Multifamily Investing: See How to Boost Your Portfolio with Real Estate
One of the most important tenets of investing is diversification. Many people diversify their investment portfolio by adding different stocks, bonds, and maybe a few mutual funds or ETFs. It’s possible to further expand and diversify your portfolio by investing in real estate. In particular, multifamily investing has proven time and time again to be one of the premier ways to build wealth.
If you want to diversify your portfolio, grow your net worth, and generate a passive income stream, here’s everything you need to know to turbocharge your investments with multifamily real estate!
What Is Multifamily Investing?
Of course, before getting into the benefits of investing in multifamily properties, it’s first worth defining what these investments are!
There are typically three “classifications” of real estate. The first one, single-family homes or condos, are what most people know. Load up your favorite real estate app, and you’ll see hundreds of homes and condos available for sale. You can buy any one of those homes and hold onto it as an investment. Typically, people buy these homes, renovate them, and then either rent them out or flip them for a quick profit.
The second classification is multifamily, which encompasses all the types of real estate that allow more than one family to live on the premises. Examples include apartment buildings and condos (not individual condos, but the entire building). There are also smaller multifamily units, like a bigger house with four separate entrances allowing four different families to live there. Many people assume multifamily properties are large apartment buildings, but many properties only allow for a few people living there.
Lastly, commercial real estate is the third classification. Commercial real estate comes in various types, from warehouse buildings in a small town to the most significant skyscrapers in New York or San Francisco.
Multifamily investing refers to investments in multifamily units. When you make this type of investment, you will own all or part of one of these buildings.
Why Not Invest in Single-Family Homes?
When you think of investing in real estate, you may think of buying a home and renting it out. This process is typically straightforward – you buy the property, either with cash or a mortgage, renovate it a bit, and then put it up for rent. Most people will use a property management company, although some try and do everything themselves.
However, there are three fundamental problems with investing in single-family real estate: income reliability, market conditions, and maintenance. Let’s go through each of these issues in more detail.
One of the most significant flaws of single-family real estate investing is that income is not as reliable. If the family renting your property cannot pay their rent, your income goes to $0. Yet, you are still on the hook for all the mortgage payments, upkeep, and fees to evict the renters if it tragically gets to that point. You may get lucky and have lovely tenants who always pay on time. However, that’s not guaranteed, and the more single-family properties you own, the higher the chance of eventually getting one that doesn’t pay!
Single-family homes are much more subject to market conditions than multifamily homes. Local and national economies can turn on a dime, and that home worth $1 million is now suddenly only worth $500,000. Due to this risk, in part, banks tend to hesitate more to provide loans for single-family investment properties. Expect to see interest rates 0.5% or more above the prevailing rate for a primary residence. These loans will also face more scrutiny.
When something breaks with a single-family home, there’s only one person responsible: the landlord. That means you! You could find yourself needing to spend thousands of dollars because the water pipe broke. Or, you might need to spend money on fixing the foundation because it cracks, or the AC suddenly breaks. Bottom-line: homes (and, to a certain degree, condos) have a lot of maintenance costs.
The real danger, of course, is when a home needs maintenance, the tenants move out, and the market conditions head south. If all that happens at once, being the owner of a single-family rental property can be tough.
How Is Multifamily Investing the Better Option?
Multifamily investing solves many of the issues above. To illustrate how, consider a hypothetical investment of a small multifamily complex with four units.
Let’s assume you rent out those four units for $1,000 each. That brings in $4,000 cash flow per month. Now, one family decides to leave. Instead of bringing in $0 per month with a single-family home, your multifamily property still has three tenants left, which means you still earn $3,000 per month. That provides you with at least some money to cover the bills and mortgage.
Since the multifamily property should bring in at least a few thousand a month, it always has some intrinsic value. Most people looking at single-family homes either want to live in them or renovate them. As such, these properties derive their value from appealing to prospective residents. Multifamily homes derive their value from investment potential. In technical terms, as long as the property has fair market value rent above projected net operating income, and the ability to fill vacancies quickly, your cash flow should be positive, and your investment will hold its value.
Three other benefits are also worth pointing out:
- There’s less overhead for you as the owner. For example, it’s much easier to manage one multifamily property with four units instead of four independent single-family homes.
- The tax benefits for multifamily investing are impressive. You can deduct most costs and expenses. You can also take advantage of depreciation. Of course, you’ll need to consult with a tax professional to determine precisely what you can take, but there are numerous tax benefits to multifamily investing.
- Multifamily investments are more scalable, too. Instead of buying single-family homes one by one, you can expand faster with multifamily homes that offer more consistent cash flow and retain their value.
Another Important Perk of Multifamily Investing: It Hedges Against Inflation!
Inflation is a hot topic among investors. Choosing investments wisely becomes especially crucial with the potential for 5%-10% inflation. Picking an investment that pays 2%-3% might still make money, but it’s technically a loss in purchasing power.
Real estate, and multifamily real estate, in particular, tend to do well in high-inflation environments, and the reason is simple economics.
Real estate has both intrinsic value and investment value. The intrinsic value is the worth of the building, the land, and its development potential. Additionally, the investment value is the amount of passive income an apartment building can generate. In periods of high inflation, both of these values rise.
Inflation, by definition, raises the price of assets. More money in the system means more money that can chase after investment opportunities. High inflation also makes bonds less attractive, so investments tend to flow into equities and assets, which increase with inflation. Multifamily properties will also increase in value.
