Real estate investing is a key strategy in most successful financial portfolios. Real estate investments consistently out-perform the S&P, and the right opportunities can provide passive income as well as secure long-term financial growth.
There are many ways to make money in real estate, but if you are longing for investment with strong cash flow and lower risk, multifamily investing is a great option. A multifamily investment is a financial investment in a property with more than one legal address, that provides immediate cash flow as well as long-term investment value.
Multifamily investing may look different for different investors. Some start as owner-occupier of a four-plex, while others’ first multifamily investment is via real estate syndication. There are benefits to every approach, but the key is to get started as soon as you can!
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What is a multifamily property?
A multifamily property is simply a single building that contains more than one home. A multifamily property can be a duplex, townhome, condo, or apartment building. If there is more than one legal address associated with the building, it’s a multifamily property.
It’s important to note that buildings with more than four homes are considered commercial properties. Most of the benefits of multifamily investments are magnified in bigger properties, but they come with added complexity for individual investors.
Benefits of a Multifamily Investment
There are many benefits to multifamily investing—from income and cash flow, to higher value and lower risk as compared to other real estate investment opportunities. If you’re still trying to decide how to diversify your portfolio, multifamily real estate investing may be the solution you’ve been looking for.
1. Cash flow
The primary reason that investors add rental properties to their portfolios, and multifamily properties especially, is cash flow. No other investment opportunity offers the same kind of stable and lucrative monthly income.
Cash flow is the balance of cash to/from the investment. In multifamily investing, that’s investor expenses vs. rental income. The 1% rule in real estate advises investors that the total monthly income from a multifamily investment should equal 1% of the initial investment. A $1,000,000 apartment building, then, should yield $10,000 in rental income per month.
And compared to single-family properties, cash flow is greater and more reliable with multifamily investments. First, it’s the difference between one rental income and two. If you invest in a single-family rental, there is not going to be a large source of cash flow.
Second, 0% occupancy is much less likely in a multifamily property than in a single family house. Every time a tenant moves out of a single-family rental, the property owner has to find a new renter, establish a new contract, etc. All the while, missing income. With a multifamily property, one vacancy does not mean a complete halt of cash flow.
2. Passive income
Many investors and financial consultants consider multifamily properties “passive income,” but truly passive income means the investor isn’t actively managing the property. If you invest in a multifamily property that you personally own and operate, you will always be managing that investment.
The best way to earn genuinely passive income from a multifamily investment is to invest with real estate syndication companies. Multifamily real estate syndication companies will find multifamily investment opportunities, raise money for the syndication, arrange the financing, and find vendors for the property. The syndication team will also coordinate the day-to-day management of the property, and you will just collect passive income distributions based on your investment.
3. Maintenance help
Owning real estate requires management, but multifamily properties often provide enough surplus cash flow to enable investors to hire a professional property management company to manage the day-to-day operations. Renting a single-family home doesn’t provide the income to support the investor and a separate property manager, so the investor handles the management of the property.
4. Higher value
In addition to passive cash flow, multifamily investments offer a higher long-term value. No investment always appreciates, but the value of multifamily properties is unique in several ways.
First, multifamily investments are not as susceptible to market fluctuations as single-family residences. The value of a single-family home is based on market value and even recent sales in the neighborhood (“comps”). Single-family home values can even vary based on the values of homes in the area, whereas the value of a multifamily property is based largely on their potential to produce income.
Multifamily investments also create a variety of opportunities for investors to “force appreciation,” which is simply action taken by the owner of a property to increase its value. Value can be added by adding amenities, updating units, improving the landscaping, adding parking fees, etc. These will increase the value of the property, in turn increasing rent prices.
5. Lower risk
We talked about how the relatively low risk of a multifamily property aids in valuation, but it’s also a consideration for your investment. One vacancy or one problematic tenant is easier to deal with when you have many other units providing income to cover your expenses. When that one vacancy or difficult tenant is your only source of cash flow, however, the investment is much riskier and can leave you responsible for paying another mortgage out of your own pocket.
6. Mortgage simplicity
When purchasing properties outright, a multifamily investment is often financed with one traditional bank loan, no matter how many family units it includes.
Anyone who has tried to manage more than one mortgage knows how valuable it is to consolidate when possible. Most investors would much rather collect multiple streams of rental income on one mortgage, than deal with one mortgage per rental income.
7. Insurance simplicity
Similar to the mortgage consideration is insurance: If you’d rather work with one insurance policy instead of many, a multifamily investment is simpler. You will get the same coverage for comparable units, all nested in one convenient insurance policy.
If you expand your portfolio later, most insurance companies will also provide a consolidated plan to cover all your rental properties in one policy.
8. Tax benefits
There are several tax advantages that can be applied to multifamily investments. For instance, multifamily properties can be depreciated over time, even if the value of the property actually increases. The depreciation is counted as a loss on your taxes. This is often done to offset rental income.
Additionally, cost segregation is a financial strategy that essentially allows investors to accelerate depreciation. Rather than eventually depreciating the entire cost of the property over 27.5 years, you can depreciate most of the property’s value in less than a decade. Real estate syndication companies usually do cost segregation on behalf of investors, so you’re collecting distributed cash flow but showing a loss on your taxes.
Investors can also take a deduction on mortgage interest paid during the fiscal year. The deduction is usually higher in the early stages of the investment, because the loan then begins to amortize.
