The Beginners Guide to Multifamily Real Estate Investing
Multifamily real estate investing can make your portfolio look great if you are planning to diversify your real estate investments. Single-family homes are still the primary focus of real estate investors. However, starting with multifamily home investments can pave the way for a steady rental income and also teach you the basics of real estate investments- acquisition, renovation, and selling.
Multifamily real estate investing by definition
Multifamily real estate, as the name suggests are residential properties that comprise more than one housing unit. Home configurations that fit the description of duplexes, apartment complexes, condos, and townhomes, are referred to as multifamily homes. Multifamily homes usually comprise of an owner/investor who occupies one of the units and puts the others up for rent or sale. Investors who are new to the market may find multifamily home investments to be a novel means of capital appreciation.
3 effective tips for starting with Multifamily Investing
Building a portfolio with one or more multifamily homes and then single-family home units are both a rewarding and a learning experience. If you do not want to limit yourself to single-family assets alone, then you should welcome the idea of multifamily real estate. The key points to remember when starting off with such investments, are:
1. Calculate your Net Operating Income (NOI)
Calculating the Net Operating Income is the best way to sift the most profitable multifamily asset deals among all the options on the table. Investing in a multifamily asset can set you up with expected income sources from rental fees, storage fees, parking fees, etc.; and, expected expenses such as repairs and maintenance.
To surmise which deal is more profitable of all the options you have to opt for the 50% rule, in the event you lack the neighborhood comp numbers. The 50% rule sees you halve your expected income and assume it to be an approximate indicator of the expected expenses.
2. Cash Flow Calculation
Take an account of the estimated monthly cash flow to arrive at an estimation of how much you can pay off in monthly mortgage payments. Deduct the monthly mortgage from the Net Operating Income, to deduce the Cash Flow. Once you have an approximate cash flow figure you can determine the viability of any given multifamily asset deal.
3. Capitalization Rate Inference
Lastly, you need to calculate the Capitalization Rate. Capitalization or Cap Rate is an important deciding factor for any deal as it states how quickly you will receive your ROI. The Cap Rate helps you determine whether an investment deal is ‘safe’ or not; a safe Cap Rate value ranges between 1-2%. But, bear in mind that a safe or low Cap Rate also means low risk and low returns, while a high cap rate calls for vice versa.
To deduce an accurate Cap Rate, you need to multiply your Net Operating Income, multiply it by twelve, and divide it by the property’s current market value. A multifamily asset with a Cap Rate ranging between 5-1% moderates the risk factor, while also promising a significantly higher return than a ‘definitely safe’ Cap Rate Value.
5 Things to Determine the Potential of Multifamily Assets
Multifamily investments require careful introspection and due diligence if you wish to reap rich benefits. That often includes keeping an eye out for potential assets that are available for less than their market value, assessing their potential for capital generation, etc. The actual effort of locating such property will see you sifting through several potential investment options, comparing their prices, the short and long-term costs involved, and an estimation of the rentals.
The primary focus should always be on the numbers when it comes to multifamily asset investments. Investors must bear in mind that all of this calculation is to establish a base-line for your investment, rather than an exact figure. The numbers you work with are influenced by several factors that also influence your search for potential multifamily assets.
Location is the factor with utmost importance in multifamily investments. When you opt for a location that meets the criteria demanded by your primary tenant demographic, the overall appeal of the property shoots up. Look for areas that offer high-yield, and high-growth; such properties in coveted locations will always usher demand from well-paying tenants.
No. of Units
You can take your pick from the options on the table once you have an ideal location that promises such, in mind. The higher the number of units in a multifamily asset at an in-demand location, the better the ROI. Keep an eye out for the number, quality, and configuration of the units as well.
There are three types of property configurations that meet the attributes you are looking for- duplexes (two units), triplexes (three units), and quadruplexes (four units). If you are a beginner in the investment game, then these configurations should grant you less risk and better affordability.
