Things To Look Out For When You Buy a Multi-Family Property

As you make the switch from residential rental properties (i.e. less than 5 suites) to multi-family there are some things to watch out for. In fact if you are not prepared you could be in for a rude awakening. The process is just far more intense – taking much more time and much more money than what you may be used to.

When you buy a multi-family property you are buying a little business, complete with multiple sources of revenue and multiple cost centres. Because of that your lender will require a lot more information. Here are some things you need to be aware of:

Cost of Reports: At a minimum you will be required to supply:

  1. a) an Appraisal – You are used to getting an appraisal but a commercial appraisal is much more detailed and much more advanced. It will also cost you a couple of thousand dollars. While the bank probably paid for the appraisal when you bought your last residential property, you will be responsible for obtaining and paying for a multi-family appraisal.
  2. b) a Building Condition Report – to create this report an engineer will go through the building and inspect the roof, wall system, boiler / furnace, plumbing, electrical, windows, foundation (basically the entire building) to find issues that need repair or replacement and to determine the remaining useful life of the building. Typically a lender will amortize a mortgage to a maximum of the remaining useful life plus five years. The engineer will also want to see two or three individual suites to get a feel for the quality of finishing. This report will also cost you two or three thousand dollars.
  3. c) a Phase 1 Environmental report – this is a report where an engineer or consultant will go back in the past to see what existed on your property and on neighboring properties and if there was ever anything that may have been environmentally hazardous around your site. For example, did there used to be a gas station with underground tanks that may have leaked? Was there ever a plastics factory or an auto junk yard? Are you close to railroad tracks where there may have been an accident that leaked chemicals into the soil? The bank wants to be aware of what might be in the soil that could come back to create a future environmental incident. If nothing is found then no problem. If something does come up you will have to do a Phase 2 and probably re-mediate the issue. All reports are at your cost and will run you two or three thousand each.

You may also be required to test for asbestos or mold.

All of the above reports will be at your cost and must be from a list of vendors that the bank approves of. This is to lower the chance of mortgage fraud.

Cost of Money: The bank probably didn’t charge you a fee to get a residential mortgage but you will have to pay them to give you a loan on a multi-family property. “What? I have to pay them to give me money?” Yep. This will probably be around 1% of borrowed funds plus maybe an application or processing fee. In their defense there is a lot more paperwork / effort for them to process a file of this size. However, there is a bit of ‘they will charge you just because they can’. The people / corporations that buy multi-family have more money and the lenders know that. You will also be responsible for not only paying for your own legal fees but that of the lenders (and those fees will be higher than in the residential world too).

Personal Guarantees: You and your partners will probably be required to sign personal guarantees on the loan. That means that if you run into trouble and can’t pay the mortgage for this property that they can come after you personally to get the money. Having the property owned by a corporation won’t help you here.

Time: It takes significantly more time to buy a multi-family than it does a residential property. While it typically takes four to six weeks to arrange financing on a residential property (i.e. two or three weeks to get inspections and arrange financing plus a couple of weeks to close), it will take you three or four months to get the keys on your new apartment building. All of the reports listed above will take three to four weeks to create. The bank will need the same to process the application once they get the reports back before they can issue you an actual commitment letter. Add on three to four weeks for legal and it starts to add up. Make sure, that when you make your offer to purchase with the vendor, that you put a closing date of 90 to 120 days. Do not let them talk you into anything less.

Due Diligence: While the engineer will go through the major building systems (roof, wall, plumbing, heating, electrical, foundation etc.) they will only visit a couple of representative suites. Make sure you go through the entire building with the engineer AND make sure you go through every suite. This is so you know what repairs are required in every suite and in the building as a whole. If there are major issues that you were unaware of (with the roof or foundation for instance) you may want to renegotiate the deal or even get out while you can.

Tenants: You also want to get a feel for who your tenants are and how they live. These detailed visits will let you know who the hoarders are vs. who keeps things neat. You may see some bugs / pests which will allow you to eliminate those issues ASAP after purchase. If anybody is doing anything illegal you need to know that before you buy the property too.

Other Sources of Income: One of the good things about multi-family properties is that they can provide more sources of income. For example, laundry – are the machines under contract with a service or will you own them and be responsible for their repair. Do you have a chance to have extra parking revenue? Can you clean up a storage room and rent it out? Can you rent out your roof to a phone company to put up their antenna? Can you put some advertising outside?

