Every year, many individuals start out with the intention of making it big in real estate.  Many never get past their first investment and only a handful ever create real wealth and build a large portfolio.  Buying correctly is probably the biggest determinant in the financial success in multifamily investment.

If purchased right, multifamily properties can create strong cash flow and help build long term wealth.  In addition, rents can be increased over time, creating an even better investment.  But while multifamily can be a great investment, it also comes with the risk of moderate or even severe financial loss.  Many new investors overlook these pitfalls in their quest to create a passive income empire.

Learning from mistakes can be a great way to grow and improve your real estate business, but those mistakes don’t necessarily have to be your own.  Below are five of the biggest mistakes I’ve seen investors make prior to purchasing a multifamily property.  They are listed in no particular order.  Often, these investing mistakes come with a high price tag – and in some cases they will mean the difference between creating wealth in real estate or never getting beyond your first investment.

Mistake #1:  Not Doing Your Own Research

Sure, the broker package says there is 10% upside in the rents.  But is there really?  If it was that easy to raise the rents, why hasn’t the current owner increased them?

And, even if the newest tenants on the rent roll are paying 10% more, what is the quality of those residents?  Did the owner drop his standards in order to ‘prove’ high rents (for the purpose of selling the property for top dollar)?  Did the unit sit vacant for two months just waiting for the one person who was willing to pay that much?

Also, were any concessions given?  Perhaps a free month’s rent, or a lower security deposit.  Without doing thorough due diligence, you won’t really know.

Your job is not only to see the potential of the deal, but to take the time and look for possible hidden issues.  Go through the property files.  Maybe the Seller has collection problems with the current residents.  Unless you look at the collection and delinquency history for each month, you probably wouldn’t discover that.

Use this time to review any surveys, title reports, and all legal documents.  Check for any liens or encroachments on the property.  Go down to the building department and check the permit history.  Usually there is no problem, but I’ve occasionally found enough issues to make me want to walk away from the property.

Mistake #2:  Being Too Aggressive with the Numbers

Many investors have had their plans destroyed by overestimating items such as how quickly they could turn units and lease them up, how much rent they could achieve, how easy it would be to pass through utilities, or how quickly they can stabilize a poorly performing property.

You might think you can bring those existing ‘low rent’ units up to market rate by simply issuing a rent increase.  But in their current state, market rent for those apartments might be lower than you think.  And, if by going ahead and doing the rent increase anyway, you create vacancies, do you have the funds available to turn the units and do whatever upgrades you have planned?  How will that impact your pro-forma?

Best to be a little conservative with your projections.  If you can make the property work under a conservative scenario, then should you do better than planned, it is all upside.

Mistake #3:  Not Doing a Thorough Physical Inspection of the Property

While you are in the inspection period, you need to check every unit.  I’ve heard too many horror stories of investors who only walked a ‘representative sample’ of the units only to later find out the units they didn’t walk were in much worse condition.

It’s not only the apartment units that might need a lot more work to bring them up to market, you might need to replace some of the major building systems.  Maybe the roof only has another year or two of life in it.  How’s the water pressure?  Do you see lots of extension cords when you walk the apartments?  You may have a potential fire hazard as wires are being overloaded.  Are any windows or doors sticking?  This could indicate a settlement problem.

There are many issues that you would only discover during a physical inspection.  Maybe you come across a sump pump in the basement, which triggers questions about the building flooding occasionally.  Are there any signs of mold growth or dry rot?

Check the permit history.  Were any major improvements done without permits?  If you’re planning to do any extensive upgrades, make sure there are no hidden surprises.  For example, if you want to increase the electrical service to the apartments, do you need to relocate the subpanels?  Are you required to move the meter locations?

You want to know as much about the property as possible BEFORE you buy it.  Act as if you are bringing investors/partners into the deal, even if you are not.  Could you answer all their questions about the physical aspects of the property and its operations?

Mistake #4:  Relying on Market Appreciation

Seasoned investors know that they need to be the ones to create the value.  Rents can both increase and decrease.  Appreciation is not guaranteed.  If you can’t make the property cash flow, after implementing your business plan, then you are paying too much for it.

Markets go up and down.  Neighborhoods can change.  You want to make sure you’ve built in a cushion on cash flow.  That’s why many lenders insist on a 1.25 or 1.3 debt coverage ratio (that you have at least 25% or 30% more cash flow projected than it takes to make the mortgage payment).

What are some ways to ‘force appreciation’?  You can add additional services or amenities that will allow you to increase the rent.  You can convert extra space to rentable space, such as for storage.  You can start charging for amenities such VIP parking.  You can reduce unnecessary expenses.  Anything that increases your NOI and cash flow will help increase the value of the property.

Real estate is a great long-term investment.  But there will be ups and downs along the way.  Cash flow is like oxygen.  You can’t go too long without it before it can kill your investment.

Mistake #5:  Not Really Knowing the Market

You can’t truly know the market until you are in the trenches and actually trying to rent your apartments.  However, that is not an excuse for doing a little more research than the average buyer.  Many years ago, I was sold an apartment property that appeared to have good upside.  The units were large, the rents were low, and if the landscape was redone, this property would really shine.  Little did I know that I was one block over on ‘the wrong side of the tracks’ and that no amount of work I did on the property would overcome the local reputation of the street my future purchase would be on.

Speak with some property managers or other owners who operate buildings in the area.  Go by the property at night and see if things are still as peaceful as when you walked the units in the morning.  Go online and do research about the area.  Check crime statistics.  Find out about the schools.  Speak with local merchants and others that know the neighborhood to get a better feel for the potential upside of your purchase (or lack thereof).

Do The Work BEFORE You Buy the Property

There will always be issues with properties.  In fact, the way you make money in real estate is by solving problems that the previous owners did not.  However, too many people rush into a purchase without really knowing what they are getting into.  Zig Ziglar once said “Some of us learn from other people’s mistakes, and the rest of us have to be the other people”.

Before purchasing a multifamily property, you must examine all the information provided to you by the Seller and by the real estate agent.  If you are new to this, see if you can get someone (who doesn’t stand to gain or lose anything on the transaction) with more experience to be a second set of eyes and help you in your analysis.

You want to know everything you can about the property you plan to purchase before you buy it.  Sometimes it is hard to walk away when so many hours have been invested into a potential purchase, but the cost of deciding not to move forward now is minimal compared to the cost of being stuck with a poorly performing property.  I know – it happened to me in my early days of multifamily investing.  Don’t let it happen to you.