Multifamily #1 Year one reflections

Last updated on 24 Dec 2024

How we got here, and the big lesson

In June 2019 I made the jump from single family rentals to multifamily, there are A LOT of good reasons to do this and I’ve written extensively about how I made this switch. I am now past the one year mark with this asset and I thought it would be useful to discuss the lessons I’ve learned and the mistakes because like all the content I make I like to leave bread crumbs along the way to make your life easier. Additionally, I’m about to buy another one of these multifamily properties and now I have experience, I have more knowledge, more confidence, and I feel downright DEADLY going into my next deal. If you want to participate in a deal with me in the future you should be able to read this and know without a doubt that I know my shit….despite some glaring mistakes I made along the way.

The biggest mistake I made on this deal is the biggest mistake most business owners make all the time: going in under capitalized. That decision permeated through this entire deal and amplified all sorts of other mistakes I made that would otherwise not be such a big problem. The deal itself is solid, it was how I structured it on my end that I screwed up. Most of the following problems I’m going to talk about all stem from this initial error, but I’m going to go through my thoughts in detail because NUANCE MATTERS If you don’t want to watch this whole video and don’t care about the nuance of why this is important but you can just take this big lesson and leave: go in with a MORE MONEY than you think you need…. then add another 15% on top of that. Don’t get cocky kid

Ok here are the bulk of the mistakes I made on this deal and how I intend to fix them for the next one.

Double insurance escrow costs

This happened right off the bat and I didn’t expect it, and I totally should have because I’m in lending but when you’re doing these deals there are so many moving parts it’s easy to get lost in the details. In single family homes I pay for the first year of insurance out of pocket in cash and then I build the next year’s insurance into escrow with the mortgage, but on this deal we didn’t pay the insurance for year one up front and the bank wanted year 2 insurance built into escrow from the start. What this means is we were paying year 1 insurance costs out of operating expenses, and year 2 out of debt service, this was an extra 5% of my gross income right out of cash flow, ouch bro! Additionally the bank takes another $500 per month out of my cash flow for repair escrow, now this money is sitting at the bank and I’ll get this back but it still hurts my cash flow month to month and specifically, investor returns. These two things have been very painful and I’ll NEVER make those mistakes again and you shouldn’t either.

The fix

In future deals I will raise the money for entire first year insurance costs from the initial capital raise and pay it up front. I also want to account better for repair escrow costs but those aren’t as negatively impactful to me. Neither of these things change the total money of the deal but it does change how the funds flow which is to say it really hurt my cash flow year one and for no reason other than poor preparation. Lesson learned!

Expectation management for my investors

I should have been more patient with this deal, I sort of knew this thing would take a year or so to stabilize and I under-appreciated that process. In retrospect I might have been able to turn it faster if I were more experienced but through this past year I was constantly beating myself up giving my investors less than fantastic news (even though the deal has still been profitable). I knew the deal wasn’t bad and I knew it would turn around but month after month we were basically breaking even after escrow costs. This made me feel horrible because taking investors money and paying them profit on that money is something I take extremely seriously, it’s the most serious responsibility of my life, and if I had just prepped them better on a tough first year of stabilization then all would be good. We weren’t losing money, but the returns were quite a bit less than I had wanted while we got all the old tenants out. Part of this was because of those artificial escrow costs as I described above, but the real problem was that I didn’t have a big pile of extra cash to weather the pain while I stabilized because I was undercapitalized.

The fix

Now that we are past year one our incomes are stabilizing, my double insurance costs are gone, the property is starting to kick off really good cash flow. It’s a good thing to expend emotional energy on things we care about but I invested a lot of unnecessary stress into this deal and I mis-set investor expectations where under promising and projecting a slow start would have been a better approach. In future deals I’m going to build in a higher expectation of volatility in the first 12 to 18 months, I’m going to raise the funds to cover that volatility, and I’m going to manage my investor expectations better. Underpromise and over deliver bro!

I assumed I could do unit improvements from cashflow

In retrospect this is a ROOKIE MISTAKE and a lazy mistake. When we took over this asset we had a tenant base that didn’t take care of the property very well and had a ton of late/no pays. The previous owner did a fast lease up when he was prepping to sell and the quality of tenant just wasn’t that great, and that’s not a dig at all at the seller this is an extremely common thing you’ll see happen because it’s impossible to sell a property with a high vacancy. Once we took it over what I should have done was start evicting people left and right, rehab the units when they moved out, bump rents, and start jacking up the income side. The problem is since the tenants weren’t paying well so my cash flow wasn’t that great, I couldn’t afford to kick people out because I didn’t have a big chunk of cash on the sidelines as a safety net, which means I definitely couldn’t afford to do big rehab, which left me only one option – hobble along and try to eek out small increases in tenant quality and stability with normal turnover. We got through it, but it just could have easily not worked. What took me 13 months should have taken me 4 or 5 months if I had put together a big capex budget right from the beginning.

The fix

Raise money for improvements at the time of the closing. I raised about $280,000 for this property but if I had raised just an extra $35-40K or so from the start almost all of my first year problems would have been solved.

Single bedroom homes means limited upside

Those are the big mistakes I made and I’ve been able to fix most of them inside the first year but they are still things that cost me time, money, and stress. They say a smart man learns from his mistakes, but a wise man learns from other people’s mistakes, meaning I hope YOU are paying close attention.

The property is pretty stable now and it’s kicking off more cash flow than ever which allows me to reliably provide great returns to my investors. I make this content focusing on the negative because it’s addressing our mistakes that make us better, not patting ourselves on the back. I also don’t care for anyone’s approval so telling everyone how great I am does nothing for me and it doesn’t help you but talking about my errors instead of wins may actually be of help to you.

Wrap

What’s next?

I’m going under contract for a new property in the next few days. I’ve fixed all the mistakes I listed here, the property is a better quality and has a higher upside, and I checked my ego and tagged in a partner that was smarter and more experienced than me to help.

I hope to make a post for that property once we close it, but for anyone trying to make the transition from single to multifamily I hope this post can help you. Feel free to email me if you have specific questions.