All Forum Posts by: Ellie Perlman

Things are not the same, but there's no reason not to continue to invest. It just requires a different approach than before. In case this is helpful for anyone, these are a handful of mistakes I've seen some people making and the best way to adapt is to make sure we take time to learn important lessons along the way. 

Mistake #1: Stopping Renovation

When the pandemic hit, every investor and sponsor was worried about whether or not their tenants would still be able to pay their rent. It’s understandable, because many people suddenly became unemployed. So, sponsors stopped renovation, and shifted the focus to keeping the units full. Logic dictated that trying to increase rent through renovation at that time didn’t make sense. Like many others, we put our renovation on pause as well.

Instead of simply stopping renovation in the long term, we looked at our business plan and decided to adjust to “Renovation on Demand.” When a new tenant came in to lease an apartment, we would offer them the option of choosing our “classic units” at the current rent, or the option of choosing a renovated unit at a higher rent. The difference between the current rent for a “classic unit” and a renovated unit is called the “premium,” which could add 10% to 30% to the current rent. Surprisingly, 70% of new tenants opted to go with the renovated units. These were at a 10% - 29% premium over regular rents.

Instead of simply stopping renovation and giving up the chance to increase overall monthly income, sponsors may consider adjusting to a different business model as we did. By avoiding the mistake of stopping renovation, the sponsor remains open to making more money.

Mistake #2: Lowering Rents

The logic behind lowering rents makes sense – property owners want to keep their rents low in order to attract and retain tenants, and they accomplish this by lowering rents. It was a strategy to avoid high vacancy rates during the beginning of the pandemic, which I totally understand. However, it might have been a good decision early on, back in April or May, but not in June when collections were stable.

Every market and every property are different, yet based on my experience operating in the markets where I have units, which includes Texas, Georgia and Florida, there is no real need to lower the rents at this point. What makes sense in one market doesn’t necessarily make sense in another market. The key is to maintain high rent collections.

Currently, occupancy rates are stable, at 95% on average, and with some very few exceptions. tenants continue to pay rents on time. Lowering rents means giving up income, and if it isn’t necessary then it doesn’t make any sense to do that. If occupancy rates fall or collections are a problem, then it may be worth reconsidering. Otherwise, it’s a mistake you can avoid.

Mistake #3: Letting Emotions Dictate Decisions

The pandemic has exposed the fact that many investors and sponsors are letting their emotions dictate the decisions they’re making. There are two types of emotions faced by investors. One is the absolute fear that paralyzes passive investors or sponsors and prevents them from buying additional properties or entering the real estate market. They just don’t know what to do, given the volatility in the market and the uncertainty in the country due to the pandemic.

There’s also a small group of people who believe there are exceptional opportunities available to buy properties – which are motivating them to buy properties at the wrong time or in the wrong market. This emotion is enabling them to take unnecessary risks, which is why I try to keep emotions out of the equation completely.

Remember, real estate investments are simply transactions. You have to look at the numbers and see if they justify making a purchase. If not, walk away, as there will be other properties to buy. Do the numbers make sense? There’s no real fear involved – if the numbers do make sense, move forward. Fear can cause you to miss opportunities or push you into making the wrong decisions. Conversely, when you’re over-excited about a deal, it can help to cloud your judgement and purchase a property that the numbers simply don’t justify.

Mistake #4: Not Digging into the Numbers Enough

A lot of passive investors are letting emotions make investment decision for them – and don’t look at the numbers closely enough. They look at the beautiful photos, they look at the way the beautifully packaged presentation is put together. They avoid looking at the 5-top deal components that every passive investor should examine. That’s fine when the economy is strong and real estate investments are solid. But now, during a pandemic, there’s a lot of uncertainty and the numbers are more important than ever.

Numbers to look at include the cap rate (Capitalization Rate), and the exit cap, paying particular attention to the cap rate versus the exit cap. The cap rate shows the relationship between the Net Operating Income (NOI) of the property and the price of the property. For example, if the NOI of the property is $50,000, and the price of the property is $1,000,000, you would divide $50,000 by $1,000,000 and have a cap rate of 5%. The lower the cap rate, the higher the price of the property.

