new deal Risk Tolerance? using anticipated occupancy % to decide how big multiplex you should buy?

6 Replies

im trying to decide how big of a multi family property debt i should be willing to take on.       ( MFH type of properties are something Ive been looking to get into)

so on a 4plex for example im assuming a worst case scenario occupancy rate of 50%. although I only look at good areas with realistic rents and I anticipate over 90% being the actual, I am trying to look at worst case scenario to ensure i can cover the monthly carrying costs if for some reason I had a couple units vacant at the same time or any unforeseen happens. 

Should I be assuming this, am i being to optimistic or to pessimistic? assuming that I need ANY of the rent in order to make the monthly bills of the property or should i only be looking at scenarios where i can cover all monthly costs regardless which would severely limit my buying ability? 

I know a 0% occupancy and even a 50% occupancy is extremely pessimistic, and again i am looking at properties that are already at or near 100% occupancy currently. Me being a newby to multi families I just want to make sure I can sleep at night regarding debt and not being overextended. I do have a decent sized commercial LOC which i could use if something major came up within the first month or two of buying, but again thats more debt, what should I assume?

thanks!!

Talk to your local property management companies to find out what their vacancy rates are, as this varies widely based on the local market.  Most investors use a vacancy rate of 8.25% (one month per year) or 10%.  You can't make money if you have a 50% vacancy rate and a 50% vacancy rate indicates a serious property management problem.

God Bless You!

@Michael Evans   Thanks for the post Michael. 

the reason i suggested 50% though was just regarding risk and ensuring you can cover the monthly carrying costs under a worst case scenario. (or maybe a person should assume the ability to cover a 0% occupancy carrying costs?? that would really lower my buying power comfort level than)

You have to have a system for managing risk.  The way we manage vacancy risk is that we enter into lease-purchase agreements.  This allows us to collect a non-refundable down payment that goes toward the purchase of the property, which can be used to cover any vacancy costs if they decided to no longer lease the property (and also not purchase the property).  We also use this method to shift the maintenance costs to the tenant via the lease-purchase agreement.  The trade-off is that the appreciation profit is locked in via the sales price agreed upon in the lease-purchase contract.

Remember, no risk, no reward.  Don't avoid risk, manage and shift risk.

God Bless You!

At a minimum consider 3 months empty, better to 6 months. See if your insurance policy covers loss of rents and when that kicks in!

In a 4 plex I've considered 50% for 3 months or 2 vacant in a tri. First look to reserves, then your ability to cover the debt entirely. Then you might consider financing like credit cards for another 3 months, that gets you to 6 months coverage.

You need reserves to hold properties.

Your area market vacancy is relevant to cash flow assumptions but not to reserves or holding costs.

Consider these aspects;

Tenant has a crack party and they get busted and the health department shuts you down

Fire damage, you don't get an insurance claim paid the next day, I never did.

Tree falls and takes out the roof, tenats move out and you should have removed that dead tree, no insurance or at least you have to fight them

Furnace blows in the winter, they aren't staying there.

Water main is out, or worse, bad water, you may have folks pull out on you.

Community emergencies, gas main blow up, rail road derails, mandatory evacuations, while these things usually only last days, it can change opinions of some tenants to leave.

Then, if your building does get cleared for an issue, will you have new occupancy inspections?

Things can happen is my point, I've not had too many issues other than damages from fire and storm, but be prepared financially because you never know. :)

What @Bill Gulley said about reserves. Not having enough reserves is what I would call a huge dollar risk even if it's lower probability.

Alternatively to running your risk model with high vacancy you might want to consider running it with a low rent number that would guarantee very high occupancy.

Good point Jessie, many landlords are too greedy trying to get market plus some, I'd rather rents would be low enough where my tenants never wanted to leave yet still cash flow. Pricing equilibrium ! Run the numbers and you'll find the highest rent isn't the best way to go. :)

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