I recently read a question on a real estate discussion forum that asked about what type of multifamily property a new investor should get started with. It reminded me of a few articles I had written a while back. Well, I found them, and here they are. Enjoy! 

ARTICLE 1

DETERMINING WHAT TYPES OF MULTIFAMILY PROPERTIES YOU ARE LOOKING FOR

        Here is one of the first myths that the gurus will teach you. They will say the first thing you need to do is identify an “emerging market”. Look at the cycles and where the market is in its cycle and then buy at the right time. You won’t go wrong.

        Here’s what they don’t tell you. If you by a lousy property in the best market, guess what, it’s still a lousy property. As we say, you can’t put lipstick on a pig.

        So before you even think about looking at all the websites and broker sources for any properties for sale, save yourself a lot of time and get to know yourself a little better. Here’s what I mean.

        Picture your life one year from now, three years, five years. Where are you? What are you doing? How much property do you own? How hard do you plan on working every day? Are you a hands-on owner or do you have another occupation and owning property is your retirement nest egg?

        It is imperative to understand what your objectives are in real estate just like you would do with any other type of business. Are you an entrepreneur, manager, technician? When you answer these questions honestly, then you will know what types of properties you should be looking at. Once that is determined, then you can change the focus and begin looking at particular markets.

        I have owned all types of properties – A, B and C quality assets. I can assure you, each one of them comes with their own unique set of issues and problems. My A-class property has had three straight months of 100% occupancy and 100% collections. I have incurred no unbudgeted capital expenditures for the last twelve months. As I tell my wife, we need to own more properties like this one; the kind that you forget you even know you own.

        The C-class asset was an entirely different story. As I now tell everyone, from my own personal experience, life is too short to own C-class property. It may be right for some investors, but I have learned that it is not the type of property that I want to be involved with.

ARTICLE 2

THE MULTIFAMILY REPOSITIONING FALLACY

        One of the biggest fallacies that I hear many new investors talk about is how much money they are going to make by buying a C-class property in a B-class area and then reposition the property and cash out. Or it could be a B-class in an A-area. Regardless, they never understand what repositioning really means because the most important part of repositioning is never explained properly to them.

        Just like with fixing and flipping single family homes, any problem can be fixed with money. You can take a C-class property and drop $6,000 per unit in rehab expenses and make it absolutely gorgeous with granite countertops and hardwood floors but that does not make it a B-class property. Remember what brings value to a multi-value business -  the contracts.

        The only way to get more valuable contracts is to get higher-paying customers/residents. The fact that a unit has been completely rehabbed and is absolutely beautiful does not mean that a new tenant base is set to move in.

        Repositioning an asset has two components. First, you must turn the units so that a new class of residents will want to move in and then you have to reposition the tenant base so that you begin receiving the larger valued contracts. The first part is easy. If you have the rehab money, you can have a parade of contractors lining up to rehab your property.

        But the second part of repositioning is the hardest part and the one that the “gurus” never tell you about. Repositioning will fail if you rehab every unit and then re-rent to the exact same clientele that you had living there before.

        Here’s the success formula for repositioning. For repositioning to succeed, you must purchase a property that, once rehabbed, will be the type of place that a higher level of clientele will want to move into. It’s that simple but believe me, that task is not all that simple.

        When you hear yourself saying the words, or hearing the words, “it’s a C-property in a B area”, stop for a moment and think like a B-class resident. Let’s say you are a newlywed couple looking for your first apartment. You have entry-level jobs and you are looking to save money to buy a starter home. Or you just graduated from nursing school and you and your college roommate are looking for a place to live. These are your B-class residents. You know these people. You may have been one yourself. Your children may be in this position right now. What you need to do now is to think like them.

        When the broker takes you to look at the property and tells you that this is a great repositioning opportunity; think like a newlywed, think like a new nurse. Would you want to walk down the street late at night with your new puppy or is the neighborhood not the kind of place you would want to be found dead in? Is it the type of location that you would want to have the new in-laws over for Sunday dinner or would you be afraid they would have to step over police tape from the night before to enjoy your yams?

        You can change the property. That is within your control. You cannot change the neighborhood. Leave that to ACORN (and we know how successful they have been).

        Once I purchased a property that the broker told me was on the edge of a neighborhood that was very desirable. Let’s say for the sake of this discussion, the area within this city was called Eggtown. This property was on the line of Eggtown and North Eggtown. North Eggtown was very desirable. It was going through a period of re-gentrification and all the young people were moving there. The property that I was looking at was located in Eggtown but one street away from North Eggtown. The broker described this property as being in North Eggtown when he was trying to sell it to me.

