Have you invested in a real estate deal and had something go wrong?
You're not alone. No deal goes perfectly for the whole time you own it. Even when distributions are beating projections, a good sponsor is still sharing the bad news along with the good.
The better question is whether they told you these things could go wrong before you invested. There's a good chance they didn't. That means it's your job to ask. Ask good questions, give examples, and ask follow-up questions when the first answer is too smooth.
Here are five things that can go wrong, and do, more often than most people expect. For each one, we've added the questions we'd want you to ask.
1. Renovation costs jump
Material costs spike. Tariffs change the price of what you already budgeted. Contractors find water damage behind a wall that nobody could see during inspections. Some of this can be discovered before closing. A lot of it can't.
We've had to shift priorities on properties more than once. An on-site manager quits, a freeze hits, a local employer lays people off, and the plan you made at closing isn't the plan you're running six months later. Each shift needs its own sequence of tasks with real targets, not a feeling that the outcome looks about right.
Ask: Do you keep a reserve account for renovations? How big is it compared to the renovation budget? What happened on your last project when costs came in over budget?
2. Insurance premiums climb faster than expected
Insurance has gone up far more in recent years than it did in the past, and in some regions it's been the biggest surprise on the expense side.
Ask: How have premiums trended in this region? What did you assume for insurance growth in the projections? What are you doing to manage increases, such as shopping carriers, adjusting deductibles or bundling properties?
3. New units hit the market
Every new apartment that gets built has to be leased. If a developer just finished a big new complex down the street, they're going to offer deep concessions to fill it. Those residents might have been yours, and now you're competing with free rent.
Ask: How many units are under construction within a few miles? When do they deliver? How did you account for concessions in the rent projections?
4. The property manager under-performs
It doesn't matter how carefully you qualified the management company. Some don't do a good job, and some start out great and slip. It depends on staffing, the regional manager, how many properties they're juggling, and a dozen other things.
Ask: How do you watch the property manager's performance month to month? Have you ever replaced one? Do you know other good managers in this market? What's Plan B?
5. A big employer downsizes
If a large share of residents work for one employer and that employer cuts jobs, occupancy can drop quickly.
Ask: Do you know how many residents work at the largest employers nearby? If one employer accounts for a high percentage, what's the plan if those residents lose their jobs?
The take that may be controversial
If a sponsor can't clearly explain what can go wrong, they haven't thought it through.
We watched this play out across the industry during the recent run of high interest rates and inflation. Ownership groups turning properties back over to their lenders had mostly overlooked the same basics: variable rate loans, aggressive rent growth assumptions, and optimistic exit cap rates five years out. It doesn't take many mistakes stacked together to be unable to survive a storm, and a storm is what the industry got.
Our own properties weren't immune either. We've sat down after a hard stretch and written out what we'd do differently, because if you can't do that honestly, you haven't really learned from it. We knew the storm could happen. We'd just let ourselves forget. We plan for it now.
Experienced operators don't pretend risk doesn't exist. They don't play down how likely a problem is or make the outcome sound minor. They plan for it in detail, with reserves, conservative assumptions and a Plan B they can describe without hesitating. The goal isn't to eliminate risk, that's impossible. The goal is to make sure that when something goes wrong, and something will, the deal doesn't fall apart.
That's also how we'd read your own reaction to a deal. If you're reviewing one and don't see any potential problems, you're not seeing the full picture yet.
What a good answer sounds like
You're not looking for a sponsor who says nothing will go wrong. You're looking for one who can tell you what went wrong on a past deal, what they did about it, and what they changed afterward. Specific beats polished every time.
If you'd like to ask us these questions about how we run our properties, schedule a call with John. Bring the hard ones.