Another important number to look at is the exit cap versus the cap rate. Exit cap – which is a preview for how much the property will sell for. An exit cap is the cap rate you will sell the property at, when it’s time to sell. Higher cap rate means lower profits. For example. if you’re looking at a deal that has a 5% cap rate, and the exit cap is 5%, it means the market is going to be as strong when the property sells as it is today. Usually, it makes more sense to assume higher exit cap when compared to your purchase cap rate. Always know the in-place cap rate, and the exit cap rate. If it’s not in the investment package, ask the sponsor for the numbers.

Another number to look at is the "premium," which is the difference between the current rent, and the projected rent once the value-add renovation has been completed. If the sponsor is projecting a $300 - $400 premium, it may or not be realistic. Dig into the logic behind the numbers to see if they really make sense. Also, look at the debt structure and make sure that you're comfortable with it. Is it agency debt – debt that is backed by the government?Or, is it bridge debt from a bridge loan? Are the rates fixed, or do they fluctuate every month? Fixed rate loans are always preferable. Finally, make sure you understand the LTV – the "loan-to-value." If it's 70% - that's a good number, but if it's 90%, for example, the loan is too highly leveraged.

Mistake #5: Having Unrealistic Expectations on Returns

Sponsors predict returns on their investments, but things have changed since the pandemic hit. You simply can't expect the same returns now that you saw before COVID-19 hit. Before COVID-19, we projected a yearly 8%-9% cash-on-cash (a calculation of the cash income earned on the cash invested in a property), and a 15% -17% IRR (internal rate of return that provides an estimate of the future rate of return). After COVID-19 hit, we have adjusted our projection to 7%-8% cash-on-cash, and 13%-15% IRR. The lower numbers were more realistic based on the uncertainty due to the pandemic.

We really don’t know what’s going to happen in the market due to the pandemic, but we can assume that rents won’t grow as much as they have, or that we might not execute a value-add plan as we originally planned. Another reason to lower projected returns is that debt terms are not as good as they used to be. Lenders are offering much lower leverage (55%-65% compared to 75%-80% prior to COVID). This, in turn, lower returns. Some investors still have unrealistic expectations, expecting returns that were achievable before COVID-19 hit, or even higher. While there may be some amazing deals out there, watch out for overly aggressive projections.

First Thing First: Do Your Homework

While I have my own investment criteria and business plan, yours might be different. Regardless of how you approach a multifamily deal, the universal key to a successful investment is to do due diligence. That includes the location and the property, so get ready to do your homework.

Finding the right market begins with an in-depth market analysis. You’ll want to look for rental income growth, job growth and a close-up look at the demographics of the market. Who lives there? Is there an abundance of millennials and baby boomers in the market? It’s important to know because those two groups are the ones fueling renter growth, so you want to be sure their numbers are high.

To ensure you’re investing in a strong market, it’s time to do some analytics. To make your job easier, there are many online tools available that provide the market data you need. That includes population growth, demographics and other key factors. Start with Census.gov and City-Data.com. Both provide the information you’re searching for. In fact, you could even Google the name of the city with terms like “population increases” or any other topic you want to search.

There are also some advanced tools available that reveal a large variety of metrics on property appreciation, employment, neighborhoods and more. They include the Yardi Matrix, IRR.com and Veros. Just be aware that these websites are expensive. To find out if a state is "landlord-friendly," check out Vertical Rent, which lists policies in each state. You don't want to find out after you invest that you can't evict a tenant for nonpayment of rent.

Build Your Out-Of-State Team

Managing out-of-state properties is a team effort. I learned this firsthand by syndicating out-of-state deals. You want to have a group of professionals who understand both multifamily properties and the market you’re investing in.

Your team should include a broker because they’re often great sources for recommending other team members. You’ll also want to include a CPA and a lawyer, both with experience in out-of-state investments. In addition, you’ll want to include a property manager who is local and knows the market inside out.

What It Takes To Invest Out Of State

Hiring a remote team takes time and effort, but it’s a crucial step if you want to invest out of state. After you have your team in place, your job is not over. You will still need to visit your property, which may be a six- or seven-hour flight from where you live. You’ll want to be a present owner. I visit each of my properties at least once a quarter to check on its condition and see how the team is doing.

Yes, it does take time, money and effort to travel to remote properties. Not every market is worth the hassle; it needs to be a solid enough market, and the property needs to be good enough to generate the right amount of cash flow to be worth it. You should have a number in mind that will make it worth it. Many investors want to invest out of state but don’t want to deal with the hassle of managing it remotely. The solution for them is to invest in a syndication.