How They Are Valued: As a business, multi-family properties are valued based on their ability to produce money. The income / revenue of the building is more important here than the financial strength of the borrower. I go into great detail on multi-family valuations in my book Comparing Real Estate Strategies.

What Banks Won’t Lend On: Sometimes the quality of the building will be so bad that the traditional, level 1 banks won’t lend on them at all and you will have to go to a private lender and pay more interest. For example, banks won’t lend on motels that have been converted to apartment buildings (because the rooms are too small). They won’t lend on boarding houses (where multiple bedrooms share a common bathroom or kitchen). If there is significant mold or asbestos you will get a ‘No’ from the bank too. I bought a building once that had sat empty for two years with a leaky roof resulting in grass and mushrooms growing on the carpet of the top floor – definitely a deal for a private lender. If you own an entire building that has been condominiumized so that each suite can be bought and sold separately, the bank will still treat it as an apartment building and lend on that lower value vs. the higher individual condo value.

Insurance: You may have trouble finding insurance at all for empty buildings that require some significant renovations to get back to normal. Insurance companies get scared by empty buildings and major redos. If the electrical in your building is older and has the older fuse style panels (as opposed to the newer breaker style) or if your building has aluminum as opposed to copper, you will also be looking at fewer companies who will even entertain giving you a quote. Those that do quote will quote very high until you can bring the building back into balance. The lender may have their ‘insurance consultant’ review the insurance that you do get to ensure they are protected. This will be at your cost too. Make sure you factor extra time into purchasing the building if you think it will be harder to find insurance.

As you can see there is money going out the door for fees and reports every time you turn around during the purchase / diligence phase. Now that you are aware of that and can budget for it you won’t be surprised. Also, make sure you give yourself enough time to get everything done properly. It will cost you money if you have to go back to the vendor and negotiate an extension.

Read more about this in Comparing Real Estate Strategies.

Tips On Saving Money While Doing Flips

A good way to save money when doing fix and flips is to look for deals on materials wherever and whenever you find them, and buy extra material at a deep discount, regardless of whether you need that material on a current job or not.

Store this material in a rented garage until you need it. For example, if you go to an auction planning to buy one thing but then have the opportunity to buy two full kitchen cabinet sets at a deep discount, maybe you should do that. Sometimes your local plumbing contractor orders in a bunch of sinks for a large job that they had bid on and won, only to find out the job was cancelled or delayed. Now they are selling the sinks at 10 cents on the dollar. Buy them.

If you buy a house to renovate and are going to install a new, modern carpet but are thinking that the existing carpet is in okay shape and can be re-used in some future rental reno, then store it. If you are good at this type of thing, then over time you can have your own little Home Depot in your own garage.

When you need something, you can spin by your garage, get those 10 boxes of tiles that you bought two years ago, and save a ton of money on your existing job. A rented garage is also a great place to store your tools when you are not using them.

A word of advice: get a garage close to your job sites. I have tried to use this strategy on several occasions, but I am horrible at it. My garage has often been too far away from the job and it was easier and faster just to run to the supplier and buy what I needed new.

I was also bad at remembering what I had in the garage. I would be doing a reno, buy new product, and install it, and then two weeks later I would be in the garage and realize I already owned five bags of that product.

However, I have a friend who does this really well. He has built up five garages over the years filled with stuff he bought for next to nothing. As he needs it, he remembers what he has and where it is. Prior to each new job, he drives around to all five garages and gets what he needs for that job. Sometimes this affects what he will do on that job. Maybe he was planning on going for a green-themed color scheme, but after realizing he already has a lot of stuff with a brown theme, he switches it up prior to starting. No harm in doing that.

Having said the above, you will constantly be deciding whether to try to find the cheapest materials you can find on each job and designing your renovations around that or whether you will use the same materials on every job and save money by buying your materials in large quantities at large discounts.

For example, if you use the exact same brand and color of paint; the same baseboard and casing; the same electrical lights, plugs and switches; the same tubs/toilets, taps and sinks; the same towel bars; and the same interior doors, you can save a lot of money by buying pallets of things as opposed to one or two of each.

Read more about this in Comparing Real Estate Strategies.

