While multifamily real estate can provide a reliable source of passive income and long-term wealth, it may present challenges for beginners who lack experience in the real estate market.
In this article, we will explore the fundamentals of multifamily real estate investing. This includes the meaning, benefits, and risks of multifamily real estate investing. The goal is to get you better informed on what to expect in your investment journey.
Multifamily real estate investing involves the acquisition and ownership of multiple-unit properties. Examples are apartment buildings, townhouses, or duplexes.
The ultimate goal of multifamily real estate investments is to generate multiple income streams through rent payments. In other words, the objective is to make more from rent payments than the mortgage and other overhead expenses. The property’s value also stands a chance to appreciate over time, meaning you could, in that case, make a considerable resale profit.
Some investment options for multifamily investors include purchasing an entire building or a portfolio of properties, house flipping, or real estate investment trusts. This class of investors may also either manage their properties themselves or hire a property management company to oversee the operations.
What is a Multifamily Property?
A multifamily property is a real estate building containing more than one housing unit for residents. Unlike single-family homes, these properties are designed to house multiple families and often have shared amenities like a pool, fitness center, and parking lot.
Multifamily investments offer beginners flexible pathways to get started in the industry. For instance, whereas those with a massive investment portfolio would likely manage their properties from afar, some new investors would find it more convenient to live in one of their housing units while renting out the others under the same roof. Such residences are known as owner-occupied properties.
Other investors may like to renovate and flip properties. And some others (who want to get into the real estate market without having to buy or manage a property themselves) would instead go for real estate investment trusts.
Multifamily vs. Single-Family Investing
At this stage, one topic you must deal with is the multifamily versus single-family property debate. It’s vital to note that both are types of real estate investment properties with specific pros and cons.
Multifamily properties, such as apartment complexes and townhouses, are residential buildings that contain multiple housing units. Investing in these properties allows you to rent many units and potentially mitigate vacancy-related risks.
Although there is a potential for higher rental income and consistent cash flow, you must also prepare for the increased maintenance and administrative costs associated with managing multiple tenants.
On the other hand, single-family homes are standalone properties designed for one family. The main advantage of single-family rental properties is that they are often in high demand and are easier to rent. This higher demand is because they are usually located in desirable neighborhoods and are more appealing to families or individual renters.
Among the single-family investing benefits is that they require less time and effort to manage. The reason is that there is only one property and tenant to deal with. Investing in a single-family residential rental property can mean moving to a new home and keeping the old one for rent. It can also mean refinancing your old house and potentially increasing your profit by lowering mortgage costs or freeing up funds for other investments. However, the vacancy risk of a single-family residential property is usually higher because any difficulty replacing an outgoing tenant leaves you with no other units to make up for your lost revenue.
Overall, both multifamily and single-family properties have their benefits and drawbacks. It’s crucial to consider your investment goals, budget, and risk tolerance when deciding which type of property is right for you. An experienced real estate professional can help you evaluate your options and make an informed decision.
Pros and Cons of Multifamily Real Estate Investing
A multifamily real estate investment property offers many advantages and a few disadvantages, as highlighted below:
- Steady Income: Multifamily rental properties generate regular revenue from many tenants in one property, providing investors with a stable source of passive income.
- Appreciation of Property Value: Like other real estate investments, the value of multifamily real estate properties can appreciate over time, enhancing your long-term capital growth potential.
- Portfolio Diversification Benefits: Investing in one type of real estate (like single-family homes) can be risky. You can diversify your portfolio by delving into multifamily properties as well. Besides, by investing in a multifamily property (i.e investing in multiple housing units at a time), you are not only expecting more cash flow; you are also spreading your investment across various housing units, thereby reducing risk. How? Because you are not reliant on a single tenant or property for your entire return. If one unit is vacant or not performing well, you can still rely on the income from the other units.
- Tax Benefits: Investors can take advantage of various tax benefits, including deductions for mortgage interest, property depreciation, and Often referred to as “OpEx,” operating expenses refer to all costs necessary to operate and main....
- Economies of Scale: Managing a large multifamily property is often more efficient than managing several single-family rental properties, as there are economies of scale in marketing, maintenance, and administration.
- Inflation Resilience: Multifamily real estate can be a good hedge against inflation. This is because most owners of multifamily real estate properties operate under fixed-rate debt or fixed-term leases, meaning their expenses remain constant even if inflation increases while rental income may rise annually with inflation.