1. Offer Early Bird Discounts

During early March, we already understood that April would be a tough month. We created an early bird program and discounted rents by $50 if residents paid for April by March 30 and a $100 discount for paying for May during March. In our case, about 20% of the tenants took advantage of the discount, and we later learned that some of them had lost their jobs, but it didn’t impact us since they’d already paid in advance.

2. Allow Flex Payment Plans

If one of your residents can show proof of job loss or reduced hours from their employer, allow them to pay some of their rent at the time due, and distribute the rest of the unpaid rent over the rent period. For example, if a resident pays $600 out of their $1,000 rent and has four more months on the lease, then increase their rent by $100 per month for the remaining four months. This can help residents get by during the tough months of unemployment.

3. Share Information About Charities

Yes, real estate investing is initially about making money, but it’s not everything. We also have to be humane and care for those in need. Understood that you need to help your residents as much as you can. An essential part of this involves doing market research to see which nearby charities are giving food or resources away to those in need, and ensuring your residents are made aware of nearby local resources for assistance.

4. Help Residents Learn About Federal Loans/Grants

As real estate investors, it’s our job to know what tools are out there to financially help us power through these challenging times. We've had access to tools like SBA and PPP loans, but tenants don’t necessarily have access to the information we do. Summarize the information on relief programs, and send it to your residents, in case some of them operate small businesses or work from home as sole proprietors or independent contractors. Also send information to residents about their stimulus checks or unemployment benefits to keep them informed, as well as encouraged.

5. Send Gift Cards

While I know that this might not be a popular strategy, we decided nonetheless to send Walmart gift cards to every tenant who was impacted by the coronavirus. Not only did we feel that was our way to give back, but we were also hoping that our residents would feel more inclined to pay rents when they became in a better position to do so. It worked — kindness still goes a long way.

6. Allow Residents To Use Their Security Deposits To Pay Rents

If someone can show proof that they’ve lost their job, let them use some or all of their security deposit to pay rent. The challenge is that you also can’t expose yourself to an unnecessary risk of releasing the security deposit. To mitigate that risk, allow residents to sign up for security deposit insurance, which basically replaces the one-time security deposit with monthly payments of $5–$10.

7. Be Proactive

As you can see, proactive is the name of the game here, and it’s smart to take a very active and proactive approach in protecting your investments. Once stimulus checks arrived, for example, we reached out to all the residents who opted for our flex payment plan and asked if they would make their deferred payments early now that they had received their checks from the IRS. Many opted to do so.

There’s a famous Chinese proverb that says, “Wealth never survives three generations.” America has its own version, which says, “Shirtsleeves to shirtsleeves in three generations.” But while 70% of wealthy families will end up losing their wealth by the second generation and 90% will lose it by the third, there are ways to avoid that from happening.

The concept of generational wealth is simple: It’s money earned by one generation that is passed on to the next. The generation earning the money is one that is working hard and is earning a high salary. The problem comes in when they stop working. The money stops flowing when you stop working, and there are limits to how much one can earn. The solution is investing the money, which lets you increase your wealth and use the money you earn to generate more money.

Apartment Syndication

Many families have built their wealth by investing in multifamily properties, and it’s still possible today. The demand for multifamily properties is strong and growing. Many investors are even overbidding on properties just to get into the game.

Syndication is a smart way to invest in multifamily properties. With syndication, a syndicator, or lead investor, brings together a group of investors to buy a property. The syndicator forms a limited liability corporation (LLC) and sells shares in the corporation to passive investors. Everyone involved is entitled to numerous tax benefits, and generally investors are able to invest in properties that are much larger than they could afford or manage themselves.

The participating investors are called passive investors because they don’t take any active role in the deal. Most passive investors don’t have the time or experience to find the right property in the right market, bring together other investors or negotiate the deal. That’s the responsibility of the syndicator.

Passive investing is an ideal approach for those investors looking to earn ongoing income and ultimate appreciation when the property is sold. It’s also a long-term wealth-building strategy that will play into creating generational wealth.

Building Wealth Takes Time

A word of caution to potential investors: You won’t get rich overnight. Even those who have made a lot of money in a short period of time didn’t have the monetary discipline needed to reinvest and manage their money, so they ended up losing it. As Warren Buffet is credited with saying, “It’s pretty easy to get well-to-do slowly. But’s it’s not easy to get rich quick.”

