:21 am

Yes, that’s if the seller HAS tax returns! In my case, she didn’t, that is, there wasn’t one separate for the building. Now, if she would or could not produce bank deposit records, I would have walked from the deal because there would have been no way to verify what the tenants are actually paying !

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Jimmy April 1, 2014 at 9:02 pm

Michael

Great post. Would you mind sharing how you find your deals?

In my area the MLS is way too picked-over and nobody wholesales them here.

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Eric April 3, 2014 at 7:10 pm

An investor of multifamily properties, greater than 4 units, should get some education. There are a ton of places to get an education, for only a few hundred dollars. It will cost way more of you get a bad deal. One bad deal, and your RE investing career might be over.

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Michael Blank April 4, 2014 at 7:22 am

Good advice, Eric ….!

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Swat Khan April 3, 2014 at 9:01 pm

Michael,

Great points. #2 and #3 can be the root to a lot of problems.

Overpaying is a common issue I see in a strong sellers market. These are the properties that pop up with motivated sellers asking for too much.

Also operating poor property management with not enough effort by the owner to implement systems/policies that their managers STICK TO. These are not triple net leases and hands off.

Especially with C properties you have to buy right, do your DD, and run tight management. You can get away with more on the smaller properties in B areas just because of an easier tenant base and stronger demand for rentals (this is heavily based on the submarket as well).

-SK-

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