Multifamily real estate, an intriguing blend of residential and commercial properties, consists of buildings with multiple separate living spaces for families or individuals. One of the most enticing aspects of investing in multifamily real estate is its potential to generate passive income.
Although some of the bigger risks you take involve high-interest rates and market volatility, there are long-term growth opportunities in the multifamily market.
Single-family vs. Multifamily Real Estate
When most people invest in real estate, they look to single-family real estate, which is any individual property bought to rent it out. This option usually involves less risk, but with it, comes fewer rewards. However, multifamily investments hold a treasure chest full of benefits:
- If one unit is vacant, the other units with tenants continue to bring in the money, ensuring a more stable income stream.
- You can increase the value of your property directly by improving the units or managing them effectively.
- Multifamily properties allow you to expand your real estate empire without multiplying your workload.
With various financing options, syndications, and partnerships, even investors with modest means can tap into these benefits.
What To Look For in a Multifamily Property
As you navigate the world of multifamily property investment, there are several landmarks to note. These markers will help ensure your efforts are worth the risk.
Location
From the broader neighborhood to the specific street, location can make or break an investment deal. Although the housing market rises and falls a variety of other factors, you can easily the worthiness of your investment by considering the location and keeping the following in mind in your search:
- An area with robust job growth will attract more residents, driving up demand for housing;
- Locations with recent population growth, which signifies a thriving community, leading to increased rental rates.
- Locations with easy access to local amenities will always be more desirable, leading to higher occupancy rates.
While predicting market fluctuations is challenging, understanding what makes a location desirable may overrule any current happenings in the economy.
Potential Income
The potential revenue and cash flow from a property are like the wind in your sails — without them, everything can come to a sudden halt. To calculate this element, dive into real estate capitalization rates, which provide a snapshot of a property’s potential income relative to its purchase price.
These rates essentially measure how quickly you’ll get a return on your investment. However, cap rates are not constant; they ebb and flow depending on various factors — the location, the type of property, and the mood of the local market.
To fully map out your potential income, consider the following:
- Rental income: Review the rental rates of comparable properties in the area.
- Vacancy rates: An area with higher vacancy rates can also mean lower rental prices.
- Property taxes: These vary depending on the location and type of property.
- Operating expenses: The cost of running a building, like property maintenance and insurance.
Understanding these factors allows you to create a realistic budget and assess potential returns.
Down Payment and Financing
Even though anyone can dive into multifamily real estate investing, you do need some kind of capital to start with. However, you can also seek out financing options to help you out, such as:
- Securing a mortgage: In a mortgage loan agreement, you must prove your trustworthiness to lenders by providing your credit history, income, debt levels, and the amount of your down payment will all play a role in determining this.
- Hard money loans: These are a great option for those who lack good credit or the cash to make a hefty down payment. This loan offers immediate access to funds but comes with higher interest rates and fees.
- Syndications: Allow multiple investors to pool their resources together, making it possible to purchase larger multifamily properties.
A word of caution: commercial loans often come with higher interest rates and more stringent requirements, which may ultimately change your budget and financing options.
Understanding Risk
While the prospect of returns is enticing, it’s equally important to understand the risks in the multifamily real estate investing world, including:
- Market risk: Includes changes in interest rates, economic recessions, and shifts in the demand for housing.
- Asset risk: Pertains to the potential for the physical property to decrease in value due to structural issues, environmental hazards, or a decline in the local area.
- Financial risk: This can arise from changes in lending rates, higher-than-expected financing costs, or even personal financial strain.
- Liquidity risk: Real estate is typically less liquid than other investments, so it can take time to sell a property and access your capital, particularly in a slow market.
- Inflation or systemic risk: Refers to the potential impact of wider economic changes on your investment. For instance, rising inflation can erode the value of your rental income.
Successful real estate investors acknowledge that risks in real estate investing are complex and diverse.
Exit Strategy
An exit strategy is your map out of the multifamily property investing maze. It outlines how and when you plan to sell your investment and recoup your capital. It’s your investing end game, culminating all your efforts and strategic decisions.
Each type of investment vehicle has its risks and potential exit strategies. For example, if you’ve invested in a multifamily property as a long-term hold, you might plan to exit by selling the property once it has appreciated sufficiently. If you’re in syndication or a real estate investment trust, your exit strategy might be tied to the terms of the investment structure.
Consider some of the best exit strategies for real estate: wholesaling, seller financing, rehabbing, flipping, or passing on to heirs. Each can be effective, depending on your investment goals, risk tolerance, and market conditions.
