Everyone who has successfully broken into multifamily real estate (MFRE) investing will agree on one thing: Your first deal is the most important. Why? Because brokers, sellers and lenders will not take you seriously if you’ve never owned multifamily property. You’re a newbie, a tire kicker, a waste of their time. This situation presents a real problem: no one will do business with you when you’ve never closed an MFRE deal, and you can’t close a deal when no one will do business with you. In a very difficult profession, getting your first deal could be the biggest obstacle of all. But you can overcome it.
The Problem: Newbies are Risky
Very few MFRE professionals want to do business with new investors because most newbies will waste the professional’s time, money or both.
The risk for a seller is that a property goes into contract but the deal does not close. Once a deal goes to contract, a seller must expend significant time and effort providing due diligence materials to the buyer, lender, and third parties such as surveyors, title insurance companies, and appraisers. It must deal with irate tenants upset over disruptions caused by the inspection process. The seller will incur unrecoverable expenses connected to the transaction, like legal fees. And, most importantly, the market may move against the seller while the property was off the market during the contract period. Thus, sellers are wary of new investors, who may not have the resources or qualifications to close the transaction. For this reason, a seller may reject a higher offer from a new investor in favor of a lower offer from a buyer with a history of closing deals.
For brokers, the buyer’s ability to close trumps everything else. Brokers spend significant amounts of time and money preparing and marketing a property for sale. Once a deal goes under contract, they will also spend significant time helping the seller provide due diligence materials to the buyer. Most importantly, brokers are only paid if a deal closes. And almost as importantly, brokers risk their reputations with their clients, the sellers, if they bring unqualified buyers to the table.
Lenders also see significant risks in dealing with new investors. A very important consideration for them is the buyer’s ability to operate the asset properly and maintains its value as collateral for the loan. Lenders favor buyers with a history of successfully operating multifamily properties, and some lenders will even require a borrower to have two or more years of prior operational experience, regardless of the deal’s inherent attractiveness or the buyer’s creditworthiness. Sellers and brokers also know it may be tough for new investors to qualify for mortgage financing, and for this reason as well, they may be resist doing business with them.
In reality, sellers and brokers have very few ways of determining whether an investor really has the resources and qualifications to close the deal. (Lenders will get your balance sheet, so they will know.) So, sellers and brokers have nothing else to go on but your past history. Even though closing prior deals is no guarantee that a buyer will be able to close this deal, sellers and brokers usually feel that a buyer with a track record is less of a risk than a new investor, whose ability to close is unknown.
The Solution: Build Your Credibility With Stakeholders
Just because you have no history of closing deals and running MFRE properties, don’t give up hope! Everyone in the business got past this hurdle. So can you. The key is to develop credibility as an investor even though you don’t have a track record. These steps will help.
You’re An Investor: Own It
A typical mistake new investors make is not to believe they are investors until they close a deal. If you don’t believe you are really an investor neither will anyone else. If you are devoting substantial time and effort to learning this business, then you are an investor. Believe it, be it, and own it. Doubt yourself, and so will they.
Develop Your Knowledge and Learn the Lingo
For anyone to believe you are an investor, you must sound like one. You must master the essential concepts of multifamily investing and understand the profession’s vocabulary. If you don’t know the meaning of “cap rate” or “economic vacancy,” you had better learn now.
Fortunately, many educational resources are available, from books to websites to full-blown certification courses like CCIM. Broker packages are an excellent overlooked resource. Many brokerages allow anyone to register on their site and receive all of their offering materials. These materials are a treasure trove of information about how brokers and investors think. And while broker materials should be seen for what they are – sales materials – they are a terrific resource for helping you learn the lingo.
Leverage Your Own Credibility
Just because you don’t have a background in MFRE doesn’t mean that your background is irrelevant. In fact, it can greatly enhance your credibility with people in the real estate field. Did you graduate from a well-know university? Do you have an advanced degree? Do you have a prestigious professional job such as doctor, lawyer, banker, consultant, etc.? Have you successfully built a business in another field? Have you already built a portfolio of single-family homes? Whatever your background, you can mine it for elements that make you stand out as professional and accomplished, and these elements will help you establish credibility with people in the MFRE business.
Build A Team
If you really want to build your credibility before you go out and try to find deals, you must build a team of professionals. In addition to the management company, you will need a real estate lawyer to help you negotiate the purchase contract and close the deal and the loan; a real estate accounting firm to prepare tax returns and prepare financial statements; a surveyor; a title insurance company; and, if you are using investor money, a corporate and securities lawyer to prepare the proper legal documentation for investors. Having these professionals in place in advance will show brokers, bankers, sellers, and investors that, even though you are new, you are well prepared and serious about this business. It will enhance your credibility, as well as make it much easier to close the deals you do find.