        The residents were less disingenuous. They said they lived in Eggtown.

        Where do you think the newlywed and the nursing school graduates thought the property was located? They saw the property as being solidly located in Eggtown and were not interested in the refinished hardwood floors and new bathrooms that I had put in all the units. They would not be want to tell their other roommates or their new in-laws that they have achieved such great success in their young lives and now live in Eggtown.

        It wasn’t happening. The repositioning was a bust.

ARTICLE 3

WHAT’S THE RIGHT MULTIFAMILY PROPERTY FOR YOU?

        Allow me to describe for you the lifestyles that I have lived based upon the type of property that I have owned. Once you get a flavor for what each property entails, you will have a better understanding of which type of asset you should be focusing on.

        Class A – Life is simple when you own Class A property. My A-property was built in the late 1990s, is beautifully landscaped, separately-metered utilities and is perfect for a potential condo conversion if the world ever sees those again. The level of capital improvements that takes place on that property is very low. I think the biggest unexpected expense I get is a broken water heater.

        More importantly, though, is the quality of residents that I have living there. The police are never called for any crime issues and the last time they were called was because a resident had a heart attack. For a three-month period of time this year, this property had 100% occupancy and 100% collections. For those of you experienced in multi-family ownership reading this, you can close your mouths now. It is true. Evictions happen but very infrequently.

        If you are looking to get into multi-family investing as a sideline to your day job and you would like to increase your chances of being successful, then only look at buying A-class property. It is more expensive, the returns are lower, and the up-front costs could be higher, but your lifestyle will not change and you will easily start looking for another property just like it.

        Class B – This is where the best deals can be found for new investors. But make sure you know that the property you are buying is truly a B-class property and not a C-class in sheep’s clothing. (As you analyze the income and expense statement, you will see that there are indicators in the financials that will help you determine whether the property truly is a C or a B class asset).

        My B-property is a nice property. It is a place that I would not mind living in if I needed a place to stay. The residents are nice people, the majority of them keep their residences neat and they enjoy staying there. There is some crime on the property but it is usually isolated to problems within the household.

        The issues that I have with the property primarily stem from its age. It was built in the late seventies through the mid eighties. As a result of its age, things always need to be fixed. Twice in the last two years I have had to have my plumber come in and replace the water pipes from the street. (I love how it is never the city’s responsibility. Always mine). This just means that when you are calculating your budget, you need to make sure that you reserve enough cash to cover these types of expenses. B-properties burn through cash much faster than A properties. Be prepared. Regardless, if the property is purchased at the right price, B class property can be a great investment.

        Class C- What follows is my own personal opinion learned from personal experience. I will never purchase a C-class property again. It may be right for some investors but it does not fit my investment strategy. As I now say, life is too short to own C-class property.

        C-class property is a tough property to own both from a physical plant basis as well as a clientele basis. They are the oldest property and therefore have the most upkeep. There is always something going wrong with it. If you get into a C-class deal without having a large bucket of money to start rehabbing units and keeping the lights on while you do that, then you have just created a monster. That is the easiest recipe for disaster.

        In addition, the mindset of the C-class property resident, if you are like most people, is like nothing you have ever known or been able to understand. You have to have a very strong back if you are looking to get into this side of the business. The only good thing that I can say about my experience is that I learned it early in my career at a time when I could recover financially from the disaster that it became.

        Let me stress this again. This is my personal experience. There are many investors that make a great living investing in C-class property. I just learned very early on what my limitations were. If I had a contractor’s mindset, I would be able to walk into these types of properties and see dollar signs all day long. Unfortunately, I don’t. I see the financials of a property and base my decisions on that.

ARTICLE 4

WHAT ARE YOUR MULTIFAMILY BUYING PARAMETERS?

        Once you are ready to get out in the market looking for that property that is going to be the start of your dreams, you will contact a broker and start a dialogue and one of the first questions that they will ask you is “What type of property are you looking for?”

        The more specific you are in your response, the more experienced and knowledgeable you are about the business and the broker will instantly know that you are not there to just waste his time.

        When I am posed this question, I give the exact same answer every time. My answer is based upon my experience as an owner/operator and the elements of the property that I request tell me things about the property that the broker may not otherwise share with me.

        Here’s my stock answer: “I am looking for B-quality assets, 1980s construction or newer, pitched roofs, individually-metered utilities, 150+ units and some type of management issue that I can get in there and address.”