Cons of Multifamily Investing
- It’s More Expensive: Investing in multifamily real estate can be more expensive than a single-family home. Especially considering the high upfront costs of purchasing, renovating, or marketing the property.
- Management Requirement: Managing multifamily properties is time-consuming and requires expertise in property management. New investors usually hire a property manager or build a team of experts to mitigate the challenges of managing multifamily properties.
- Higher Maintenance Costs: Multifamily properties are more demanding in terms of maintenance costs because they require ongoing attention and expenses.
- Financing Challenges: Financing for multifamily properties is usually more complicated and expensive than for single-family homes.
- Tenant Turnover: Multifamily properties are subject to tenant turnover, resulting in periods of vacancy and loss of rental income.
- Slower Appreciation: Property appreciation rates are lower for multifamily homes than single-family real estate in some markets and regions.
What to Look for in Multifamily Real Estate Properties
New investors should always conduct their due diligence before pursuing a multifamily real estate investment opportunity. Such ventures are usually counterproductive since the involved investors lack critical information on the current market trends and can’t plan for the future.
To make an informed multifamily real estate investment decision, the following are some top factors to consider:
A property’s location is one essential consideration for most investors. It’s always better to focus on areas where properties are in high demand.
Also, look for a well-maintained neighborhood with good transportation and access to shops, restaurants, and other amenities when investing in multifamily apartments.
The best recommendation is to go for properties with modern amenities. Some top amenities to look out for include property-wide smart access, video intercom, fitness centers, property-wide Wi-Fi, electric car-charging station, rooftop space, and other community amenities such as a swimming pool, car parks, etc. However, not all properties will have all these amenities. Some investors may prioritize certain amenities over others.
It is also crucial to have the property inspected to determine its condition. Are there any necessary repairs or renovations? What is the cost of these repairs, and how can it impact your return on investment (ROI)?
Also, evaluate the whole property and consider the number of units. This includes the number of rooms in each housing unit.
The best recommendation for new investors is to begin their real estate journey with two-unit, three-unit, and four-unit properties. These smaller multifamily properties offer more advantages with the least risk for new investors compared to larger ones. They are comparatively more affordable as well.
The demand for commercial real estate in the area can determine, to a large extent, the potential return on your investment. You can research the rental demand in a particular area by considering vacancy rates, occupancy rates, rental rates, and the overall state of the local rental market. Invest in areas with high rental demand and low vacancy rates.
The location’s demographic trends, including the local population’s age and income, are another top consideration. Areas with a growing population of young people are often better for multifamily investments since young professionals are mostly attracted to multi-unit homes. An area with a large population of retirees might have more demand for smaller units
How to Invest in Multifamily Real Estate
Investing in multifamily real estate is a great way to diversify your investment portfolio, generate passive income, and enjoy the stability that comes with owning income-producing assets. However, investing in multifamily real estate can take some work for beginners. To simplify things, here is a step-by-step guide you can follow:
1. Do Your Research
Before making any multifamily investment, you must conduct proper research to understand the market and the asset class. You can start by reading books, attending seminars, and connecting with experienced investors to learn as much as possible about multifamily real estate investing. This knowledge will help you determine your investment goals.
The next step is identifying and choosing a growing market with strong economic potentials like population growth and low unemployment. Such a robust market makes it easier to find properties in high demand and likely to appreciate value-wise.
To ensure a profitable investment, you must figure out the required monthly income to cover all expenses (including the cost of management, maintenance, repairs, and vacancy advertisement) and leave you with some gain.
Below are some terms you will come across as you calculate your numbers:
The capitalization rate, or cap rate, is one of the most widely-used metrics for estimating the yiel...
The capitalization rate (cap rate) is the ROI rate of a real estate property based on the income the property is expected to generate. The cap rate helps you estimate how quickly your multifamily property will yield a return on investment.
Cap Rate = Net Operating Income Divided by The Property’s Current Market Value Or Purchase Price
NOI (Net Operating Income)
The The revenue a property earns minus operating expenses, vacancy, and uncollectible receivables. The n... is the annual revenue generated by a property (including the rent and other additional fees like parking, storage, landscaping, etc.) minus all the expenses incurred for managing the property, including maintenance costs and property taxes.
Net Operating Income = Total Revenue Minus Operating Expenses
In the context of real estate property investment, cash flow refers to the amount of money generated by a rental property after all expenses, including property taxes, mortgage payments, insurance, and maintenance, have been subtracted. It’s a measure of a property’s net income and is an essential consideration for real estate investors, as it indicates the potential return on investment.
