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Multi Family Real Estate Investing
Multi family real estate is one of the best ways for any investor to diversify their portfolio—from hobbyist investors branching out from the stock market and retirement savings, to large institutional investment firms bolstering their portfolio in new markets.
In this article, we’ll look at the benefits of multifamily investing, why it’s so popular, and how to make your search for investment properties and owners easier.
Why Multi Family Investing is Suitable for Every Investor Type
Multi family real estate investing is one of the most popular forms of real estate investing. Duplexes, triplexes, quadruplexes, dorms, senior housing, and mobile home parks can all be considered multi family.
For one, it’s relatable: most people have lived in an apartment at one point in life or another.
People can wrap their heads around multi family rentals. They can understand the basics – each unit needs to have a functioning kitchen, bathroom, and some combination of bedrooms and living space.
Secondly, it offers a way for investors to enter the markets they want at less of a financial barrier to entry.
Buying multi family real estate for sale is an incredible way to generate passive income, and they can dip their toes into the multi-family market slowly if they so choose.
Multi family real estate investing is especially popular for those investing in property close to their own homes. The closer they live to the multi family property for sale they’re considering, the more likely they are to understand local market drivers like major employers, school districts and more.
For these reasons, it’s no wonder why multi family is the most popular type of real estate for the masses to invest in. There are several reasons why you may want to consider investing, too, as we’ll get into below.
Benefits of Investing in Multifamily Real Estate
1. Buying multi-family real estate is a good way to grow passive income.
Investing in multi family real estate is a great way to generate additional income without lifting much of a finger.
Let’s use a physician for example:
Physicians tend to earn high incomes, so coming up with the 25% down that a lender requires for an investment property is generally achievable.
For example, if a physician decides to purchase a $500,000 four-unit multi family property, this will require him to put down $125,000. It’s no small chunk of change, but it’s usually something that more established physicians can manage.
Yet physicians are busy. They work long hours. They’re often on-call and need to respond to emergency situations. Responding to tenant calls in the middle of the night is usually out of the question for a physician.
That’s where a property manager comes in.
Hiring a property manager is a great way for someone with little to no real estate experience to collect rental income. The property manager can take care of all the day-to-day activities for a physician – for every type of investor, for that matter.
2. Investing in multi-family real estate is a good way to scale your income.
Most people earn an annual salary. Some may be eligible for a bonus each year, but generally speaking, those who work on a salary basis can usually only grow their income so much each year.
In that regard, investing in multi family real estate can be a game-changer.
Let’s go back to the physician who owns a four-unit investment property. Let’s say that he generates $1,500 a month in net revenue from that property after expenses, including the property management fee.
That’s an additional $18,000 in his pocket each year.
Now, let’s say he decides to renovate those units.
He puts $10,000 into renovations for each unit, so the total cost to renovate is $40,000. He’s able to increase the rents and now generates $2,000 a month in net revenue from the property. That’s now $24,000 per year.
While the free cash flow is one benefit, this also doesn’t take into consideration the added benefit of paying down the mortgage in the process.
As rents come in, and as the mortgage is paid down, the physician is building equity in the property. He can tap this equity at a later date to grow his real estate portfolio even more – this is what’s known as leverage.
Leverage is an incredibly powerful concept in multi family real estate investing. Here’s a real world example from an investor friend:
Let’s say investor Patrick purchased a three-family home in Boston in 2012.
He purchased the multifamily property for sale for $470,000. Because he owner-occupied one of the units for a short period of time, he only had to put down 5% for the mortgage, or $23,500.
He’s since moved out and has been netting roughly $2,500 a month in rent ever since. Meanwhile, he’s been paying down the mortgage. Now, he only owes $400,000. That may not seem like a lot, except the property has significantly increased in value. It’s now worth an estimated $1.2 million.
Investor Patrick is able to tap the equity in this 3-family home to purchase another property, this time, a four-unit multi-family property for sale. He uses equity from the 3-family, so there’s no actual capital outlay on his behalf.
The 4-unit property generates another $1,500 per month in net cash flow. Investor Patrick has leveraged his investment to grow his passive income to $4,000 and now owns nearly $2 million worth of property.