You won't be able to build generational wealth by putting $50,000 in a few multifamily investments. It takes discipline, and you have to be willing to reinvest your money and let it grow over time. For example, if you invest $100,000 in a multifamily property with an IRR of 15%, you will double your money. (IRR is the percentage of interest you earn on each dollar invested in a property over the entire hold period.)

Generally, when you invest in a syndication, the equity split (meaning, the cash flow that the property generates, and the proceeds from the sale of the property) between general partners and limited partners is 70-30 or 80-20, where the investors receive the bulk of the funds.

During the hold period of three to five years, you’ll receive distributions from the syndicator, including your share of rents and income. Reinvest that money in another property. When the property sells, you’ll also receive your share of the sale, which will be $200,000, including your original $100,000 investment.

Invest that money again in another multifamily property, and at the end of the hold period you will have doubled your money again, now up to $400,000. As you can see, you’ll be building your generational wealth over time.

Sign The Loan To Build More Equity In Real Estate

There is a way to speed up the money-making process, if you’re willing to sign on the loan for 5% to 10% as the general partner (GP). You’ll still be a limited partner in the deal, but by assuming additional risk by signing on along with the GP, your returns will be higher, faster.

There is a risk that you’re taking here because you are guaranteeing the loan, so make sure you know and trust the syndicator you sign the loan with and that you consult a lawyer. If you wish to sign the loan, the only requirement is that you have a net worth equal to the loan amount and liquidity equal to nine to 12 months of loan payments. You can start small, but you’ll receive additional income regardless of how liquid you are.

An Additional Option

If you have strong financials, an additional option is to network with young syndicators and let them use information on your financials to get their letter of intent (LOI) to be accepted by the seller. Syndicators who are just starting out may not have the funds or the credibility to be taken seriously by the broker, and providing proof of funds can be what they need to get their foot in the door. Your fee can range between $3,000 to $5,000 if the syndicator closed the deal. You don't take any significant risk here, because you are not under an obligation to buy the property.

Due to COVID, vetting deals requires a keen eye now, more than ever before. These are the 3 areas I think require the closest focus.

Vet the Sponsor First

Finding the right sponsor is just as important as finding the right property to invest in. A deal is only as good as the sponsor who manages it. The best way to vet a potential sponsor is to ask several key questions that will provide you with a good insight into their approach and help you determine if he or she is a good fit for you.

First, ask the potential sponsor about their own unique investment philosophy. It’s the same with investors – some want high returns and aren’t interested in the risks involved in the deal, while others are more conservative in their overall approach and are willing to accept a lower return in exchange for having a lower risk. Make sure you have a good fit with the sponsor’s investment philosophy, or you’ll be disappointed with the results.

More importantly, ask the sponsor about their performance during COVID-19. Were they able to pay their distributions on time? Did they hit their projected returns? Ask about their prior investments as well. If they demonstrated performance in the past, chances are they are performing now, during COVID-19. It may seem like an uncomfortable question to ask a potential sponsor, but it’s a fair question.

Even if the sponsor isn’t performing well during the pandemic, see how they answer an uncomfortable question. If they’re upfront and honest about their results, that shows a sponsor you would want to work with. If they skirt the question and deflect, walk away – that’s probably not a sponsor you want to be involved with. Other questions to ask include their occupancy, rent collections, cash flow and whether they have reserves available to pay the mortgage if vacancy rates rise.

Research the Location

Once you have answers to questions about the sponsor’s performance during the pandemic, your next focus should be on the area they’re planning to invest in. I recommend using an interactive website located at www.citydata.com. If you have the exact location of the proposed property, you’ll be able to look at the area’s crime rate, median household income and other pertinent data that will provide you with an overview of the type of people who live there.

If the area has a high crime rate and a below-average median household income, it probably isn’t an area that will perform well during a pandemic. In fact, with citydata.com, you can even check the infection rate for COVID-19 to see how prevalent it is. If there’s an exceptionally high number of infections, you probably won’t want to look at that particular deal.

Take a Closer Look at the Numbers

When it comes to reviewing the numbers, one of the key areas to look at is the debt, and that's one area that most passive investors tend to overlook. What you want to see is whether the debt is conservative – in other words, there isn't high leverage in the deal. For example, if the sponsor has a very high loan to value (LTV), of 80% to 85%, it could spell trouble down the road. The reason is that the mortgage payments would be extremely high with an 80% to 85% LTV, and if vacancy rates rise, the sponsor may not be able to make debt payments in a short period of time.

