How thorough is your due diligence when you’re investing in real estate? Those of us in the business for a long time have heard so many stories of how they got burned, and what they should have done to prevent it. I have, and I keep track of them.
Fires, earthquakes, hurricanes, tornadoes, hail storms to name a few. Most of these, there is very little we can do to prevent them.
Except one – flooding. You can prevent it by not buying in a flood zone. Radical? No, it’s not, it is prudent and it is easy to discover. It might be a rare occurrence and for most areas there is insurance to cover the damages, but the insurance is expensive and recovery is long term. Look at anywhere in the U.S. over the last year that has had flood damage. A year later and recovery still seems like a long way off.
Awhile back I spoke with a syndicator about a property they were raising capital for. I did my basic research, looked it up on the FEMA website and discovered it was in a flood zone. He wasn’t aware of it. He continued to raise capital, successfully closed, and the property is just fine. I’m sure it will continue to be fine because the odds of a flood are low.
I was firm that I wasn’t going to take a risk like that. If there’s a tangible risk to the ongoing viability of a real estate investment like flooding, I’m going to pass because there are too many other opportunities.
Recently I was looking closely at a property, and even had an offer in. I was continuing my due diligence and did discover it was in a flood zone. But it was a creek. A creek! Not a river or a valley or somewhere else that’s obviously at risk. This city had dug wider culverts upstream and there was other development near the creek. I did not feel concerned about submitting the offer because this seemed “safe”.
A few days passed and my offer was accepted so I started the PSA. Then I took the next necessary step and called the city, spoke to their “Flood Plain Manager”. She said there hadn’t been a flood for over 50 years but said she’d do some research. Later that day she sent me a surprising email.
Not only is it in the flood plain but the city placed onerous restrictions on future development and permitting, making it much harder. A permit would require an engineering study and then approval from FEMA. Approval would not be assured.
Now I know to do this due diligence task earlier in my review.
Market update
Jacksonville, NC – This lucky city is on the coast of North Carolina, one of the most beautiful stretches of coast anywhere. If you know the city, you might know the answer to this question.
What is Jacksonville ranked #4 in the nation for?
If you guessed anything related to being home to Marine Corps Base Camp Lejeune, you would be wrong. It ranks #4 in the Milken Institute’s ranking of high-tech GDP growth. 79% from 2018 to 2023. Very impressive. A one-time jump? No, it continued with an 11% growth from just 2022 to 2023.
In fact, Jacksonville ranks #8 of all Tier 1 Small Cities in Milken’s Best-Performing Small Cities study. #9 two years ago, up to #8 last year. With a population of 72,000, it is large enough to sustain the real estate investment services that multifamily investors require, including property management.
While jobs growth has been healthy, averaging almost 3% over the last three years and ranking #11 for job growth in Milken’s report, the source of these jobs is mainly the Marine Corps base.
Rent growth has been healthy as well, 4% over the last year according to Zumper and over 8% according to rentdata.com.
It is hard to project the strength of this city’s economic prospects when it is dependent on a military base. While the base has been healthy and has attracted growth in very desirable industries, a large deployment would eliminate private sector jobs. Even if your tenants are not military, there are no guarantees they’ll still have jobs and be able to rent from you.
However, the rewards from taking risks in markets like Jacksonville, North Carolina can make the risks worthwhile.
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Finer Points of Multifamily Properties
Surprising Benefits of Budgeting for Your Properties
If you own multifamily properties and you have a professional managing them, you need to have targets to hold them accountable. You can create all the metrics and charts you want to show success or failure, but if you wait until the actual numbers are reported before deciding if they’re good or not, you’re wasting your time.
I worked as a consultant at Microsoft for years and metrics were one of my areas of focus. We built systems to report numbers that triggered green or red based on whether the numbers hit their targets. There was no manual intervention, no fudging the numbers. The numbers hit or they didn’t. The discussions were congenial if those managers hit their numbers, sometimes unpleasant if they didn’t.
That’s how you should view a budget. These are your targets.
Take as much time as you need to create the budget. Create your budget in December so you’re ready to use it in the new year. The budget should be comprehensive, covering every line item in the P&L. Make the first draft in December include revenue projections, and make sure your PM is in agreement. They have to sign off on it and it can’t be forced on them.
Now you have a foundation for meaningful conversations. Each month you discuss the actual numbers compared to the budget. You’re mainly focusing on the numbers that missed their target, which is the budget. How much were they missed by? Ten percent? Three percent? For every missed target, there might need to be corrective action.
Your PM should present a corrective action recommendation for every missed target. If repair costs were too high, are you budgeting enough for capital asset replacements? Do you have deferred maintenance that needs to be addressed?
The most important of these is rental income. By the end of the month you should already know how you performed for that month. If rental income is declining, you should know that you didn’t get lead traffic, didn’t convert leads to applications, the units were not move-in ready. Whatever that issue was, you should know by end of month, but the actual numbers crystallize the results that need attention.
Don’t let your PM come up with excuses or pass the blame. They’re responsible and it’s your job to hold them to it. A PM that doesn’t have a solution is just a caretaker, not a PM with your ownership interests at heart.
The budget is objective. It always highlights performance areas that need attention. It is one of your strongest tools to help you add value to your asset.
“The world breaks everyone, and afterward, some are strong at the broken places.“
– Ernest Hemingway