7 Steps to Avoid a Bad Residential Or Multifamily Rental Investment

7 Steps to Avoid a Bad Residential Or Multifamily Rental Investment

Investors are always looking for great deals. They have opportunities, business plans, principals, partners, and personal contacts showing them all sorts of deals. All of these deals are presented as a great opportunities with low risk and strong probabilities of good returns.

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The fact is many do not prove to perform up to the presentations given (in fact most do not). Sorting out the weak opportunities from the good ones is a difficult task that deserves all the effective attention we can muster.

Step 1 – Assure the equity value basis for the investment on the basis of cash flow as a maintained property. This step is the surest and most certain way to ensure that the opportunity will protect invested capital.

Step 2 – Check the land and building value and assess very conservatively given that if occupancy falls the project can quickly lose this element. This is the most conservative value and should show your complete failure risk after considering debt.

Step 3 – Ensure the investment plan protects adequately against financing risk. This implies assuring a strong conservative debt service coverage from Net Operating Income (NOI), checking that the reserves are strong for capital uses and for expense protection, and verifying that should their be capital losses, large temporary occupancy or cost, etc. that the project is able to perform.

This also means providing plenty of time to replace financing prior to term and allowing for changes in the financial cost environment to guarantee financing is available and closeable with minimal additional capital and assuming no additional capital.

Step 4 – Verify that protection against tax risk is firm. Again this returns to reserves and their sufficiency. Further, this applies to how the accounting is managed. The investor should be certain that tax and insurance accruals are made monthly and that taxes and insurance is paid current.

Step 5 – Check to assure that accounting records are maintainable, detailed, accurate, and recoverable should competency issues develop. Along with this and related to Step 4, the accounting plan should assure payroll is accurately maintained and payments are kept current.

Step 6 – The investment plan should include the means to note and rectify major management issues should they develop. This should be defined in terms of occupancy, billing, collections, and maintenance performance.

Step 7 – The investment plan should provide clear means to prevent the asset being sold or transferred out from under the investor. This is principally and operating agreement issue.

Investments reviewed from these perspectives will prevent excess risk, assure return assumptions, and contain over optimistic expectations from the investment.

By Martin Fisher

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