Pre-COVID-19 LTVs were in the 70% to 75% range. Most LTVs during the pandemic are now at 50% to 55%, which is a conservative loan-to-value number and one that is appropriate and manageable. Another factor to consider is whether or not there is a bridge loan involved. I personally do not like high-interest bridge loans. It’s a personal opinion, and other sponsors may find a bridge loan acceptable, but I like properties that have a conservative LTV, no bridge loans and a fixed interest rate. Having a fixed rate is important, because if I base returns on a specific rate, and it increases the following year, it impacts the returns for investors.

In addition to debt, you need to look at a deal’s projections, particularly the renovation plan. You don’t have to be an expert to realize that projections that assume renovation work will begin as soon as the property is purchased, along with achieving a premium increase of $250 - $300 per unit are far too aggressive.

Unlike the aggressive example, we assume that any renovation work will begin between six to twelve months after we purchase the property. This gives us some flexibility in case it’s not the right time to begin renovation immediately after purchase. We do have a “renovation on demand” program that lets tenants decide if they want to rent a renovated unit or one of our “classic” units, which doesn’t include any renovation. Surprisingly, we were able to get up to 29% rent increases, with 50% to 70% of new tenants opting for a renovated unit. However, we’re not sure we can duplicate this success on a new purchase, so we always plan to postpone renovation until a later date.

The other area to look at when reviewing projections is rent increases. This is in addition to “premiums” achieved with renovated units. It all comes down to the market. A year prior to COVID-19, we saw rent increases at some of our properties of 3% to 8%. These were based on the supply and demand in the market, and not because any improvements or renovations were made. Initial increase projections during the first year or two should be small, but if you have any questions, or there’s no provision made for rent increases in the projections, ask the sponsor.

You should also look at projections of bad debt and delinquencies. As sponsors, we always look at delinquencies over the past 12 months, and project what we think the numbers would be after purchasing the property. A figure of 3% for delinquencies is a reasonable number, although the lower the number, the better. During COVID-19 that number might increase to a figure between 5% and 7%, but fortunately we haven’t seen that happen at our properties. Just be sure that the number submitted makes sense. If a sponsor puts zero percent for delinquencies, it means the sponsor thinks that he or she will collect 100% of the rents, which is not realistic.

Finally, take a look at occupancy rates. Sponsors are very optimistic when projecting occupancy rates, so be sure you’re comfortable with the projections they provide. You can assume that during COVID-19 the occupancy rates will drop, so if a sponsor indicates that the occupancy rate will remain the same as it was in the previous twelve months, ask questions as to why they feel that way.

Aside of these suggestions, are there any other adjustments you've made to vetting deals now? 

While finding the right deal in the right market is critical to achieving success as a syndicator, the ability to raise capital is equally, if not more, important. I've found that having capital from investors in place before you have a deal in hand is the best way to ensure success.

There are several reasons why you should start raising capital before you have a deal:

Investors need time to adjust. When you are just starting out, it takes people time to "process" that you are syndicating deals. Especially if you are still holding a full-time job, the likelihood of someone you know investing with you right away when they are not used to seeing you as a syndicator/investor is low.

It takes time to educate investors. Many investors have little knowledge of passive investments or syndication, so you'll need to do some educating about how the process works, the fees you charge and what returns can be expected on investments. Doing this before you have a deal to present is critical when time is of the essence — you want have that luxury while the clock is ticking on a pending investment.

It takes time to build relationships. Not every potential investor is ready to join you as a syndicator. They may not know you or your track record. In addition, it takes time to build a relationship that's based on trust. The earlier you can meet and let potential investors get to know you, the better.

You'll also need time to screen and assess your potential investors, just like they will need time to assess you. Many potential investors simply aren't interested in participating in multifamily real estate syndication. I know I've spent a lot of time with potential investors only to learn their only investment interest was in the stock market.

Having your foundation for raising capital in place prior to signing a deal may be an easy concept to grasp, but developing that foundation takes planning and hard work. I'll share some of the steps I've taken to develop that foundation in an effort to help others who are just starting out.

Step 1: Decide what type of investor you will target.

This is a key decision. There are two types of investors: accredited and non-accredited investors. This is important because when someone invests in a multifamily property, they're actually investing in a security because they own shares in an entity that owns the property. Those shares are considered securities.

