How to Manage Risk on Your Multi-Family Building

By Pierre-Paul Turgeon

Does the idea of multi-family investing keep you up at night? Maybe it’s the fear of the feat itself, or the anticipation of expanding your portfolio. (Heck, maybe you have an apartment building that is taking more than it is giving!)

You’re not alone. In fact, most investors face those same challenges on a daily basis, whether it be fear or anticipation. And one isn’t better than the other; fear keeps you stagnant while being too excited can lead to costly mistakes.

But, regardless of which category you fall under, we have the solution. The key to getting passed these hurdles. What is it?

Risk Mitigation!

All investors should adopt a risk management approach with their investments regardless of the type of investment, real estate or other, by clearly identify the risks and putting in place mitigating measures adapted to the specifics of the deal such as market and property conditions.

This is even more important in multi-family investing because there is practically NO MARGIN FOR ERROR! If you make a mistake, your reputation may be irreparably damaged.

So, how do you manage risk?

Assess the Property Condition

When buying an apartment building, it’s absolutely critical that you ensure a professional building inspector, specializing in this type of property, carefully assesses the physical condition of the property. Take a look at this guide on things to look for when hiring a building inspector to make sure you hire the best option.

Special attention should be given to the remaining economic life (REL) of main building components such as the roof, boiler, hot water heater, building envelope, structural soundness, etc. because these are very expensive to repair or replace. Fortunately, there are local maintenance services that can help you maintain these important components, and you can even pop over to these guys to learn more about them.

You want these building components to be in ‘serviceable condition’ and get written confirmation in the inspection report that their REL is at least five years or more.

If you find you do have to replace certain components like the water heaters then you will want to make sure that you don’t get a cheap replacement as this will just cause you more of a headache in a few year’s time. The GE water heaters are always really reliable and you can click here for more info about them.

Similarly, in case you find the roofing of your building to be worn out and in need of special attention, then do not hesitate to contact a professional who can do the repair work as soon as possible. However, it would be recommended that you learn a bit about various kinds of roofing materials beforehand. For example, many professionals believe that asphalt roofing shingles can be beneficial in the long run. Additionally, with the availability of online guides (like Roofing Insights: Best Asphalt Shingles) for purchasing good quality asphalt shingles, it could be possible for you to gather more knowledge regarding the subject matter.

Anyway, there are a couple of very good reasons for making sure the REL of main building components is five years or more. First, the bank and CMHC will want to know this for financing purposes. That’s because actuaries have discovered that most defaults occur within the first five years of ownership. This is also what I observed in my days as a DMRE manager. If you can survive the first five years without defaulting, you should be good for years to come and reap the benefits of investing in multi-family properties.

The second reason is to enable you to ensure that you have the funds to address these required repairs. You may want to try to negotiate a price reduction from the vendor and if that does not work, raise more money upfront to address them or create a reserve fund. If the REL of any major building component is less than five years, then that item becomes a high priority for me. My job is to protect and preserve the physical integrity of the property to make sure it continues to cash flow for years to come.

SPEND MONEY WHERE IT COUNTS

Many times I have seen novice multi-family investors spend money on the property without discernment as to whether or not it brings them a return. After all, operating apartment buildings is a business and it has to be run accordingly based on return on investment.
My advice? When you first take possession of your property, is to take the time to ease your way into your building until you know it well. Once you’ve addressed priorities as mentioned above, just take a deep breath and watch. Observe the market and determine what stage of the cycle it’s at, adapt your strategy accordingly and determine where funds would be well spent. Look for ways to maximize the performance of the building, namely by increasing rents and by reducing operating expenses.

For example, many investors spend large sums of money to replace all the windows even when the ones currently in place are still fully functional. Even if you have to brand new windows in all the suites, you cannot charge a higher rent to the tenants because of it. There is no immediate return on your money. In any case, you’ll often find that even if you install high-efficiency windows, your tenants will leave them open in the middle of January, regardless.

The same thing applies to high-efficiency boilers and hot water tanks. You always have the choice of going with mid-efficiency systems which often cost half the price of high-efficiency ones and use the extra cash to upgrade a few suites and increase the rent accordingly, which will generate an immediate return by way of a bigger cash flow.

Part of those decisions will be based on your investment horizon – when do you and your investors expect a return? The point here is to think twice about where, and on what, you spend money to ensure that the investment is a priority to preserve the physical integrity of the property and that you get a return on your money.

Be Cautious of Small Markets

The majority of the defaulting apartment buildings I had to manage at CMHC were in smaller and remote markets. This, in and of itself, is quite revealing. I observed that investors who chose to invest in these markets had not sufficiently assessed and mitigated the additional risks this type of market present. Some of these risks include: