By guest blogger Jonathan Twombly; President of Two Bridges Asset Management
So you’ve decided to move up to bigger deals, and you’re ready to buy your first apartment building. Congratulations! But before you make this big move, remember never to make these 7 devastating multifamily mistakes.
NEVER Buy Solely Based on Future Appreciation
The best way to lose your shirt is to buy only based on future appreciation. Unless you have a 100% guaranteed accurate crystal ball – in which case you should buy Mega Millions tickets rather than real estate – a prediction of future appreciation is a mere guess at best and a wild fantasy at worst. Smart multifamily investors know to buy based on actual current cash flow; if the deal works accordingly, you won’t need any appreciation to make money. You make money in real estate when you buy, not when you sell. Buying solely on the basis of your fantasy of future appreciation is the best way to pay too much and turn a good deal into a bad one.
NEVER Take Recourse Debt
“Recourse” debt means the bank can come after you if the property defaults on the mortgage. Because multifamily real estate is considered less risky than other types, banks are generally willing to provide non-recourse debt. Thus, if there is a default on the mortgage, in most cases the bank’s only option is to foreclose on the property. If you have a larger multifamily deal in hand, and no one will lend to you non-recourse, the deal probably isn’t as good as you think.
NEVER Buy in Your Own Name
You should never buy a multifamily property in your own name. Always buy through a corporate entity. (Please check with your lawyer and accountant whether an LLC, S-Corporation, or C-Corporation makes the most sense in your situation.) Buying in your own name means that creditors can seize your personal assets if the property cannot satisfy its debts. Obviously, you need good insurance (And the bank will require it anyway). But what happens if someone injures himself on your property and the award exceeds the insurance coverage and value of the property? That’s right: he’s going to come after your house, your car, and your bank account. If a corporate entity owns the property, then your liability is limited to your interest in the property itself – as long as you follow Rule No. 4.
NEVER Mix Your Personal Assets with Those of the Property
So, you were smart and you bought the property through a corporate entity such as an LLC. Guess what? If you commingle your personal assets with those of the property, courts will disregard the LLC as a fiction and allow a creditor to come after you personally. Lots of real estate gurus tell you to buy through an LLC so you can run personal expenses through it and have it buy you things like cars. This is exceedingly stupid advice, because these are EXACTLY the kinds of actions that will convince a court that the LLC is bogus, making your personal assets fair game. Hire a good accountant, maintain good books, and keep all your and the property’s assets strictly separate.
NEVER Self-manage the Property
Unless you are investing in real estate full-time and you already have experience with property, managing your own multifamily property is a bad idea. Many new investors make the mistake of self-managing because they don’t want to pay management fees. But if you are investing in larger properties, you need a professional third-party manager. Good management companies can run a property more efficiently than you ever could, more than making up for the fees. They can get volume discounts on supplies because of their larger purchasing power. They can offer better benefits to employees, getting you more qualified people than you can hire on your own. And they field those 3:00 AM phone calls about broken toilets, so you don’t have to.
NEVER Upgrade Apartments To Meet Your Own Lifestyle
If you are in a position to own a multifamily property, chances are you are already pretty successful and have certain ideas about your lifestyle. Don’t make the mistake of upgrading apartments to meet your lifestyle rather than those of your tenants. Starting out, you won’t be buying Class A luxury apartment buildings for people like you; you’re buying Class B/C properties for average working people. Your tenants will be looking for clean, safe, and affordable housing, not Viking appliances and granite countertops. If you put Class A amenities into Class B/C apartments, you’ll quickly find that your tenants can’t pay the rent increases you’ll need to recoup the money. Obviously, your property is a valuable asset and you need to maintain it properly to get good tenants. But remember, this is their home, not yours.
NEVER Be the “Four Dentists”
Nothing excites me more than learning that a property I’m targeting is owned by a group of four dentists, doctors, or lawyers, etc. Why? Because smart, successful professionals often think that owning property is easier than being a dentist, doctor, or lawyer, so naturally they can do it themselves in their spare time.
So what happens? These smart guys break most of Rules 1-6 and start losing money fast. And because they are accustomed to success in their real jobs, they blame the property rather than their own inexperience and often end up selling a good property for less than it’s actually worth–just to cut their losses. I lick my lips in anticipation, buy the property at a big discount to its real value, and make a ton of money for my investors.
So, What SHOULD You Do in Your First Multifamily Deal?
Owning multifamily real estate is not rocket science. You can learn this business; but there is much to learn, and going into it without the right team can be very costly. When you’re starting out, find people with experience owning multiple large multifamily properties and make them your partners, even if you have to give up substantial equity. Or, if you feel you’re not up to the stresses, strains, and time demands of owning multifamily property alone, seek out a good syndicator and make a passive investment in their deals. This way, you can have the potential upside of multifamily property – cash flow and appreciation – without the hassles and headaches of direct ownership.
About Two Bridges Asset Management: Jonathan Twombly is a former lawyer and current full-time multifamily real estate investor who runs Two Bridges Asset Management LLC. Two Bridges offers pre-qualified accredited investors the opportunity to invest passively in cash-flowing multifamily properties. For more information and to see if you qualify, please visit twobridgesmgmt.com or email Two Bridges.
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