Non-accredited investors can also participate if they are "sophisticated investors." According the SEC's Regulation D, Rule 506, sophisticated investors are those who have experience and knowledge in financial and business matters that allow them to evaluate the risks and merits of a prospective investment. You'll also have to have a preexisting relationship with each investor. The time to build that relationship is long before you have a deal to offer. I've decided to work with both types of investors, and that has meant spending time building relationships with them.

Step 2: Find investors.

Now that you understand the need to build your foundation for raising capital early on, I'd like to talk about finding investors. This seems to be the biggest hurdle for most new syndicators, but it doesn't have to be.

Understand that people invest in people, not the opportunities that are presented. Investors have to like you, but more importantly, trust you, so start by reaching out to your own power base. It could be colleagues, friends, coworkers, family or people you've done business with in the past. Let them know you're syndicating real estate opportunities and arrange to meet with them.

Whether you're successful with these people or not, ask for a referral to others. I've had a lot of success attracting investors who were complete strangers simply because they were referred by a mutual acquaintance. Ask for multiple referrals, especially from friends and family members.

Go outside your contact lists by attending events, such as those organized on Meetup.com. Look for real estate groups by city, and narrow your search even further by looking for "multifamily real estate investing" meetups. You'll also meet potential investors at Real Estate Investment Association (REIA) meetings. It's an excellent way to network and form relationships with high-net-worth individuals. I've started a monthly meetup called "Santa Monica Passive Investing Club" where I've met many passive investors who later invested in my deals.

Step 3: Develop an online presence.

Another important and effective way to find investors is to build an online presence. Build a website that showcases your background. Additionally, use online media to promote yourself as a trusted advisor; write articles, host a podcast or share your thoughts and knowledge via posts on LinkedIn and Facebook. Focus on topics and subject matter that would be of interest to potential passive real estate investors, and show that you're knowledgeable in the multifamily arena. I've built a website, a professional Facebook, Instagram and LinkedIn profiles and a YouTube channel, and I host weekly podcast called "REady2Scale." All of these platforms generate leads that convert to passive investors who invest in my deals.

Mistake No. 1: Investing Emotionally

Instead of making a multifamily real estate investment based on balance sheets and merit, some investors make what I call an “emotional investment” in a property. Some investors see a property and become emotionally attached to it because it’s a beautiful new building, or because it’s located in a trendy neighborhood and they want to be a part of it.

This is a situation where emotion takes over and common sense goes by the wayside, which is a huge mistake. The problem is that emotion clouds judgment and, often, people ignore the signs that they may be overpaying for the property simply because they like it. Unfortunately, an emotional investment often ends up costing the investor money.

When you buy a property, focus on what the numbers are telling you: how much upside the deal has, how much will it cost to manage it and the rent growth in the submarket. Avoid focusing too much on how pretty the building is or how “trendy” it is to buy in a certain market.

Mistake No. 2: Counting On Appreciation

When investing in a multifamily property, investors earn profits from two main sources. The first is income or cash flow (rents and other income the property generates, such as fees on reserved parking, etc.); the second is appreciation (the profit you make when the property sells). When evaluating a multifamily investment, it’s important to look at the cash flow because that’s where the income will come from prior to selling the property.

Some investments have little cash flow but have the potential for strong appreciation. This is generally in core markets like San Francisco, New York and Los Angeles, where properties have a 1% to 3% capitalization (cap) rate and negative or zero cash flow. On the other side of the equation are properties in the Midwest, where there's high cash flow but minimal property appreciation. (Cap rate is the ratio between the net operating income, or NOI, and the purchase price. The lower the cap rate, the more you'll pay for the property, which is why sellers try to sell their properties at the lowest possible cap rate).

The mistake that some investors make is to count on very high appreciation where they hope to make a “killing” on the property when it sells. However, that’s a risky proposition because you really never know when or if there will be an option for appreciation when it’s time to sell. For example, if there’s a recession, there could be zero appreciation.

There are ways to increase the cash flow from multifamily properties. One way is by upgrading or renovating the property and then increasing rents. Another way to increase cash flow is to reduce operational expenses. Whichever option is used, it’s beneficial to investors to have additional income.

The key for investors is to have a well-balanced market that generates both appreciation and operational income. That way if one of the potential income streams is weak or changes, you can have income from the remaining one. For that reason, I like to buy properties in markets that provide both positive cash flow of at least 7% and appreciation, such as Atlanta; Jacksonville, Florida; and Dallas.

Mistake No. 3: Focusing On The Wrong Market

Many investors choose a market simply because they’re familiar with it. For instance, they buy properties where they live because they know the city and the surrounding area. However, counting on familiarity when it comes to buying properties can cost you money.