Multifamily properties are the perfect solution for scaling real estate investments. Adding multiple residences to your portfolio with a single investment creates sufficient cash flow to continue growing your investments and your wealth. From there, you can step up to the next level, to invest in more opportunities that will create generational wealth.
Challenges of a Multifamily Investment
No investment, and no real estate acquisition, are without their challenges. Investors should always educate themselves on the “cons” of any opportunity.
Most of these challenges, however, are easily overcome by investing with a multifamily real estate syndication company. These organizations allow individual investors the opportunity to invest in large and lucrative investment opportunities and receive passive income distributions.
Multifamily investments require a larger up-front investment than single-family properties. That means the cost is one factor that tends to keep people out of multifamily investments, as even a 20% down payment on the property is well out of reach for many investors.
The solution offered by multifamily real estate syndications is the ability to pool your resources together with other investors. Real Estate syndication companies allow investors to get involved in multi-million-dollar projects with a minimum contribution generally ranging from $25,000 to $100,000 for most multifamily real estate syndication firms.
2. Sharper competition
The real estate investors who are in the market for multifamily properties are usually very experienced. These properties require some experience to manage, and experienced real estate investors can make for sharp competition. Experienced multifamily investors have the team, investors, and network around them to close deals.
All of that means it can be hard for new real estate investors to break into multifamily investments. A good strategy is to partner with more experienced investors at first, to build your network of vendors, and get your feet wet before taking down your first multifamily property. Another route is to invest in a multifamily real estate syndication, syndicators will already have the experienced, professional teams—as well as relationships with brokers—to find and operate multifamily investments.
3. Limited availability
Multifamily properties don’t hit the market quite as often as single-family investment opportunities. There are fewer of them, and they’re held for a long time (because they’re such good investments). Many investors trying to break into multifamily real estate by purchasing a property themselves find that it takes longer than they expected to find a worthy investment to begin with.
Multifamily investing with a multifamily real estate syndication firm erases this challenge for investors, because syndicators have a team of experts who are always actively searching for deals on behalf of their investors.
4. Additional regulations
Every landlord faces regulations regarding how a property can be rented. Investors who own multifamily properties face even more regulations. Before investing in a property on your own, make sure you understand local, state, and federal regulations regarding multifamily properties.
Multifamily Investments are Long-Term
Neither a “pro” nor a “con,” it is simply important to remember that multifamily investments, like all real estate opportunities, are long-term investments.
It’s true that you will generate some cash flow in the short-term, and occasionally a really good deal comes across your path. A few of the multifamily real estate syndications here at Disrupt Equity closed two deals within 18 months, generating a total investor return of 365%+ for our passive investors. This is not, however, not the industry standard.
As an asset, real estate is always considered long-term.
That means that investors need to be prepared to weather some fluctuations. It’s true that multifamily investments are not as subject to the whims of the market as single-family homes, but if a housing market collapses, even multifamily properties are affected. Hang in there: Real estate eventually turns upward again.
Multifamily Real Estate Classes
Multifamily properties can be divided into four different asset classes. Each one requires a different investment strategy, so it’s important to know the difference.
- Class A: These multifamily properties usually consist of luxurious apartment complexes. These properties are newer and located in popular areas. Their per-door prices are incredibly high and the cap rates (the ratio between capital investment and net operating income) are generally lower.
- Class B: This type of multifamily real estate is less luxurious than Class A, and they’re usually about 15 to 20 years old. These properties have been maintained adequately and have a medium cap rate. An investment in this property class is more for the appreciation than the cash flow.
- Class C: Properties in Class C are slightly outdated. They have below-market rents and are rented out of necessity. Class C properties provide great opportunities for investors who want the best cash flow. These properties can be purchased at a low markup rate, renovated and rebranded, and then rented out at better price points.
- Class D: This is the lowest property class in the multifamily real estate genre. It consists of buildings that are more than 40 years old and that are pretty run down in aesthetic as well as functionality. These are the most challenging asset to maintain, as the units may remain vacant over long periods of time.
Multifamily Investment Strategies
There are a few different strategies to consider, based on the condition of a property, as you consider multifamily investments.
- Stabilized: These properties are well maintained, and in multifamily investing they are well occupied. They provide reliable rental income immediately and may only require moderate interior updates. These are generally Class A and Class B properties.
- Value-Add: Value-add real estate is property that requires some improvement to bring it up to market value. In multifamily investments, these are usually well occupied at the time of sale, but have clear opportunities for improvement that will allow the owner to raise rent prices. This is a good strategy for investing in Class C properties.
- Distressed: These properties are in poor condition and suffer high vacancy. Investors who are interested in rehabbing distressed properties need to have access to financing and a plan to complete the work in 12 to 24 months. This is a good strategy for optimizing the long-term value of Class D properties.
Getting Started in Multifamily Investing
Real estate is a great way to expand an investment portfolio, and multifamily investing might be the best real estate opportunity you can find. It can be difficult to get into, because of higher costs and sharp competition, but once you’re in, the benefits are generous.
As with any investment, and especially real estate, start your education now. Whether you’re purchasing a property yourself, or pooling your resources with other investors, it’s crucial to know as much as you can about multifamily real estate.
And if you want to get involved in multifamily investments, but don’t have time to get involved in real estate or property management, consider multifamily syndication. When you pool your investment with others via Disrupt Equity, our expert teams identify and acquire multifamily assets, rehab and manage them as needed, and facilitate an exit at the right time. You just watch your portfolio grow.
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