How to Manage the Risks of Multifamily Investing

Interest in multifamily investment is growing exponentially. According to data, the U.S. multifamily market recorded a positive net absorption of 70,200 units in Q2 of 2023, the highest quarterly demand recorded since Q1 of 2022.

As more investors chip into this lucrative sector, several are wary of the risks that multifamily investing may pose, potentially making their efforts unrewarding. Like any other investment, multifamily properties pose several risks such as market volatility, financing risks, tenant turnover, and illiquidity.

Here's a comprehensive look into the top risks you may face as a multifamily investor and strategies you can use to mitigate them effectively.

The Top Risks of Multifamily Investing

Multifamily investing can be highly rewarding if done right. There's high trust in the sector from investors, with data showing that investment volumes have been increasing yearly, with 2022 recording a volume of $234 billion, 10% higher than 2021's $213 billion.

However, there are risks these investors have had to work around. Here are the top multifamily investment risks you should be aware of.

Market Volatility

Real estate markets are not immune to market fluctuations. Changes in job market conditions, interest rates, and overall economic health can impact property values and rental demand.

For multifamily properties, market volatility affects property appreciation and rental income, which can affect the asking price of your property if you choose to sell it later.

Asset Risks

Multifamily properties are affected by asset risks, including the property's physical condition, value, utility issues, structural and code issues, and crime rates in the neighborhood.

Your property's current rental income and expenses will also play a crucial role in its valuation. Moreover, without proper due diligence, you risk overpaying for an overvalued asset with high inherent risks.

Stiff Competition

High competition for tenants can affect the returns of your multifamily property investment. If you buy in a rapidly developing area, you risk new competitors developing newer and more featured properties with various amenities that can compete steeply with your property.

In some markets, construction materials and labor shortages may lead to steep renovation and development costs. Depending on how much renovation work you must do on the property to be competitive, this can bite deeply into your profit margins.

Property Management Challenges

Multifamily properties require careful management for the multiple units and tenants. Lack of proper management can lead to several issues, such as high tenant turnover if tenant issues are not addressed quickly, property deterioration due to poor maintenance, and loss of value by your property, leading to losses.

Inherent Real Estate Risks

Multifamily properties are subject to inherent real estate market forces that can value or devalue your property. For instance, there's the potential risk of selling your property at an inopportune time if you acquired it at the height of the market before a slump in demand.

If you're unaware of the market cycle in the area you're investing in, you may buy into the multifamily investment market at the wrong time.

Legal and Regulatory Risks

Real estate investments, including multifamily properties, are subject to various laws, compliance requirements, and regulations. Lack of compliance and adherence can lead to various legal issues, penalties, or fines.

To avoid legal complications, you should understand your local landlord-tenant laws, zoning ordinances, fair housing regulations, and building codes. Therefore, you should consider working with real estate attorneys and property managers.

Financing Risk

Multifamily properties purchased using short-term variable interest rate loans are typically at risk of interest rate hikes. When interest rates rise due to economic fluctuations, the cost of the loan will also hike, thinning your cash flow.

If your cash flow is significantly affected that it can't service the loan, you risk defaulting and losing your property. While short-term financing options often have refinancing as an option once the financing term matures, it may not always be available, forcing you to make an exit sale.

Tenant Turnover and Vacancies

Vacancies and tenant turnover can significantly affect your multifamily property investment returns. When your units are vacant, you earn less rental income, heightening the burden of covering expenses.

Frequent tenant turnover also increases leasing and marketing costs since you must advertise the vacancies and prepare new leases more often.

Real Estate Illiquidity

Real estate is a hard asset that is typically illiquid. This means that it's hard to quickly dispose of it and get cash to boost your reserves or add to some capital. Multifamily projects typically last 5 – 7 years. Moreover, a disposition can be postponed due to market conditions, significantly affecting your returns and resulting in losses.

Therefore, capital investments in multifamily property can be inaccessible for years.

Strategies You Can Use to Mitigate Risks in Multifamily Investing

It is almost impossible to make any multifamily investment risk-free. However, you can use a few strategies for risk management for multifamily properties to ensure your efforts are not wasted.

Here are the most effective ones.

Check the Property Condition

The condition of a multifamily property is a crucial factor in assessing its risks and potential losses to an investor. A property in poor condition will need expensive repairs and renovations.

To mitigate this risk, you should have a qualified inspector evaluate the property and identify any potential issues affecting its value before purchasing.

Moreover, after acquiring the property, you should invest in a professional property management team that will maintain and improve your property to ensure it remains in top condition and retains its value.

Factor in the Cost of Financing

Before buying a multifamily property, you should ensure the investment is financially viable. Therefore, you should factor in the cost of financing, including fees, interest rates, and closing costs.

To mitigate the financing risks, you should work with an experienced lender who will provide competitive financing terms that are not easily prone to interest rate hikes. You can also consider unconventional financing options such as private lending or crowdfunding.

Assess Market Saturation

Overbuilding in real estate markets is one of the primary causes of high vacancy rates and lower rental rates. Therefore, before buying into a market, you should conduct thorough market research to ensure the location is not saturated with multifamily properties.

This research includes analyzing supply and demand trends, demographic data, and rental rates.

When assessing the market saturation risk, you should also consider the local job market and economy. Markets with low unemployment rates and strong job growth are often low risk.

Invest in Tenant Retention

Reducing tenant turnover will ensure your property has very low vacancy rates, boosting income. You can improve tenant retention by providing high-quality services and amenities that will keep tenants satisfied and motivate them to stay.

You can also offer lease renewals with incentives to encourage current tenants to stay.

Work with an Expert Who'll Help You Manage Your Risks

Investing in multifamily properties is rewarding for most investors. If you know your risks and employ the right strategies to mitigate them, you'll enjoy greater returns from your investment in the long term. Talk to an expert and learn how to make a risk-managed multifamily investment.