Positive cash flow shows that a rental property generates more income than expenses, while negative cash flow implies that your costs surpass your rental income. Investors desire properties with positive cash flow to guarantee a profitable investment.
Once you’ve calculated your numbers, done your budgeting, and determined how much you can afford to invest, the next step is to explore different financing options, including applying for Federal Housing Administration (FHA) or conventional loans.
- Conventional Loans: This is the most traditional form of financing for real estate investment and mainly involves borrowing from banks or other financial institutions. Conventional mortgages usually have the lowest interest rates but strict underwriting requirements, including a high credit score and a large down payment.
However, although Freddie Mac and Fannie Mae are Government-Sponsored Enterprises (GSE), all loans backed by Fannie and Freddie are typically conventional. Both offer high The process of using debt as a funding source in real estate financing, usually as a strategy to pur... levels (75% to 80%) and low-interest rates.
Fannie Mae and Freddie Mac loans allow investors to buy or refinance multifamily real estate properties. To obtain these loans, you must work with an approved The person or party (such as a bank or corporate entity) that loans money on a commercial real estat... since both financing options do not offer multifamily loans directly to borrowers.
- FHA Loans: FHA loan programs are another financing option for multifamily investment properties guaranteed by the government. This alternative is often attractive to new investors since it requires a lower down payment and has less complicated credit requirements.
- VA Loans: The Veteran Affairs (VA) loan is mainly for those who served in the U.S. military. It is a simple alternative for veterans to finance a multifamily building. A beneficial component of VA loans is that they don’t require mortgage insurance. They also have cheaper closing fees and don’t have a minimum credit score requirement.
After sorting out your multifamily financing option, the next step will be to work closely with a real estate agent or a multifamily property broker to find a property that fits your real estate portfolio.
A professional inspector should help you review the property and ensure it meets the necessary standards.
After having your loan approved and evaluating the property, you can submit an offer. As a new investor, your agent or broker can always help you through the negotiation process if necessary.
Once your offer is accepted, you can close the deal and prepare the property for your incoming tenants.
The next steps after closing the deal include doing the necessary upgrades or renovations and making arrangements to manage your new property effectively.
Investing in multifamily real estate is a long-term commitment. It’s crucial to weigh your options carefully and consider all aspects of the investment discussed in this blog post.
While you can create multiple income streams through multifamily investment, the management burden could be cumbersome for any newbie. As a first-time investor, working with experienced professionals is your best bet to minimize investment risks, manage your property efficiently, and guarantee long-term success.
- Challenges: high upfront costs, management requirements, maintenance costs, finding financing
- Potential rewards of investing in this asset class: steady income, appreciation of property value, portfolio diversification, tax benefits
Lument Solutions for Multifamily Investors
Lument delivers a set of capital solutions and is a reliable financial partner for small-balance investors looking to invest up to $7 million in multifamily real estate. With our deep understanding of the asset class and an outstanding record of delivering real estate investment results, our multifamily clients can expect the best professional guidance throughout the process.
We also offer a quote tool that allows small-balance investors to instantly obtain quotes for multifamily loans and start investing right away!
Frequently Asked Questions
They can be. Investing in multifamily properties is an excellent opportunity to generate better cash flow than single-family properties. Besides, you will benefit from having multiple housing units under one roof. Apart from the steady income and lower vacancy rate, you get to spend less on maintaining many units under a roof than single-family homes across different neighborhoods.
Anything between 14% and 18% is a good ROI for multifamily investment. However, many factors can affect a property’s ROI, including the local real estate market, asset class, property condition, rental income, expenses, and financing. It’s also noteworthy that what is considered a “good ROI” for multifamily investments may vary among investors, and factors affecting a property’s ROI may also depend on individual circumstances.
A property is multifamily if it contains more than one housing unit. Each unit has its kitchen, bathroom, and living space. The units are usually rented out to individual tenants, with the property managed as a single investment.
The 2% rule asserts that an investment property’s monthly income should equal or be greater than 2% of its purchase price. An example of the 2% rule for an investment property worth $200,000 is $200,000 x 0.02 = $4,000.
The idea behind this rule is that a rental property that generates a higher monthly income than its purchase price is a better investment, provided the real estate market, property location, condition, and rental demand are favorable. While the 2% rule can be helpful in evaluating potential investments, it should not be the only determining factor and may not always apply to all situations.