Not bad for an initial $23,500 investment.
Investor Patrick can continue leveraging his real estate assets to grow his portfolio over time, all while collecting substantial rent in the meantime!
Soon he’ll be able to purchase the 12-unit apartment building he’s been eyeing… And so on and so forth. This snowball effect is one of the reasons multifamily real estate is so attractive to investors of any caliber.
3. There are significant tax advantages to buying multi-family property for sale.
Multi family real estate is highly tax advantaged.
Most investors take out a mortgage to finance the property they want to invest in. The interest paid each year is then tax deductible. Any interest paid on credit cards, lines of credit, or other loans used to acquire, improve or otherwise benefit the property can also be deducted come tax time.
Depreciation typically offsets a significant portion of the rental income collected each year, making this a highly attractive asset class for investors of all kinds.
Other multi family rental expenses can also be deducted come tax time, such as the costs associated with hiring a property manager.
Insurance premiums, legal and professional fees, and all marketing activities can also be deducted. The larger your portfolio, the greater the tax advantages.
Considerations When Buying Multi Family Property
Despite all of the benefits of investing in multi family property, it’s not necessarily for the faint of heart. There’s no guarantee that a property will appreciate in value.
Vacancies are bound to happen, which will disrupt your cash flow. And over time, especially as your real estate portfolio grows, you’re sure to encounter major capital expenses (a new roof, heating systems, and more) that will require a significant capital outlay.
These are all things that multi family investors should be prepared to weather.
Here are other considerations when buying multi family investment property:
1. Will you self-manage or hire a property manager?
This is a big decision for any multi family real estate investor. There are several factors that will drive your decision, such as:
- How much time do you have?Self-managing will save you money and improve your returns, but it’s also incredibly time intensive.
- What level of effort is needed? Older multi family properties often require more effort than newly renovated, turn-key properties.
- Where is the property located? There are great multi-family investment deals to be had, but they aren’t always located in our backyards – particularly larger multi-family buildings and/or affordable multi family properties for sale. If you’re looking to grow your portfolio and have to widen your geography, consider hiring a property manager.
- What is the local neighborhood like? Be sure you have a solid grasp on the local neighborhood before investing in multi family property. This will help you understand your potential renter pool. Study the local demographics, crime rates, school districts.
Learn all about the local amenities, like parks, shopping centers and access to major highways. Talk to a real estate agent to understand local rents. Really take the time to understand the neighborhood where the multi family property is located.
An investment in one area may be a no-brainer. The same property located in a different area could be a complete deal-breaker.
Interested in buying in an up-and-coming area? Look for areas where new businesses are opening, or areas where homeowners seem to be investing in their properties.
Then, use the “Starbucks Test.”
Starbucks is notorious for opening in established areas. To capture the most value, try to catch the wave by investing in the area before Starbucks moves to town.
2. How do the numbers pencil out?
At the end of the day, owning multi family real estate is like owning a small business (or a large business, if your portfolio becomes substantial!).
You should be reviewing each deal with a keen eye to the numbers. Lean conservatively, especially as you begin investing. Build in a vacancy factor. Be sure to account for all local and state taxes.
Once you’ve uncovered all costs, begin to craft a detailed pro forma. This will help you anticipate the property’s cash flow, cap rates, internal rate of return and cash-on-cash return.
If you’re conservative with your estimating and the numbers still pencil out, then any net revenue beyond that is just greater upside.
3. Who else is investing in local multifamily real estate?
Whether you are looking to purchase a duplex, a four-unit multifamily property, or a 200-unit apartment complex, it’s important to first understand who else owns real estate in the area.
These are your competitors. Is it local mom and pop operators? If so, could your team bring an advantage over existing operators?
Or are most apartment buildings owned by established real estate investors? If the latter, it may take more work to position your units competitively.
Another benefit to knowing who else owns local multifamily property is that this could open the door to potential partners.
For instance, you may not have the wherewithal to invest in a 200-unit complex at this time, but you may be able to partner up with another local multifamily investor to jointly purchase a 50-unit property. If that deal is successful, you could leverage property to invest in more units down the road.