Ways to Invest in Multifamily Real Estate
There are several different ways to invest in multifamily real estate:
Purchase and Manage
This involves finding a suitable multifamily property and claiming responsibility for marketing and tenant screening, setting up lease agreements, and handling ongoing maintenance.
Advantages include being able to make decisions on tenants, rental rates, maintenance and improvements. There’s less risk of total vacancy compared to a single-family property, and it can be more cost-effective from a management perspective.
Investing in multifamily properties requires a substantial amount of capital upfront. Repairs, property taxes, insurance, and possibly property management fees, ongoing expenses can eat into your profits. You may also have to deal with management challenges such as late rent payments, maintenance issues, or difficult tenants.
Purchase and Sell
Another option is to purchase and sell, or flip, a multifamily property, otherwise known as value-adding. This involves buying a property to add value through renovations or upgrades, then reselling it at a higher price.
You can significantly increase the property’s worth and sell it for a profit — and relatively quickly, too. Seeing the transformation can be a rewarding experience in itself.
However, market conditions can change between when you purchase the property and when you sell. This means it could be more difficult to sell your property after renovations. Flipping also requires a significant upfront investment and time to renovate, and you may encounter unexpected problems like structural issues or costly repairs.
This option involves less risk and time, as you’re working with an existing structure rather than starting from scratch.
Buy and Owner-Occupy
The buy-and-owner-occupy strategy involves purchasing a property with a few units, living in one, and renting out the rest. It’s uniquely personal but financially strategic.
This strategy can help cover your mortgage and other expenses and being on-site makes it easier to handle property management tasks. Further, owner-occupants often have access to better financing options and lower down payment requirements.
On the flip side, living in the same property as your tenants might compromise your privacy and being an onsite owner means you’re always on call. You’re also somewhat limited in terms of the scale of property you can invest in.
Invest in a Partnership
In a real estate partnership, two or more parties pool their resources, talents, and time to invest in a property, sharing the responsibilities and the returns.
Advantages of this strategy include:
- You share the financial burden with others. You also share the tasks related to property management, reducing the workload.
- You can spread your risk and potentially invest in larger, more profitable properties.
- You could play a more passive role, simply contributing capital and enjoying your share of the profits without the day-to-day management responsibilities.
Potential drawbacks include:
- Differences in opinion about management decisions or profit distribution can cause disputes.
- If the investment doesn’t perform as expected, everyone feels the impact.
- A partner failing to meet their obligations can affect the entire investment.
A successful partnership requires trust, clear communication, and a shared vision.
Buy Shares in a Real Estate Investment Trust (REIT)
Real estate investment trusts own or finance income-producing real estate across various property sectors. With this option, you buy shares in a company that manages a portfolio of properties rather than investing in the properties directly.
Some possible benefits include:
- You can earn dividends without having to worry about managing properties yourself.
- REIT shares can be bought and sold like stocks on the open market, providing more liquidity.
- You can add another layer of diversification to your investment portfolio.
You should also consider the following drawbacks:
- You have no direct control over the properties in the REIT’s portfolio or how they’re managed.
- REITs are traded on the stock market, which means they’re subject to market volatility.
- Dividends from REITs are typically taxed as ordinary income, which can be higher than long-term capital gains.
When weighing up REITs against other investment vehicles like syndications and real estate funds, consider your investment goals, risk tolerance, and desired level of involvement. Syndications and funds can offer more direct real estate exposure and potential tax benefits, but they may also require a larger initial investment and carry different risks.
Co-fund a Purchase or Development
This approach involves teaming up with private funds and firms to acquire partial ownership of a real estate development. However, it does come with a few risks, such as potentially high initial investment and low liquidity.
There are a few ways to fund this path:
- Real estate crowdfunding allows investors to pool their resources, offering a relatively low entry point and the potential for solid returns.
- Private equity firms pool funds from multiple investors to acquire and manage real estate assets. While the entry point is typically higher and the investments less liquid, they often target higher returns.
- Real estate syndication firms offer investors an opportunity to invest in specific properties rather than a diversified fund.
Beyond these, boutique firms provide a more tailored service, crafting custom strategies for individual investors. These firms often offer opportunities in niche markets with potentially lucrative routes.
The Bottom Line
Conducting thorough due diligence is vital for any new investment. Scrutinize the track record of any fund, firm, or partnership you’re considering joining. You should also seek professional advice from a certified financial advisor before making any big financial decisions.