If you are interested in commercial real estate, multifamily property is a great first step. This type of real estate is exceedingly popular because most people have rented an apartment or owned a home and having done that provides an understanding of the basics.
Buying multifamily property is much less complicated than investing in other types of commercial real estate. It is a good way to get started in commercial real estate investing. In this article, we will go over some pros and cons, and tips and tricks to get started!
What is a Multifamily Property?
A multifamily property is a residential property containing more than one housing unit. There are several different types of multifamily housing:
Apartment Buildings and Condominiums
This is the most common type of multifamily housing. These contain several units and usually, several floors.
The difference between apartments and condos is ownership. An apartment building is usually owned by a single owner that leases units to tenants. A condo is usually an individually owned unit in a multifamily housing complex, with shared common spaces equally owned by all condo owners.
Duplex
A duplex is a building divided into two separate houses. Each unit has its own entrance and there are not typically common spaces inside the duplex.
Triplex and Quadruplex
These are similar to duplexes but they have more units.
Mixed-Use Building
Mixed-use buildings are used for multiple purposes including residential, commercial, cultural, industrial, or institutional. They are often configured by keeping commercial spaces on one floor and residential on another.
Just keep in mind properties with four units and less are typically treated as residential transactions, while the properties with greater than four units are considered commercial transactions. There are two reasons behind that classification. First reason is that the local disclosure requirements might be more detailed for those properties in the first category as their buyers are assumed to be less sophisticated as opposed to commercial property buyers. Second reason is that lenders look primarily at the income and credit-worthiness of the borrower at four unit or less deals, while they look at the income of the property to determine how much they can lend in case of the deals with greater than four units.
What to Look for When Investing in Multifamily Properties
Now that we know about the different types of multifamily properties you can invest in, let’s think about what to keep an eye out for when shopping for real estate.
Multifamily investing requires more attention and thought than simply browsing. You want to identify a property below market value and then analyze its financial sensibility by comparing prices, short and long-term costs, and rental estimates. This will give you a ballpark figure to predict an investment’s true value.
Some other things you should keep in mind during your search:
Location!
Location is everything for real estate investment. Especially when investing in multifamily properties. Investors should look for high-growth, high-yield areas where properties are in high-demand neighborhoods. Job growth, increase in young population, access to public transportation are the main demand drivers for Multifamily rentals. Every unit needs to appeal to renters which leads us to our next point…
Number of Units & Unit Mix
Evaluate the property as a whole. Think about how many units are on the property and the rooms in each unit. The unit mix (Studio, 1 Bedroom, 2 Bedroom, 3 Bedroom) must match the demographics in the area or you will have trouble filling the units, meaning there will be more vacancies. Tenant turnover and vacancies are expensive.
If you are new to investing in commercial real estate, focus on duplex, triplex, and four-plex properties because they have the least amount of risk and are more affordable.
Potential Income
Determine the income a property can bring in. You can use sites like Craigslist or Zillow to verify rental prices and income or better consult with your Broker to find out the ongoing rental rate for that property. Age and condition of the property are also important as older units require more upkeep and their rents will be reflective of their condition, which can erode the Net Operating Income.
See if you can create an extra source of income after the purchase. Most common sources of income are laundry coin, garage or storage unit rentals, vending machines, game room revenues, advertising revenues, & revenues from any distribution of outside services like cable, satellite, or internet.
Gross scheduled income of a property is the sum of all rents that would normally be collected from all units if there were no vacancies. However, even if the property is 100% occupied, you would still need to adjust that income for a vacancy rate that is acceptable for similar types of properties in that area and add other potential income.
Gross Schedule Income (GSI)
GSI * Vacancy Rate
+ Income
--------------------------------------
= Gross Adjusted Income
Example:
If the Property is 10 units that each rent for $2000/mo and $3000 vending machine income, the Gross Scheduled Income would be $240,000. With 10% vacancy, Gross Adjusted Income will be $240,000 - $240,000*10% = $216,000 +$3000 = $219,000
Operating Expenses
Identify the annual expenses such as utilities, real estate taxes, payroll, management fees, insurance, exterior maintenance, legal accounting, advertising, brokerage fees, reserves for maintenance and capital expenditures and budget for them. Watch out for potentially expensive problems like roof issues, leaky windows, dated bathrooms & kitchens, life safety deficiencies, ADA compliance issues, mold, lead paint, and asbestos, HVAC problems, termite, and pest problems.
A good rule for beginners is the 50% rule. You should be spending maximum half of an investment’s income on the expenses rather than the mortgage. This is conservative for more experienced investors, but it is a good place to start.
Calculate Your Net Operating Income
To calculate your net operating Income, first, add up all of the Annual Income and adjust it Vacancy rate and calculate your Gross Adjusted Income and subtract all of the Annual Operating expenses.
Goss Adjusted Income
- Annual Operating Expenses
------------------------------------------
= Net Operating Income
Why Invest in Multifamily Properties?
Multifamily investment is pretty similar to single family investing, so why pay more money to invest in a multifamily?
There are many benefits:
Bigger & Steady Cash Flow
Single-family property generates one monthly income while a multifamily generates multiple forms of monthly income. This benefit is simple. Multifamily investments provide an opportunity to generate more income from a single investment. Furthermore, apartments are typically easy to rent and provide steady cash flow throughout the year.
Control Over Value
Because multifamily properties are earning multiple streams of income, the value is higher than single-family properties. Single-family properties value is calculated based on the comparable sales while Multifamily value is usually determined based on the income generated from the building. By changing and upgrading the units, rental income might easily be increased, which ultimately will have a direct impact on its value.
Less Risk
With single-family units, income is lost when the home is vacant. Multifamily properties have several units so there isn’t as much loss when one unit is empty.
Scalability
Multifamily investments provide an opportunity for growth. It works as a stepping stone to venture into mixed-use and apartment investing in the future. You can build your real estate investment portfolio and gain some experience.
Less Involvement
Single-family properties do not make enough income to hire a property management company but MDU typically do. You can hire a property manager to handle repairs and daily operations which allows you to take a less active role in your rental properties.
While you’re thinking about whether you want to get involved in this type of real estate, the benefits are a clear plus. This type of investment allows for more income than a single-family property. It is ideal for those looking to grow their business, but also has less risks in generating monthly income. Once you know the ins and outs, it’s worth a shot!
These are all important factors to think about as you decide what type of investment to get started with. Do your research, think about your motivations and what works best for you! Good luck investing!
You may SEARCH for the list of Multifamily Properties on the market by clicking this link. If you need more information on Multifamily Investing or need help with finding out more Multifamily alternatives, CONTACT us.
Here is my recent video presentation on Washington DC Multifamily Market