However, not only does the intrinsic value of multifamily property increase, but its investment potential does, too. During inflation rents increase, mainly because increased home values pose a broad challenge to first-time homebuyers. Since people need somewhere to live, they need to rent, driving up the price of units in multifamily properties – from smaller duplexes to large hundred-plus unit apartment buildings! The increased rent values make multifamily investing even more attractive.
In effect, the building’s cash flow and intrinsic value increase with inflation, making it the perfect inflation hedge! Stocks may rise with inflation, but seldom do the dividends significantly increase. Bonds are bad investments in inflationary periods. And other assets, like gold or crypto, are a little more unpredictable. Only multifamily real estate is likely to see both appreciation and cash flow increases track with inflation, at a minimum.
What Types of Multifamily Investing Are Available?
If the prospect of having an investment that hedges against inflation, generates pretty reliable monthly income, and provides you with tax benefits sounds appealing, you’re not alone! People from all walks of life have found that multifamily investing is a fantastic way to build wealth.
The question, of course, is: what types of multifamily investments are available? Or, put another way, how do you get started investing in these buildings?
There are three ways you can start your multifamily investing journey!
Buy a Multifamily Building
This method might sound obvious, but you can buy a multifamily building outright! If you have the funds for a down payment (20%+), you can typically work with a lender to give you the rest and buy the unit. As multifamily properties tend to be quite expensive, this usually requires significant capital.
However, it will give you complete control over your investment. You can renovate it how you want, market it how you want, and even sell it when you want!
Join a Multifamily Syndication
A real estate syndication company is a group of people who come together to buy a property that would otherwise typically be unaffordable for one person or company. As a quick example, let’s suppose there’s a $5 million complex with 20 units. Ten people might join a syndication, and each put $500,000 down to pool their resources to buy the building. All profits, including rent distributions and the property’s final sale, would be split evenly between each shareholder.
That example is simplified, of course, but it shows the power of syndications – they open a world of investment opportunities that may not otherwise be available!
Syndications are also a fantastic way to invest in real estate passively. They typically have General Partners and Limited Partners. General Partners handle all the maintenance, finding the building, buying, selling, bookkeeping, and everything else that comes with operating the rental property. Limited Partners bring the bulk of the finances but do not partake in the day-to-day operations of the multifamily investment.
While syndications vary (and every investment involves the risk of loss), they are typically five years in length, have a minimum investment of $50,000 for Limited Partners, and fetch between 8%-10% returns each year plus a final 30%-50% return on the initial capital when the building sells. The total ROI can be between 70%-100% of your initial investment, or about 14%-20% year-over-year.
The best multifamily investments certainly have the potential to beat inflation!
Some REITs focus exclusively on multifamily properties. They typically aren’t as plentiful as those focusing on commercial real estate, but they exist. You can sometimes even find REITs that focus on specific areas, like San Francisco or Washington, DC.
The dividend yields for these REITs typically do not match what you can find with syndications. The average dividend yield is under 3%, which pales compared to the 8%+ a syndication can sometimes provide.
The upside, of course, is that there are no minimums. Depending on your platform, you can start your real estate investing journey with as little as $1!
Multifamily Investing Risks
No investment is 100% perfect, and multifamily real estate is no exception. There are risks associated with most multifamily properties, including but not limited to:
- Market conditions change, resulting in depressed rents, or vacancies become harder to fill. Either way, this can impact your revenue, affecting your bottom line. If vacancies become too prevalent, it can make your property much harder to sell.
- Financing risks can occur if you use a variable-rate loan to finance the property. Interest rates rising (very common in high-inflation environments) could make the property financially unviable.
- Natural disasters, tenant issues, and structural problems can lead to significant damage or loss. Additionally, there’s also the risk of lawsuits from tenants.
- Renovations can run over budget. If you’re planning on renovating units to boost their rent, you might find more problems than you initially anticipated, leading to higher renovation bills and lower ROI.
These are just a few of the potential risks of investing in multifamily real estate. It’s also worth noting that many of these risks happen with all forms of real estate. There’s nothing intrinsically more risky about multifamily than single-family or commercial real estate. They all have various risk factors that investors need to consider!
Some Additional Tips
By now, you have a pretty good sense of the pros and cons of multifamily investing. If you decide to go ahead and put some of your hard-earned capital into one of these investments, here are three things you’ll want to remember:
- Make sure you analyze the prospective investment thoroughly. Understand it, know the neighborhood, and make sure it fits your overall risk profile. Knowledge is power, and for real estate, that’s key!
- Remember the 50% rule! If you want to work out what a property’s monthly operating expenses will likely be, multiply the property’s gross rent by 50%. You’ll need to do due diligence to confirm this, but that’s an excellent way to get a ballpark estimate.
- If you aren’t going with a syndication, buy these properties at value. Make sure you don’t pay more than the property is worth before you start your repairs and renovations. Too many people will pay the “post-renovation value” without doing the work yet!
Conclusion: Multifamily Investing Will Turbocharge Your Portfolio
While there are no guarantees on any investment, there’s no question that a high-quality multifamily property has the potential to be a lucrative investment. The rental income plus asset appreciation make multifamily investing somewhat unique. There aren’t many other investments that have the potential for capital appreciation and significant rental income!
If you’re looking for a way to turbocharge and diversify your portfolio, please consider multifamily investing. It’s one of the best ways to get started in real estate!