There have been rumors of an impending recession for the past several years. And this probability now seems more likely considering the present trade wars with China, the present inverted yield curve, Brexit, and a lot more indicators. Does this simply mean that one should stay away from purchasing real estate properties or invest in them?
Of course, the answer is a big NO. While it is true that it is better to obtain no deal at all than tying yourself up with a bad deal. But it does not mean that there will be no better deals along the way. Patience is a virtue. Again, the competition is stiff and the prices are a bit too pricey. That is why you require to be even more cautious and selective. You have to pay close attention to the essentials when investing in multifamily real estate. We have listed five important methods to minimize your risk when investing in multifamily properties:
- Market Condition. A bad market will destroy even an excellent property investment. On the other hand, an excellent market will make a bad investment not look so bad. You have to pinpoint which types of industries are most likely to get the hardest in times of economic downturn. You have to stay away from cities that depend heavily on those types of industries.
You also have to look for places with excellent employment potential and a broad array of opportunities because this type of place is a lot more economically resilient as compared to a city that is so dependent on just one industry or sole company.
- Cash Flow. Having healthy cash flow is imperative in maintaining a happy investor. A property with a great cash flow generates at least six (6) percent cap, which is the net operating income (NOI) divided by the initial purchase price. You may not have this 6% minimum cash flow at the onset, and it depends on where you purchase, but you should have reached this number at least after some renovation.
But, prospective cash flows are solidly dependent on the capitalization rate of a specific market. The cap rate of a hot market is somewhere around 3-4 percent, so it is a bit complicated to obtain a property in this kind of market to a 6 percent cap, even after adding value to the property.
Ergo, you require making sure that your real estate investors know of this. Let them know that a significant amount of the return will not be realized until the property is disposed of. In this regard, they will get the idea if they do not see a high return during the holding period especially if you hit a recession and require extending the holding period several more years.
- Appreciation. Always be conservative with your underwriting. Do not depend much on appreciation or growth in rent too much. Even if there is significant growth in the market last year, do not expect the same growth each year or for the next succeeding years. You have to peg an amount that is closer to the history over the past decade.
If the present market cap rate is five (5) percent, you have to assume that you will be selling the property at around 5.25% or a bit higher in the next five (5) years. The principal rule is to enhance the capitalization rate at a sale by five basis points yearly.
- Capital Reserve and Capital Raise. Do not ever depend on cash flow to finance and shoulder your renovation cost. This will surely lead you to disaster. Depending on when you rely on your cash flow to finance the renovation, it will restrain your capital and slow down the progress of your value add. It will be too risky if the cost will land much higher as compared to the original budget. Do not earmark money that is just enough for renovation. You have to raise an additional ten (10) to fifteen (15) percent of the computed budget since the world of construction is full of surprises.
- Term of loan. Try to secure permanent financing as soon as probable. You can sign for either twenty (20) or thirty (30) year loan immediately, or obtain a loan with an option for permanent financing. Permanent financing is very crucial because you will not have to worry in terms of refinancing for many years. If a recession manifests and negatively affects your property, you do not have to worry in terms of refinancing at a much lower value or selling your property.
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