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How to Buy Your First Multifamily Apartment Complex or Building as an Investment Property

 

In this guide, I will share with you tips for buying an apartment complex or a small building and will walk you through important factors to consider before making this investment.

If you have decided, “I want to buy an apartment complex”, you’re in good company. In the real estate investment world, multi-family properties are considered a relatively safe investment. The reasons for this are:

  • Residential rental units are needed even during economic downturns.
  • Multi-tenant properties spread the vacancy risk.

Every investment, however, has its risks. Beginner multi-family investors can better manage that risk if they take the time to learn how to buy a multi-family investment property.

Let’s start with the costs involved.

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How Much Does It Cost to Buy an Apartment Building?

A multi-family house such as a duplex and 3-4 unit properties can be found for $400,000 to $800,000. Properties that have 10 — 20 units will have a smaller price per unit, approximately $155,000/unit, but a higher overall price tag.

Larger apartment complexes are usually out of range for first-time investors.

Apartment assets are classified based on the age, condition, and amenities of the property. Classification determines how much rent the owner can charge which determines the investment value of the property.

Lower classified apartments are older and may have deferred maintenance needs. If you have to make improvements or repairs in order to achieve market rents, the initial purchase price isn’t the actual cost of the property. We will discuss this option in one of the subsequent sections of this guide.

Note: we have another guide: Is Buying an Apartment Complex or Building a Good Investment? You may want to read it to learn more about the pros and cons of different multifamily investment options.

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Closing Costs when Purchasing a Multi-Family Property

The buyer in a multifamily property transaction will have costs associated with the purchase that are accounted for at the closing. They include:

  • Inspections
  • Title search
  • Title insurance
  • Survey
  • Legal fees
  • Pro-rata property taxes
  • Financing costs (loan fees, appraisal, credit report).

In our guide to multifamily property closing costs for buyers and sellers, you will find a detailed explanation of each, how much it is, and who pays it.

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Buying a Multifamily Home with Tenants vs. Unoccupied

When it comes to income-generating properties, a property with tenants in place has a higher value than a vacant one. If the tenants have a stable payment history, purchasing a property that has tenants can be a plus for beginners buying an apartment building.

When you put an apartment property under contract, you will be entitled to receive the property rent rolls and financial statements. These will show you how long each tenant has been living there, how much longer their leases have to go, and how dependable they are in paying rent.

Having rental income from the start of your ownership will give you the chance to put aside leasing reserves before a unit becomes vacant. These are the funds you’ll need to clean, paint, repair, and market vacant units to new tenants.

However, if existing tenants are a problem for the owner, then buying an occupied property may not be in your best interests. If tenants are behind in their rent, or worse, if they are involved in disputes with the landlord/owner, this may be why the property is for sale. A new owner will face extra costs in dealing with these issues.

An unoccupied multi-family property could be an indication that living there is not desirable to tenants. If the reason for this is the location of the property, there isn’t anything you can do to fix that.

However, if the reason that tenants avoid the property is because of mismanagement, it might present an opportunity. A multi-family property like this should be available at a discount. You might be able to buy more units within your budget.

Mismanaged properties usually need work to bring them up to market standards. If you can finance those improvements, this is something that you might want to look at closely.

Do not buy a fixer upper property unless you have the funds to make repairs and upgrades. Beginner investors sometimes think that they can create the needed funds from operations. A weak apartment building will not draw the stable tenants you need to provide enough rent to keep up with the operation of the property and raise additional reserves for improvements.

If you are a beginner, you should make your first investment as simple as possible. The only way you should go into a more complicated project is if you joint venture with an experienced partner for your first property. The lessons you learn from a veteran investor might jump start your investment career.

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Where to Buy an Apartment Building or Complex as Your First Investment Property

When buying multi-family homes, apartment building owners are looking for the same thing that other business owners look for — is there a need, or demand for your service? Residential rental demand can be researched in several ways, and you should use all of them.

First, look at the demographics of the market. The US Census Bureau website contains detailed information on markets throughout the US. Look for the median age of that area. A younger population is more likely to rent before buying a home.

Also, consider the income levels of the population. Can they afford the rents that you need to charge? And finally, search the demographic data for population growth. A growing community is attracting people from other areas, including renters.

Next, determine the Price to Rent ratio. This will tell you if it makes more sense for the population to rent or buy. It will also indicate whether or not properties can be purchased for a price that will fit your budget.

Price to Rent is calculated by dividing the Average Price of homes for sale by the Average Annual Rent. You can find average home values in census data and local sales prices by looking at area listings.