Suggested Splits In Real Estate Joint Venture Partnerships

So you have found a property that looks like it will be a good investment to add to your portfolio and you have even lined up a potential joint venture partner. Outstanding! Now comes the part where you have to negotiate the split with your J/V. How does that work? What is fair?

A joint venture is where two or more parties (hopefully with different skill sets or assets) come together to do a deal. There is an infinite number of ways that joint ventures (J/V’s) can get put together.

Maybe the two parties will both put in the same amount of money and both do an equal amount of the work for an equal split of the profits.

Maybe one of the partners will handle anything to do with paperwork—insurance, financing, accounting, purchasing material, etc.—while the other partner does the active management, renovations and site supervision.

Another relationship is where one of the partners does all of the work (the real estate expert) while the other partner puts up the money for the deposit and any renovations (the money partner).

How the partners split the profits is subject to a number of factors such as the experience of the real estate expert, who puts how much money in and who arranges financing. Here is a generic starting point for negotiations:

  • 50% to the partner(s) that put up the money to pay the deposit (the money partner)
  • 20% to the partner(s) that qualify for the mortgage and are on title
  • 10% to the partner(s) that manage the asset after purchase (different from property mgmt)
  • 20% to the partner(s) that find the deal and co-ordinates the work related to the initial purchase and eventual exit strategy (the real estate expert)
  • Note: if the property is especially run down and in need of significant renovations then special consideration will be given to the partner(s) that co-ordinates these renovations

It has been my experience, in smaller deals, that the person that puts up the money gets at least 50%. For larger buildings, where more cash is required, the money partner(s) would expect to get more. That is because there may be multiple money partners. The money partners might even insist on receiving interest and ownership.

In other words, the money partners would get paid interest on their money during the three to five-year rental period and then the partners would split the profits when the building is refinanced or sold. Typically, in return for doing all of the work but not having to put in any money, the real estate expert would have to wait until the money partner gets all of their money back before the real estate expert would see any money. That means they may be working for three to five years for free before getting their payday.

Keep in mind that if you are going to be paying interest during the hold period of a rental property, you need to make sure that the revenue is enough to support the regular expenses, the regular bank mortgage AND your partner’s interest. There are not many properties that can do that, so be careful. I find the best properties for this use are those that are really beat up that you can buy at a discount, fix up, and raise the rents.

So the question arises, why would a money partner do a 50/50 split when they are putting up all of the money (not including financing)? The answer is, if somebody with money doesn’t mind doing all of the hands on work too then they don’t need a real estate expert. The real estate expert only gets into the game when the money partner wants to be hands off.

There is definitely value in being the real estate expert. It is hard work to find and manage a property – work such as finding a property that is investment grade, arranging financing and insurance, coordinating the appraisals and inspections and taking care of the management and other issues after the purchase such as any renovations. A lot of money partners don’t have the time, expertise or patience to do that.

In most cases the money partner needs a real estate expert and the real estate expert needs money. If you are going to position yourself as a real estate expert then you have to have some expertise behind you. You have to sell yourself and your qualifications to a potential money partner.

Personally I have done J/V’s where my partner and I both put in equal money and I did all of the work for a 1/3 : 2/3 split in my favor. I have been the real estate expert and had a money partner on a 50 / 50 split. In other deals, where the purchase price of the building was really large the money partner wanted 50% plus an interest portion.

The bottom line is that if you are in a situation where you don’t have a large war chest, you will need to partner with somebody who has money. What the split or terms of that partnership will be will depend on how strong you look to a prospective partner and how good of a negotiator you are. To find a partner you will need to bring some expertise in real estate to that relationship. Do what you can to gain that experience with the resources that you have.

If you are just starting out and the money partner is putting up all of the cash and is the only one on the mortgage they you may be looking at a 70/30 or even an 80/20 split until you can bring more to the table.

Read more about this topic in Cash Management in Real Estate Investing.

Landlording Before the Internet

I am going to date myself here and give you one of those ‘I remember when’ stories (damn kids get off my lawn). Things have come a long way and life is a lot better for landlords now that we are in the internet age.

Take advertising for example: before the Internet, the only way to advertise your rental property was in the newspapers. It cost you close to $40 for 3 lines of abbreviated verbiage that was hard to decipher and didn’t explain anything.

