During a recent dinner out with family, my brother-in-law turned to me to tell me about a deal in his local community he was considering purchasing. As he shared details about the mixed use property, I could hear how excited he was. He asked me if I would go with him to walk the property immediately following dinner.
So we met the owner, and she walked us through the space. She used to have a flower shop in the commercial space and had decided to close her shop down. This comprised the first floor, and the second floor was a 4-bedroom apartment, which was currently rented by college students. She provided a very thorough walk through of the property. We asked a ton of questions and thanked her for her time.
When we got back to my sister’s house, my brother-in-law and I stayed up and chatted about the deal. He told me that the property cash flowed a few hundred dollars a month so it seemed to be a good deal. I then proceeded to ask a bunch of questions about the market, the property expenses, and competition.
After our conversation, he decided to pass on this deal. The deal was probably not going to make the cash flow that he was originally projecting it would make. On my way home the next day, it hit me that many newbies miss many important areas when analyzing deals — especially multi-unit deals (multi-family and mixed use). I wish I knew these areas I am about to share with you when we began many years ago. We probably would NOT have purchased some of our earlier deals!
Here are some important areas that you don’t want to miss when evaluating a multi-family property.
Newbies: Don’t Forget These 4 Areas When Evaluating Multi-Unit Deals
1. Management Fee
Back to the mixed use property I was telling you about earlier — as I shared, my brother-in-law said that the deal would cash flow a few hundred dollars. My first question to him was, did the current owner list a management fee in expenses she sent you? I then followed with, did you add a management fee in your evaluation of the deal?
He said he did not since he would be managing the property himself. After all, he lived within 10 minutes of the property. I challenged him on this. I told him this could change. What if he decides one day that he is no longer interested in managing the property? Or he moves away and it becomes too difficult to manage the property? Your expenses should always include a management fee whether you self-manage or pay someone else.
2. Capital Expenditures
Think of capital expenditures as “long term” investments in your property. Examples may include a new roof, new hot water heater, new electrical, new appliances, new rugs, and the separation of utilities. These are typically higher dollar investments in your property.
If you are purchasing a multi-family that has not been completely renovated recently, then you will need to evaluate the level of capital expenditures that will be needed. Most new investors don’t estimate enough money for these capital expenditures. If you have a motivated seller and someone who has owned the property for a long time, chances are there will be some deferred capital expenses. This should not deter you from purchasing the property. Just make sure you budget correctly for these areas!
I wish we ran the numbers for potential deals with an appropriate number for maintenance when we began. However, as the old adage says, you don’t know what you don’t know! I recall assessing some of our first multi-family purchases by using the current owner’s maintenance numbers. These numbers were very low per unit, so we were excited because the deal made great cash flow based on our numbers. Well, we owned these units for 10 years, and I can tell you the maintenance expenses always averaged more than the expense line the previous owner told us.
The key with maintenance is to assess the condition and age of each unit and the building as a whole. You also should know what the typical maintenance number is per unit for the market you are buying the property in. This will help you evaluate the future expenses of potential deals even more accurately. In our market, it is $400-600 per unit per year for a B-class property. So we use our estimated number in our assessment of deals versus the previous owner’s numbers.
4. Utilities Paid by Tenant and Landlord
This might seem really simple, but this is big one. You can have two properties in the same area being sold for the same price. Same rent roll, same exact condition. However, the utilities in one building are separated and paid by the tenant, while in the other building the utilities are not separated and paid by the owner. This difference will certainly change your expenses and thus change your cash flow and ultimate return on your investment.
Make sure you get specific utility expenses from the owner. Once you receive them from the owner, conduct some research to ensure these utility costs are accurate and aligned with the local market. I would even go a step further and find out what the cost would be to separate utilities in your prospective deal. It’s great to assess this up front before you purchase a property.
I hope you found this list to be helpful. Obviously, this is only a sample of the areas newbie investors overlook. What other areas do investors often miss when evaluating multi-family deals?
I would love to get a discussion going!
Please share your comments below.