HUD publishes Fair Market Rents on its website. This data is broken down by zip code which helps with the accuracy of your calculations. Take the monthly rent and multiply it by 12 to find the annual rent.

Price to Rent ratios of 15 or less is considered low, 16 to 20 is moderate, and more than 20 is a high number. The lower the number, the less desirable it is to rent in that market.

Higher Price to Rent numbers may show that renting is preferable, but they can also indicate that properties are too expensive for your desired return. Beginning investors will do well to focus on neighborhoods with moderate Price to Rent numbers as a start.

And finally, look at listings for rental units online and in local publications. A large number of listings can mean that demand is low in that market. You should take all of this information into consideration and make your decision based on an in-depth view of potential markets.

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How to Do Multi-Family Real Estate Investment Analysis

When buying multi-family homes, you’ll first need to sort through the available properties and make an initial assessment based on maximizing your returns.

 

Pro Forma Budget

Your pro forma budget is a roadmap to the acceptable investment properties that you can afford. Think of it as your purchase budget. Your purchase expenses will include legal fees, inspections, initial insurance premiums, closing costs, and finance costs.

Subtract your estimated costs from your available funds. The remainder is the amount you have for a down payment on your purchase. Assume that the required loan to value on a conventional purchase money mortgage is 75%. To find the total price that you can afford, divide your available funds by 25%.

If you have $100,000 in available funds after costs, divided by .25, your acceptable purchase price is $400,000.

 

Gross Rent Multiplier (GRM)

How do you know if buying that $400,000 multifamily property is a good investment? One way to put the property through an initial “sniff” test is to use its Gross Rent Multiplier (GRM).

The GRM uses the gross income and compares it to the price, or property value. This method isn’t as accurate as the analysis you’ll perform once you have detailed financials, but it is a good way to separate potential investments from undesirable properties. Sometimes the marketing material for a multifamily property doesn’t give you much more than the price and the gross rents.

By dividing the price by the gross annual rents, you’ll get the GRM. If the $400,000 property mentioned above has gross rents of $40,000, the GRM is 10.0. Once you perform this calculation on the available properties in your price range, you can compare their GRM and narrow your search.

Make sure that you are comparing similar properties when using GRM. Lower-class properties will have lower prices resulting in a lower GRM. It would be misleading to compare the GRM from a Class B property to that of a Class C property.

 

Value Add Opportunities

Your greatest opportunity lies in a property that can be moved up in classification. Look for apartment properties that can be improved in ways that don’t cost a lot of money and still justify rent increases.

This can include improved landscaping, modest renovations to the units, and weeding out slow-paying tenants. You might be able to include some improvements in your financing.

 

How to Appraise a Multifamily Property

Real estate is appraised in one of three ways:

  • Comparable Sales Method
  • Cost Method
  • Income Method

Comparable Sales mean just that. What did other investors recently pay for comparable properties in the area?

The Cost Method uses the actual cost to replace the improvements plus the value of the land to determine the property’s value. This is usually appropriate with newer properties that haven’t developed an income history.

Multifamily properties are ongoing businesses that require the Income Method to determine value. You’ll need to know how to analyze multifamily investment opportunities based on the business operation and the potential return on your investment.

The financial statements and rent rolls you receive from the seller will enable you to base your decision on the actual income and expenses of the business operation. You may be able to add value later, but your purchase is based on the physical and financial condition of the property at the time of the sale.

You’ll need to calculate the property’s NOI, Net Operating Income. The NOI is the total income minus the total expenses. This does not include debt service.

Once you have the NOI, you can determine the property’s Capitalization Rate or Cap Rate. The Cap Rate shows you the return that you can expect based on the property’s price and operating income.

The Cap Rate is found by dividing the NOI by the property’s price. This will give you the return as a percentage. For example, if the purchase price of a multifamily property is 850,000, and the NOI is $75,000, the Cap Rate is 75,000 / 850,000 = 8.82%. The Cap Rate can be used to compare the subject property to other multifamily properties or other investment vehicles.

The other thing that you need to consider is the cash flow or cash on cash return. This is when you include your mortgage payments as an expense along with reserves. The NOI minus debt service and reserves is your cash flow. If you divide that by the amount of cash that you invested, you’ll see the Cash on Cash Return on your actual investment.

Borrowing money for the purchase will boost your cash investment returns. If you put down 25% on a $600,000 property, and your cash flow is $40,000, your Cash on Cash return will be 40,000 / 150,000 = 26.67%.

To learn more about how to appraise multifamily properties, go to our article on Multifamily Property Valuation. When you find a property you are considering for investment, consider hiring one of your local top-rated professional multifamily property appraisers from our directory.

