THE 8 REASONS WHY COMMERCIAL INVESTMENT PARTNERSHIPS GO BUST
Development and Rehab Costs Do not overimprove the property. Improvements must add value. Adding value means increasing the rent charged or occupancy of the property through these improvements. If the improvements don’t add value, they should not be underwritten. Not all expenses and improvements are considered to add value. Everyone expects to have lightbulbs and toilets in their apartments. Adding value means New-Skin bandages, a paved parking lot, and perhaps a new lobby for your tenants to brag to their friends about. Expert Tip: Don’t be surprised to see property taxes on multifamily dwellings perhaps double, as local politicians are desperate to close their widening budget gaps. The fourth reason real estate can become distressed is capital structure : The investment structure should align interests and reward those taking the risk. This is simply asking the operator how much money he or she has in the deal, meaning hard-cash equity. And is that equity the same as your equity? If an operator has no skin in the game, then you know for sure there is nothing preventing them from walking away from your investment. Always remember going forward that aligned capital is the best kind of capital. The fifth reason for distress is the absence of key leasing or sales . In value-added transactions, operators perform a lease-up on occupancy. These numbers should be reviewed via a sensitivity analysis to understand the magnitude of the risk that will be involved if they are not achieved. Again, only an experienced operator who knows how to look at these numbers dispassionately will understand to do that. The sixth reason for distress is that the property may have been overleveraged . Here is a very important question to ask: “What
There are many potential reasons why a perfectly performing real estate deal could become distressed. This article will discuss those warning signs to look out for. The first reason is bad operators . Bad operators are always weak and inexperienced. They manage the real estate/asset themselves, usually under the banner of saving expenses. Frequently, these first-time operators don’t know how to value these multifamily buildings and are emotionally driven to overpay, desperate to get their first deal done, which is why they can’t afford a professionally licensed and insured property management company. These bad operators usually make their debut well into a market cycle just before it collapses by being the highest bid. By comparison, good operators have experience. They’ve been through two economic cycles and can turn bad deals into good ones. They look at investing dispassionately, driven mostly by the numbers.
The second reason a deal could become distressed is too much time . This is specific to those “rehab and flip” value- added deals, which are meant to be started and finished in a short amount of time. Routinely, the term runs out on their loan or the repairs and expenses have been going on far too long so the operator can never get out from underneath it. Whether the operator knows it or not, they have passed the point of profitability on the deal. They can’t get another bridge loan. Time and expenses ruin all deals and send them to the graveyard sooner rather than later, and this is why having an experienced operator who has been through at least two cycles is so critical. An increase in costs without an increase in revenue raises the asset’s cost basis and reduces returns. The operator must have control of all costs, including these: Acquisition Costs Do not pay too much on day one of the deal. The purchase price is where the money is made on real estate deals. From my experience, operators who have bought toward the top of the market because a lender was willing to lend them the money almost always have The third reason is that the costs were underestimated .
problems later. Markets work in cycles, and the worst time to buy anything is when you feel as though you need to. That false sense of pressure has killed many operators.
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