West End bung, 3 bed, 2 bath,

Avail. Apr 1, no smoke, $1500,

612-555-6245

Does that tell you anything? No. If you are a potential renter, you had no choice but to phone the person who put the ad in the paper for more information. As a result, the landlord was besieged by prospects, most of which weren’t qualified or looking for what you were selling.

That was a waste of everybody’s time and trouble. Plus it cost you $30 to $50 for only 3 days. Then you had to do it again and again until you rented the place.  Now you can post an ad online with one or all of several great rental websites. Each city or location has some that are better than others, so check around.

These websites let you post pictures and give all of the details of your property. Most have no restrictions on the amount of wording you can use, they don’t use code words, and the one-time fee (typically $20 to $30) lasts for a couple of months or until the place is rented.

Now the prospect can get all the information they want and they can see what they are getting by viewing the pictures. The address of the property is also listed in the ad, so they can do a drive by and check things out before they even call you.

Now you might only get 2 calls instead of 30 on your ad, but those 2 prospects are qualified. They are okay with everything short of physically getting inside and seeing the room sizes, layout, etc. Your closing rate (the percentage of prospects that you turn into renters) should be much higher in the new world. By the time they show up at your door, they are already okay with the rent, the terms, the location, and quality of the exterior of the building.

All you have to do is close the sale (if this is the right person for this property). This has spelled death to the newspaper industry as everybody does their advertising online now, but maybe the papers should have charged less and offered more to their clients when they had the monopoly.

Do I sound like a cynic who has paid way too much for gibberish ads over the years?

I really like the new world as it pertains to being a landlord. Online advertising also opens up your rental to anybody from around the world that is moving to your town to start a new job.

Before, somebody would have to get the newspaper from the town they were thinking of moving to in order to check out the rental situation before they physically paid a visit.

Now with the Internet, a potential renter can build a full list of properties they are interested in seeing, make calls (text or send emails) to landlords, and get a day of showings set up before they even leave their hometown. I have rented units, sight unseen, from people in other parts of the country in a tight rental market.

The other thing that this new style of advertising helps to reduce (but not eliminate totally) is the number of no shows when you finally arrive on-site to meet the tenant. This, honestly, used to be the part of the landlord game that I hated the most.

You would do your three-line ad in the paper, a bunch of people would phone, you would interview them as best you could over the phone, and then arrange to meet the people that looked the most promising. You would arrive at the proper time but the prospect would not.

That means that you just wasted 1/2 an hour to get there, 20 minutes waiting, and 1/2 an hour to go home again. Multiply that by 5 or 6 times before you finally found the right tenant and it was a pain to rent properties. I hated it with a passion.

Looking back, I think that is the biggest reason why I fixed and flipped in the early years instead of keeping rental property. One of the big reasons for people not showing up was that the first phone call between the prospect and the landlord, in the old world, was the first time the prospect learned the address of the property.

You would make a date on the phone and then the prospect would drive by the place. If he didn’t like it, he never called back to cancel the appointment. Or maybe he did show up to the appointment, saw the place, and just kept driving. Now they can see the address on the web, I state right in my ads that the prospect should do a drive by first and then give me a call. Again, this doesn’t eliminate wasted showings, but it greatly reduces them.

Verifying applicants is also easier now. There are websites now that allow you to pull a credit bureau report on a prospective tenant for, typically, less than $25 (make sure you follow the rules of your jurisdiction and ask for permission to pull the report on your application form). To save money I only do this as the last step of an applicant that I am ready to approve. An applicant’s credit score shouldn’t be the only basis for your decision to rent or not but it does provide some valuable insight to help your decision.

The Internet has also made collecting rents a dream. Before, as a landlord, you would accept cash (potentially dangerous and not recommended), check, or money order. Checks can bounce. Now almost all of my tenants pay by email transfer. You get an email, you click on the link, it puts into your bank’s website, you answer a security question, and boom! the money is in your account. You don’t even leave the house. The name of the person shows up on your bank statement so you can keep proper track of who is paying and who is not. It also keeps a permanent record of when the payment was made in case you need this information later.

Looking back I used to fix and flip because I hated being a landlord. I have gotten much better at it over the years and the internet has been a big part of that improvement.­­­­­­­­­­­­­­­

Read more landlording tips in Comparing Real Estate Strategies