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How to Work with a Multifamily Real Estate Broker

If you aren’t an expert on how to buy an apartment building, you should consider using the services of a broker. Multifamily properties are commercial properties, not residential. If you are going to use a broker, you need a commercial broker who specializes in multifamily properties.

Experienced, top-rated local multifamily real estate agents know the market, the property owners, the property histories, recent sales, and the classification of properties in that market. They should also have basic familiarity with affordable housing programs, tax credits, and 1031 tax exchange rules.

They should also know the active professional service providers in the multifamily community such as:

and their fellow brokers.

A good broker can help you find the right property, assist with access to the property for inspections, warn you about red flags, have the seller fix issues, and close on the sale.

An important guide when selecting a broker is to find one who listens to you and understands your investment needs. A broker who ignores your instructions because they think they know what you should look for isn’t helping you.

Neither is a broker who is just interested in making a quick sale. State real estate regulations require that brokers put their clients’ interests first, even ahead of their own. Make sure that they do.

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How to Get a Loan for Buying Your First Apartment Building

There are a number of options for apartment investors who want to finance their purchase. The key is to be prepared before approaching a lender.

Your loan application package will include;

  • 3 years of financial records (profit & loss statement) for the property
  • Trailing 12 months (TTM) P&L
  • Current up-to-date rent roll
  • Capital expenditures to date and budgeted
  • Operating budget
  • Property details, descriptions, photos
  • Your personal financial statement
  • Partnership or ownership entity information (if applicable).

Here are some of the loans that multifamily financing lenders offer to help you purchase a multifamily property.

 

Conventional Loans

Loans that are issued by banks and some commercial loan companies are sometimes called conventional loans. Some bank loans may be kept by the issuing bank on its books. More often they are sold on the secondary market through government chartered mortgage companies.

The chartered companies are Fannie Mae (Federal National Mortgage Association or FNMA) and Freddie Mac (Federal Home Loan Mortgage Corporation). They offer an assortment of loan terms and programs. Some are tied to government initiatives such as energy conservation or affordable housing.

 

Hard Money Loans

Hard Money loans are issued by individuals or companies, not banks. Although they look at the borrower’s qualifications, particularly their property ownership experience, hard money lenders primarily rely on the value of the property in their underwriting.

These loans are usually for shorter terms and carry higher rates than conventional loans. They can close more quickly and with less paperwork than conventional loans. For this reason, they are sometimes used as bridge loans by ‘fix-and-flip’ investors and landlords who need to quickly take on a good fixer-upper opportunity and then either resell or refinance.

 

Can You Buy a Multifamily Home with an FHA Loan?

FHA offers multifamily loan programs that can benefit first-time investors. These include long terms (30-35 years), lower down payments (10%-15%), construction or major rehab financing, and non-recourse loans. Non-recourse loans are secured by the property and not personally guaranteed by the borrower.

FHA doesn’t loan money, it guarantees the loan which is made by FHA-approved lenders.FHA loans require more paperwork and can take a lot longer to close. FHA underwriting can sometimes take as long as a year. FHA loans may have higher fees, higher rates, and they require Mortgage Insurance (MIP).

 

Can You Buy a Multifamily Home with a VA Loan?

Yes, VA guarantees loans for multifamily properties of up to 4 units. If you are a veteran, a VA multifamily loan can be a great help as you begin your investment career. Most VA loans do not require any down payment for qualified veterans. Unlike FHA, VA loans do not have private mortgage insurance.

Either you or your broker should be familiar with local VA loan size limits. The limits are based on the number of units in the property. VA doesn’t have specific income limits or credit score minimums. They do provide underwriting guidelines to lenders who will have their own requirements.

VA may require that you live in one of the units as your primary residence for at least one year.

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Where to Find Multi-Family Units for Sale at the Best Price?

When looking for an apartment building available at a good price, consider MultifamilyCashin Marketplace. On our national marketplace, not only can you find multifamily apartment buildings for sale at affordable and often discounted rates, but also take advantage of our interface. It was meticulously designed with all commercial real estate investors’ needs in mind.

You can easily see the type of deal, notably whether or not it’s a distressed property whose owner needs money fast and is ready to sell at a discount. The type of deal is also shown: short sale, for sale by owner or broker-assisted, foreclosed, etc.

Whether or not you have in mind precise criteria for selecting an investment apartment building, our filters and helpful data will allow you to see how potentially profitable a property for sale is. Apart from that, it gives you quick access to lenders and other tools helping you make the best investment decision as easily as possible.

About the Author
Chris Valverde
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