Most of us would like to avoid Risk, but lenders and professional investors, know that understanding risk is actually their path to long term success.
It’s important for all multi-family investors to understand the lender’s perspective because when you have a commercial mortgage / construction loan, your lender ultimately has a great deal of control.
Multi-family income property is an great way to build wealth and right now, it’s the perfect way to hedge against inflation, but most of us do understand that you just you don’t make money without risk, right?
Now if you’ve been out looking for multi-family investment properties to buy, you’ve probably found that any property in good condition, in a good area with good cash flow will cost so much that you won’t be able to make very much money on it.
If you want higher returns (which most investors do), you need to find properties that are underperforming and can be renovated and re-positioned to increase their income, these are what they call “Value Add” deals.
Likewise, Developing new construction multi-family is like the ultimate value-add deal because it is 100% new. These properties attract the best tenants and generally get the highest rents for the area. When executed properly, they can also create the highest returns.
Having been on the Board of Directors and the loan committee for a Chicago community bank specialized in real estate lending from 2005 – 2010, I want to talk about the risk factors involved in multi-family deals that involve new construction and/or renovation.
The fact is that, assuming the principals know what they are doing, the vast majority of Value Add or New Construction deals are going to be quite successful and profitable, but once in a while, they can and will run into troubles.
If you do 10 deals and 7 are very profitable, you may have one or two that are only so so and you may also have one or two that get caught in a bad market period.
To mitigate risk, we want to consider what can happen if things don’t go according to the original plan and have some contingency plans in place.
Once they are completed, leased up and stabilized, these projects will have all the same risk factors as any other stabilized properties you might purchase. Less actually because they will be new or newly renovated.
Of course the income numbers projected in their loan application rely on renovation / construction being completed before they can be leased at these higher rents.
This means that they will be subject to additional construction related risk factors. These risks are what we discuss here and in the next video where I’ll discuss why you need to understand the lender’s perspective on Loan to Cost and Loan to Value ratios and how they affect you.
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