There’s another problem if the property is located in a smaller market. Smaller markets may have higher cash flow due to lower purchase prices and higher cap rates, but those properties won’t be able to sustain prices if there’s a recession. Solid markets like Orlando, Florida, or Atlanta would be able to sustain prices. (That’s why I choose to invest there.)

Markets with a CoC of 7% to 8% are preferable to smaller markets that now offer investors 10% CoC. (CoC is the cash-on-cash return used to evaluate the performance of a real estate investment. It takes the property's annual net cash flow and divides it by the investment's down payment.)

While I live in Southern California, I only purchase properties in Texas, Florida and Georgia, and I'm constantly flying out to those areas to find and evaluate deals. That's where I find properties with a CoC of 7% to 8%. Research each market to ensure there are new jobs coming into the market and that vacancy rates are dropping. Those are benchmarks for a good market to invest in. Once you acquire a property, hire a local property manager to manage the asset.

Misconception No. 1: Smaller Properties Are Easier To Manage

“Smaller properties are easier to manage” is one misconception that I hear from investors all the time. Actually, the opposite is true. Having a professional property manager is critical on larger properties, because it can become a full-time job for you if you don’t hire one. They’re involved in every aspect of running the property and dealing with tenants, including rent collection, leasing units, dealing with tenant complaints, move-ins and move-outs, hiring a team to maintain the property, and so much more. If you’re planning on doing a value-add deal, the property manager will probably get involved in renovations and upgrades as well.

When you have a large property, you are able to attract a more experienced and qualified property management company due to the fee that they earn. With larger multifamily properties, most property managers receive a 3% management fee from the effective gross income (or EGI, which is income minus expenses, but before you pay the debt payments). On smaller properties, property management companies usually charge 5% to 10% of EGI, but remember that the EGI on smaller properties is much lower. Since larger properties yield higher revenues, it is easier to find more professional property management companies to manage your assets. Dealing with larger and more professional companies makes asset management easier.

Misconception No. 2: Larger Properties Are Harder To Finance

If you think financing is easier on smaller properties, think again. Most lenders are more interested in working to lend you money if you’re planning on purchasing a larger multifamily property. The government guarantees agency loans from Fannie Mae and Freddie Mac, and the bulk of these loans fall into the $1 million to $10 million category, with $1 million being the minimum on most agency loans.

Because agency loans are guaranteed, real estate investors can usually get lower interest rates on their loans with larger properties than smaller properties that do not qualify for such loans. Additionally, unlike loans for smaller properties, where lenders heavily rely on the borrower’s credit score, with large multifamily properties, lenders rely mostly on the property’s income.

Smaller properties, which would require loans of $100,000 to $1 million, are best suited for bank loans. Bank loans are often recourse loans, meaning the lender can go after the borrower’s personal assets if the loan defaults. Agency loans are generally nonrecourse loans, which are preferable for borrowers.

Misconception No. 3: Buying Larger Properties Takes More Time

The third major misconception people have is that finding and managing a larger multifamily property requires a lot more work and money than managing a single-family home or a small, 20-unit property. The reality is that finding and negotiating a 100-unit apartment building does not require much more work than a 20-unit apartment building. You might have to walk 80 more units during the due diligence process, but finding this deal and the entire legal negotiation takes almost the same amount of time. Hence, there is a significant economy of scale here: The time it will take you to find and close on a single 100-unit property is much better than five deals of 20-unit apartment building each.

I posted about this a month or so ago, but we've continued to have results that have surprised even me. If you're struggling with adapting a value-add strategy to your properties, I highly recommend you take a new approach that has been very successful for us.

There are many challenges to getting rent increases during a pandemic, but with some hard work and an innovative value-add strategy it’s quite possible. Pre-COVID-19, sponsors were able to increase rents as new tenants come on board by renovating the units. Don’t assume that due to COVID-19 people won’t want to pay a premium for an upgraded unit. We developed a “renovate on demand” strategy that gave our tenants a choice between renting an upgraded unit at a premium or a “classic unit,” and almost 70% opted for the renovated one at a higher rent. Analyze the data to be sure you’re in a strong market, because tenants in a strong market are more willing to pay for a nicer apartment. Finally, remember that by renovating units you’re not only increasing your monthly income, you’re also increasing the value of the property when it comes time to sell.

Be bold, be strong, and thrive!