Welcome, Small Axe Community! It’s your boy, Nico, here to help you sharpen your small axe and build your personal empire through multifamily investing. Today, we’re tackling a critical topic that every investor, new or seasoned, needs to hear: Don’t Do That Deal.
In the world of multifamily real estate, not every deal is a good deal. In fact, only one out of every hundred deals you analyze may be worth pursuing. The problem is that many of us get emotionally tied, financially committed, or just plain eager to close – even on deals that don’t truly make sense. This blog will break down the signs, red flags, and hard-earned lessons that will save you from making costly mistakes.
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Why You Should Walk Away
Let’s face it: there’s always another deal. As investors, we sometimes forget this when we’re desperate to close. But forcing a bad deal into your portfolio can do more harm than good. **The best deals are sometimes the ones you don’t do.**
Here’s an example from my own experience:
– I once got a nine-unit property under contract with potential for a tenth unit. It seemed like a decent deal on the surface.
– During due diligence, I found out the property was zoned for only nine units. Adding the tenth unit would require significant legal and permitting hoops.
– Then, I discovered the septic system needed to be completely replaced – an unexpected, expensive repair.
– The seller wouldn’t budge on price, and I was tempted to push forward, trying to make the numbers work.
Had I done the deal, I’d likely still be struggling with challenges like legal headaches, capital expenses, and a property at the mercy of market fluctuations. Instead, I walked away. While I lost some inspection money, I saved myself from years of stress and financial strain.
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Red Flags to Watch For
To help you avoid bad deals, here are some common red flags that should make you think twice before signing on the dotted line:
1. Market Issues
– Declining Population: Is the local population shrinking? This can be a sign of economic trouble.
– Overreliance on a Single Employer: If the area’s economy depends on one large company, it’s a major risk if that company leaves.
2. Submarket Problems
– Crime Rates: A great property in a bad neighborhood won’t attract good tenants.
– High Vacancy Rates: If neighboring properties are struggling to lease, you may face the same challenges.
3. Property-Level Concerns
– Deferred Maintenance: Major repairs like HVAC replacements, roof damage, or plumbing issues can crush your budget.
– Outdated Systems: Older buildings often come with hidden costs, like asbestos or knob-and-tube wiring.
4. Financial Red Flags
– **Unrealistic Proforma Numbers**: Sellers and brokers may present “rosy” projections that don’t align with reality.
– **Cash Flow Problems**: Verify rent collections. If tenants aren’t paying or rents are artificially inflated with concessions, your income won’t match expectations.
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Lessons Learned: My Takeaways from Nearly Doing a Bad Deal
Here’s what I’ve learned from walking away from bad deals:
1. Don’t Pencil Whip the Numbers
– Don’t manipulate underwriting to make the numbers work. If the deal doesn’t meet your investment criteria, walk away.
2. Be Realistic About Risk
– Deals with major risks – like heavy deferred maintenance or potential natural disasters – require significant experience and capital reserves to handle.
3. Stick to the Fundamentals
– 1% Rule: Ensure the property’s monthly rent is at least 1% of the purchase price. In today’s market, strive for even better metrics.
– Cap Rates: Be cautious of properties priced at compressed cap rates that don’t align with market trends.
4. Understand the Market Cycle
– Timing matters. The same property valued at a 5% cap rate in 2021 might be worth significantly less today at a 6.5% cap. This can drastically impact returns.
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How to Avoid Bad Deals
1. Do Your Due Diligence
– Inspect the property thoroughly, including structural elements, systems, and environmental risks.
– Verify rent rolls and collect delinquency reports to ensure tenants are paying.
2. Stress Test the Numbers
– What happens if rent growth stalls?
– What if vacancies increase?
– Can the deal survive in a worst-case scenario?
3. Leverage Experts
– Partner with experienced mentors, property managers, and brokers who understand the local market.
4. Have the Courage to Walk Away
– Even if you’ve spent time and money on inspections, it’s better to cut your losses than commit to a bad deal.
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Key Checklist: When to Walk Away
Use this quick checklist to evaluate whether a deal is worth pursuing:
– Is the property in a growing market with job diversity?
– Does it meet your underwriting criteria without manipulation?
– Are deferred maintenance and CapEx costs manageable within your budget?
– Does the deal cash flow positively from day one?
– Have you verified all seller-provided data during due diligence?
If the answer to any of these questions is “no,” it’s time to reconsider.
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Final Thoughts: Patience Pays Off
Investing in multifamily real estate takes time, patience, and a sharp eye for detail. Remember: It’s better to walk away from a bad deal than to spend years regretting it.
If you’re struggling to evaluate deals or want to sharpen your underwriting skills, check out the resources on my website, [Small Axe Communities](www.smallaxecommunities.com). You’ll find tools, templates, and insights to help you grow your multifamily portfolio with confidence.
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Let’s Build Together
I’d love to hear from you! Share your “don’t do that deal” stories or questions in the comments below. Together, we’ll keep sharpening our axes and building empires – one smart deal at a time.
Remember, the best deals are often the ones you don’t do.
– Nico Salgado