        Let me run through the above statements and explain what each element means and why I say it:

B-quality Asset: We know why I am not looking for C-property but I am also not looking for A-class property either. In today’s market, there is a lot of money chasing A-deals. I’m not looking to get into that type of race. Find me a nice B-class asset owned by an individual who is looking to trade up or retire and I have found my perfect buyer.

1980s Construction or Newer: As I have stated before, I lack a contractor’s mindset so the next statement I make may be laughable in some people’s mind but it won’t be the first time for me for doing that. It just seems to me that building standards changed drastically between the 1970s and the 1980s. Besides the fact that the properties are newer and require less upkeep, it just seems as though roofs, windows, foundations were all constructed in a manner that is easier to maintain than the older vintage.

Pitched Roofs: When I first started looking at property, I remember listening to the brokers tout the benefits of a building that had pitched roofs over flat roofs. The benefits of one over the other were lost on me and I plowed ahead full steam regardless of the type of roof.

That matter was solved entirely after I owned a flat roofed property. Never again. They are expensive to maintain and repair and you are always concerned whenever you see dark rain clouds on the horizon. Who needs it? Besides that, it seems as though all 1980s construction property is done with pitched roofs. That kind of supports my argument about better building standards.

Individually Metered Utilities: This is huge for a couple of reasons. First, when you pay the utilities, your residents are now in partnership with the utility companies against you.

They have absolutely no incentive to reduce the expense of their utilities. Remember the formula; if you save one dollar in expenses, you increase the value of the property ten times. If the residents pay utilities, you never have to worry about what the cost increases are. They are not your problem.

There is another reason why I only choose properties that are individually metered. First, the quality of residents goes up. If a resident can’t qualify for utilities in their own name, that usually means they burnt the utility company on another property and they will likely do the same with you. You don’t want them as a customer.

One mistake that new investors make is they find a property that is individually metered but the owner pays the utilities. They somehow believe that all they have to do is convert the payments to the residents at the lease renewal and their NOI skyrockets which then means the value of their property sky rockets. If it were that easy, why wouldn’t the current owner do the same thing and reap the benefits of doing it.

Here’s the answer. You have to look to see what the market is doing. If there is an apartment complex directly across the street and they pay their residents utilities, guess what? You will be paying the utilities for your residents as well.

150+ Units: This is a business decision on my part. You have to decide what size deals you want to be involved in. Do you want to try and buy the property by yourself or do you want to take on a group of investors to make the deal happen. We have found that with properties at that size, you get enough economies of scale to make it successful. Smaller size deals just were not as large a return as we wanted. What’s right for you is a private business decision but be prepared to be asked.

Some type of Management Issue: This is kind of a catch-all phrase. It gets the broker to start talking about the owner and what is going on with the property. Let me warn you, brokers say what they think you want to hear. That may be a rather jaded comment but if you live by it, you won’t go wrong. For instance, no broker I have ever spoken to has ever sold or listed a property that has rents “above market”. They all have rents below market. Significantly below market. Never fails.

You want to get the broker talking about what the story is with the property. You want to know what the reasons are for why he is selling. This is your opportunity to find out as much as you can about the property. Sometimes I have passed on looking further at a deal because I did not like the reasons the broker was giving me.

        One of the most important things you need to learn about this process is what I don’t say are the parameters that I am looking for. For example, I never mention cap rate. Why? Because the cap rate is implied based upon the type of property that I am looking for. If I have done my homework correctly, I will know that a property that meets my parameters in that particular marketplace will trade at a particular cap rate. If the broker sends me over a property that is trading at a cap rate that is too high or too low, then I will know right away there is something wrong with that deal.

        Another thing that I never mention to the broker is the cash on cash return. The CoC that I am looking for is none of the broker’s business. The CoC that I end up getting on the deal has nothing to do with the property but everything to do with my negotiation ability with the Seller. I don’t want the broker to limit the properties that he sends me because I am desiring a twenty percent cash on cash return. Let me look at the deal based upon the parameters detailed above and then I will submit an offer that gets me the CoC return that I need.

        I have seen too many new investors lose credibility instantly when they say to the brokers that they want to see all B-class property with a 9 cap and 15% cash on cash return. Don’t do it. You won’t get a return phone call.

So before you start looking at emerging markets or properties 1000-miles away from your home base, take as much time as you need to determine what you are looking for in an investment property by taking the time to picture yourself as an owner/operator. You can always change the way you look at yourself a lot easier than you can change the properties that you own.