In over 40 years of experience in this business, I’ve seen pretty much everything. As a result, I’ve developed what you might call an intuition for evaluating deals.
Don’t get me wrong; that doesn’t leave my “gut” in charge of which multifamily properties I do and don’t buy.
But it does help me to know a bad deal when I see one.
You may not have that intuition yet. Don’t worry; you will. For now, here are 7 strong reasons to walk away from a deal or, at the very least, to proceed very cautiously:
Drop-in Drama
Pick a few strategic times to drop by: on the weekend; during business hours; late at night. What do you see? Is the parking lot full on a Tuesday at 11 AM? Then, a significant percentage of your tenants may be unemployed. Are there sketchy individuals hanging around the building late in the evening? Does the area feel unsafe to you?
When you drop in, chat with a few tenants and neighbors. Try to get their read on the neighborhood. These are the kinds of insights you’ll never get from a seller or his broker.
If you find the reality on the ground fails to live up to the picture you’ve painted in your head, then either adjust your analysis and projections accordingly or walk away.
Features Unsupported by Facts
Sellers want to make the best case they can for their property. To that end, you can expect an Offering Memorandum and/or a Pro Forma to give off a positive impression.
Trust but verify.
As a diligent investor, it’s your job to dig into all the details. You can’t take a seller’s word for the accuracy of what you’re presented.
Often, there are going to be discrepancies between what you’ve been told and what the numbers actually show. There are times when you can chock this up to an honest mistake. There are other times when the seller’s played it a little too fast and loose with the truth.
Whatever the seller’s motive, discrepancies should give you a moment of pause. The numbers may no longer work. If so, it’s time to renegotiate or walk.
The Books Have Been Cooked
As I said above, discrepancies between advertised features and demonstrated facts should give you pause. They might not, however, lead to you backing out of a deal.
If you discover that those discrepancies are part of a willful attempt to misrepresent the truth, then it’s time to walk. If the broker is to blame, then don’t do business with them again. If it’s the property manager, also put them on your blacklist.
A Different Perspective after You See Comps
After you’ve had a chance to meet tenants, learn the market, and visit comparable properties, you’ll have a much better sense of the property’s future rental prospects. With that information, you can revisit your initial rental market analysis.
Has anything changed? Did you go into the deal expecting to grow rents only to find that the property was maxed out? Have rates in the neighborhood gone stagnant? Is the rent high with respect to area’s median income? Is that income going up or going down?
Sometimes, you’ll find that a firsthand look at the rental market invalidates your initial projections. If that’s the case, and it puts your cash flow at risk, you may need to walk.
Capital Surprises
During due diligence, it’s not uncommon to turn up additional capital improvement and repair expenses. When you look at each unit, you’re going to learn quite a bit about the real condition of the property.
All that is to be expected, but not taken for granted. Take your time, walk the property, and see exactly what you’re dealing with. If you find you’re looking at significantly more than you originally projected, the deal may no longer be feasible.
Before you walk, of course, try to renegotiate. If you can’t, or if you don’t have the capital reserves on hand to deal with the future expense, then kill the deal.
Dried-Up Funding
It’s easy to get wrapped up in a deal and fail to read the writing written on the wall. Often, in those cases, you may get a helpful nudge from a lender, equity investor or a business partner.
If your lender takes a look at the deal and decides they have to lower the loan proceeds, take that as a red flag. What do they see that you don’t? Are they just being difficult; or is there a legitimate reason why they don’t want to make the loan with your projections?
If your partners tell you they’re not interested in joining you on the deal, ask them why. Also, trust their instincts. Especially if you’ve solidified relationships with more experienced investors, you’ll want to trust them when they decide your deal isn’t worth their cash.
If you find yourself having to scrap and scrounge to piece together funding on a deal no one wants a piece of, you should take that as a sign and move on to the next deal.
The Numbers Fall Apart
Of all the signs that’d lead you to walk away, this one is the clearest. If you get to the end of your due diligence and find that the numbers won’t work, then you’ve got two options: re-negotiate or kill the deal.
At this point, you’ve done a lot of work, put in a fair amount of time, and shelled out for lawyers, inspectors, and so on. You’re going to want to make the deal work. If you can re-negotiate, then great. If you can’t, resist that urge to roll the dice and just move on.
Conclusion
To succeed in multifamily real estate, you need more than knowledge; you need wisdom. This business is about more than the science of deal analysis and contract negotiation; it’s about the art of seeing what others don’t and creating new opportunities.
Learning to read signs like these are only a step in the journey towards developing multifamily wisdom—that sixth sense I mentioned earlier. They all come from years of hard-earned experience. If you pay close attention, they might just save you from having to learn the hard way about what sets a good deal apart from a bad one.
Source: Rod Khleif
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