Cloak Yourself in Others’ Credibility
If all these steps fail, you still might be able to gain credibility by borrowing the credibility of an experienced partner or mentor. If you can show deep knowledge and real dedication, you may be able to find a veteran who is willing to help you. But be forewarned: this is not easy. Most newbies know nothing, are unreliable, and frankly are more trouble than they are worth. And an experienced investor will be very reluctant to risk their reputation on you. So you will have a great obstacle in convincing someone to mentor you. At the very least, you will have to do all the hard work on the deal and give away a very large piece of the upside. You might even be left with only a tiny sliver of the equity in your own deal. But, if you can pull this off, the mentoring, experience, and credibility you receive along the way – and getting that all-important first deal done – will more than make up for it.
Cultivate Relationships with Brokers Ahead of Time
Brokers are the gatekeepers in the business, as well as enormous sources of information, and you must make them your allies before you actually need them.
- Brokers are like everyone else: they prefer dealing with people they know. Build relationships with brokers before you start looking seriously at properties, so when you’re ready to buy they are already on your side.
- If you can, meet brokers through personal introductions. Ask your network if anyone knows a commercial broker. An introduction from the broker’s business acquaintance is helpful, but an introduction from a mutual friend outside the business is even better. Either will provide you with a level of credibility that a cold call never can.
- Do your homework before you meet a broker. Make sure you speak the language of the business. Google the broker, learn about his background, and study his current listing materials thoroughly. Demonstrating deep knowledge of him and his business will help you overcome any resistance he has to working with you.
- Once you’ve met a broker, don’t wait until you need a deal to call him again. Build the relationship now! Take him to lunch or coffee periodically. Tell him about your plans and demonstrate that you understand the business and the market. Most importantly, show a personal interest in him. Learn about his family, interests, and personal problems you may be able to help solve. It’s Networking 101, and works with brokers too. If you show interest in their success, they will take an interest in yours.
- Try to solve a lingering business problem. Ask the broker to show you old deals that never got any offers or fell out of contract – in short, deals he had given up ever making money on. Even if he’s not yet willing to trust you with one of his sweet deals, he may take a chance on you with one of the dogs. Put together a creative offer that shows you understand the difficulties of a dead deal; if it’s good enough, he will become your advocate with the seller. And, if you close the deal and make him money he never thought he’d make, you will become a go-to client.
- Don’t waste the broker’s time! Don’t overstay your welcome and make them think you are a time-sucker. Keep your meetings short. Leave the broker wanting more.
Demonstrate Your Credibility to the Seller with Proof of Funds
A seller may refuse to deal with you if he doubts your ability to close the deal. One way to overcome this doubt is with “proof of funds.” If you, your partners, or your investors have the funds available for the equity portion of the purchase price, offer to get a letter from an accountant or bank attesting to this fact. If a seller sees proof of funds, it may put their doubts about dealing with you at rest.
Demonstrate Your Credibility to Lenders With A Professional Management Company in Place
Having the right team in place can help you overcome lender resistance as well. Lenders may feel it’s too risky to lend to a new investor with no experience running a multifamily property. One way to overcome this is by having a partner with experience operating properties. Another way is to install an approved professional third-party management company to run the property’s day-to-day operations. If the lender knows that the asset is in professional hands, it may be more likely to lend on your first deal. Depending on the size of the property, you will have to pay somewhere between three to ten percent of revenue to hire a qualified manager, but on the other hand you won’t need to take the 3:00 am calls about backed up toilets.
A Word About Lenders and Your Personal Net Worth
Another issue faced by multifamily investors is qualifying for a mortgage. MFRE is considered commercial property, and, unlike residential mortgage lenders, commercial lenders require a borrower to have a net worth equal to or greater than the size of the loan they’re making, regardless of the value of the deal. If you’re seeking a $500,000 loan, you will need a net worth of at least that much to qualify. If you do not have the requisite net worth, then you will need a partner who does. You will have to share equity in the deal, but bringing on such a partner will help you get the deal done. You will need to have financially strong partners in all your deals, and give them equity, until your net worth has grown to the point where banks will lend to you on your own.
In the End, It All Comes Down to Networks and Teams
You’ve probably heard it before, but real estate truly is a relationship business. If you are serious about investing in MFRE, then you must spend the time and effort in developing a team of professionals and a network of brokers, bankers, and potential investors in advance. The time and effort you invest in building your network and your team will not only help you find that first deal, but it will also help you to close it, finance it and operate it successfully.
