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Three Decisions Every First-Time Investor Must Make

Posted on Oct 18 2019 - 8:19pm by Lance Edwards

How to make an initial approach to a changing market.

 

By Michael J. Richardson  (MultiHousingNews.com Article

With new construction expected to slow in the coming year, most economists would still agree that multifamily projects are set to maintain their status as viable investments, even for first-time investors. But how should a first-time investor approach the changing market?

First-time investors should build a business plan around three key decisions:

Pick an investment strategy. Buying a property outright may not make the most sense economically, as it requires having significant capital on the ready (expect $1 million to $10 million). Exhausting all liquid capital for the purchase can also present problems down the road if unplanned repairs or maintenance is required or the return on investment (ROI) doesn’t match initial financial forecasts. Crowdfunding campaigns are a sounder alternative that also generally boast a larger ROI, though it requires more experience to be successful. The most common first-time investment strategy—that also is quickest to market—is joining in with a group of investors who are seeking options to diversify. They invest a small percentage in a sampling of multifamily projects (the equivalent to purchasing mutual funds with annual yields ranging between 3% and 7%) to better estimate where they can expect the highest ROI, and then continue to build their portfolio armed with that data.

Commit to an investment amount. A first-time investor should expect to go in with a range of $150,000 to $5 million to a project. For a $10 million project that requires 30% down to secure the loan, a good entry point might be investing 5% of the $3 million figure, or $150,000. Since the idea is to maximize return on investments, first-time investors must determine which type of CRE property can meet respective expectations and financial projections. Industry reports signal multifamily projects to have a bullish market in the near term. With these properties, only the day-to-day operations, maintenance, and leases must be managed. Investors also have a better understanding of the ongoing operations and profits since rents are ongoing.

Determine the ROI. Depending on the investment vehicle, the ROI can be realized within months or as many as several years from the initial investment. The capitalization rate is heavily measured on the success of the investment, and different assets will allude to different times of recouping the investment. A first-time investor should look at a five-year pro forma analysis that projects the financial return on the real estate project and gauge where there is opportunity for growth.

Regardless of how a first-time investor approaches entry into the market, proper due diligence cannot be shortcut. Connecting with experienced third-party consulting groups—including appraisers, acquisition firms, brokerage firms or title companies, and local and state municipalities—can provide guidance to both seen and unseen variables associated with any project, such as a property’s age and maintenance history, among other critical factors.

First-time investors who are diligent to invest the appropriate time and energy into the discovery process and have a detailed business plan at the ready will also get the proper attention of lenders. Project financing isn’t secured based on gut feeling; it takes a loan application that’s complete, accurate, and well packaged for the lender. This means having all requested information in one location before the lender’s initial review and taking a transparent approach in sharing respective financial histories—good and bad. As an example, the lender should know up front if an applicant has ever had a property foreclosed upon or has claimed bankruptcy for a failed business venture; it will only save time and usually curry favor.

While not every lender will offer the loan type needed—for instance, a bank may only handle refinances and not new construction loans—or be willing to extend capital with the same terms, there are more options to source CRE funding today as more community banks and credit unions have diversified their lending portfolios, and nonbank alternative lenders grow their share of the pie. First-time investors are an important component of keeping multifamily alive; everyone has to start somewhere. Going into the process well informed and well prepared will stand out to lenders, and propel the investment journey.