Take account of all active and passive means of income, as well as expenses from the property, to ascertain the potential income potential of a multifamily asset. Apply the aforementioned ‘50% rule’ to determine the NOI, if you want to stay on the safe side. Follow the thumb rule, that an asset should at least grant you a 50% NOI for expenses, rather than on the mortgage.
Financing options for a multifamily asset may differ based on whether you choose to rent/flip the whole building, or whether you choose to occupy a unit yourself while renting out the others. Lenders take the rental unit’s income into account when factoring the qualifying ratios for an owner-occupied financing request. Maintaining a good credit score, debt-to-income ratio, and down payment can solidify your financing application.
Assessing the seller is also critical to investing in multifamily assets. The background or type of the seller, and their motivation to sell, greatly influence the deal. The difference between investing in a bank-owned property and a for-sale-by-owner property is the cost-saving potential.
Multifamily asset investment VS Single-family asset investment
The investment domain is quite split when it comes to deciding the better option between multifamily and single-family asset investment. The neutral perspective advises that both options have their pros and cons for investors- they have different management responsibilities, different income prosthetics, and even different exit strategies. However, to infer which option of the two is more profitable for you requires you to understand their intricacies.
Benefits of Multifamily investments
Higher Cash Flow
Multifamily assets generate several monthly income channels in comparison to a single-family counterpart. The prospect of multiple income channels in lieu of one investment and owner-occupied rent management is an inviting one.
Greater Value Control
The base value of your home appreciates with every prospect of income from a multifamily home. Better income streams equal greater value appreciation in multifamily homes, compared to a single-family home, due to the rental option.
Large Tenant Pool
Another obvious inference is that more number units equal a larger tenant pool than what a single-family home will offer you. There is a lesser chance of loss due to vacancy as there are more tenant options to mitigate said loss.
Investing in a multifamily home does more for your portfolio than a single-family asset, especially for those looking to grow their portfolio. Acquisition of multiple properties scales up your portfolio instantly and prepares you for venturing into mixed-use and apartment investments.
Best Case Scenarios for:
Delegated real estate management
Multifamily homes are ideal for investors who prefer to have their property managed via an intermediary. Single-family homes do not merit the use of such a third-party service; but, a multifamily home has enough passive income sources and units to justify the delegation.
There are ample tax benefits for multifamily properties. One can easily offset the rental income collected annually from a multifamily real estate against the depreciation of the multifamily real estate.
Benefits of Single-family investments
Single-family homes find takers; especially among those investors who are looking to invest ina budget. They do not compare to multifamily homes w.r.t. the down payments (10-15% compared to 25-30% for multifamily homes) and cost of maintenance.
In these deals, tenants enjoy the onus of utility payments, landscaping, etc. which makes long-term maintenance cheap. Also, insurance premiums are cheaper for single-family units.
Higher Value Appreciation
Lenders value multifamily homes based on how much the units fetch in terms of rent or resale value. Single-family homes, however, fetch financing based on the demand and supply of owner-occupied buyers/renters. Single-family homes always enjoy demand in good locations.
Single-family homes are easier to finance as well, due to the comparatively low-interest rate and the higher loan-to-value ratio. The purchase price is often low enough for investors to pay the whole value upfront. It must be noted however that the mortgage rates for any non-owner-occupied property are 0.25-0.50% more than that of an owner-occupied one.
Ease of management
The cost and effort of managing a single-family home are lesser than that of a multifamily home. Single-family homes give you the option to manage the property as the landlord, unlike multi-family homes where it may become cumbersome,
Multifamily asset investments come with their pros and cons just as single-family homes; and, in your case, the pros just might outweigh the cons. It must be noted, however, that while single-family homes commandeer their market with their own sets of ups and downs in every state, multifamily homes dominate the niche in certain states more than others. For multi-family investors, the best markets are:
- Los Angeles, CA
- Seattle-Tacoma, WA
- Boston, MA
- Minneapolis-St. Paul, MN
- Oakland, CA
- San Jose, CA
- Portland, OR
- San Francisco, CA
- New York City, NY
- San Diego, CA
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