Is Buying a Multifamily Apartment Building a Good Real Estate Investment?
This article will give you a close look at the pros and cons of investing in multifamily homes. We’ll discuss the opportunities and the concerns that multifamily investors need to be aware of.
Using my more than a decade experience in multifamily real estate, I will share the important details about this niche that will hopefully help you make your decision.
Read on to understand whether or not investing in multifamily housing is the right path for you.
Pros and Cons of Owning a Multifamily Home
Pros of Multifamily Real Estate Investing
1. Diversified Rental Income Stream
With multiple units in one property, a landlord can absorb the loss of a tenant more easily. You’ll also spread the expenses of property ownership over more units.
2. Less Competition
When buying multifamily homes for investment, there are fewer investors to compete against compared to single-family rentals.
3. Tax Benefits
Tax laws allow you to deduct most apartment complex expenses from taxable income. The depreciation rules are also a benefit to apartment complex owners. You can claim depreciation over 27.5 years, even if the property market value has grown.
4. Long Term Value
With more regulations impacting multifamily construction, well-maintained existing properties should grow in value over time.
5. Simplified Operations
Compared to owning multiple single-family rental properties, a multifamily apartment complex is more convenient to manage, finance, and insure. You’ll have one location to oversee and one payment date for your mortgage loan and insurance premiums.
Cons of Multifamily Real Estate Investing
1. Time / Management
With more tenants and a larger-sized property, it will take more time to manage the ongoing operation than with a single-tenant property. Compared to a portfolio of single-tenant properties though, one multifamily property can still be more convenient to manage.
2. Larger Systems to Maintain
Larger apartment buildings might have larger mechanical, electrical, and plumbing systems that have to be maintained and repaired. The breakdown of one system can affect all your tenants.
3. Purchase Cost
Investing in multifamily apartment buildings will come with a higher price tag. Both multifamily closing costs and the purchase price are higher than for single family homes. If you have liquidated multiple single-family properties, this might not be a problem. If not, you can consider partnering with other investors for your first apartment building.
4. More Experienced Competition
Although the higher cost of entry will hold down the number of competitors for these properties, those who you do compete with are generally more experienced investors.
Municipalities are increasing their regulations concerning multifamily apartment buildings. You or your attorney will need to constantly review your market’s regulations so that you stay in compliance throughout your ownership.
Is Owning a Multifamily Property a Passive Investment?
Buying a multifamily home and renting can be a passive investment. There are property management companies in every market that can handle all aspects of ownership for you:
- Reviewing applicants and leasing the units
- Adhering to local and federal Fair Housing laws
- Maintaining required documentation
- Collecting and depositing rents
- Handling security deposit and operating accounts
- Scheduling maintenance and repairs
- Handling tenant relationships.
For tax purposes, the IRS says that passive income is “income from a business in which the taxpayer does not materially participate”. This doesn’t mean that you can’t oversee the performance of your property manager.
You should schedule a regular review of the financial statements, bank accounts, and document storage, as well as visiting the property to see that it is being properly maintained.
It’s very important to know the definition of passive investing if you are using funds from a self-directed IRA. These accounts restrict investments to passive investing only.
Choose Your Apartment Building Investment Strategy
Long-term investing requires placing capital in an asset and leaving it there for a prolonged period of time. Real estate investing has several features that make this type of long-term investing particularly advantageous.
Unlike some assets, real estate doesn’t just appreciate, it also generates income in the form of rent.
The amount of rent charged should be enough to cover, at a minimum, operating expenses, insurance premiums, debt service, and reserves for maintenance and re-leasing vacant units. Even with periodic vacancies and market slumps, over time the rental income should be enough to generate profits for the owners.
Since debt on these properties is usually the largest part of the purchase price, your tenants are buying the asset for you. If you own the property long enough, you can create enough equity in the property to do a “cash-out” refinance and use the proceeds to buy additional properties.
In addition to the profits created by the asset, in most places, the market value of the property will increase over time. When you add the profits generated, the equity created by rent payments, and the appreciation of the asset, the long-term returns on a multifamily property can be quite good.
The downside to long-term real estate investing is that individual markets within the country can go down in value. This can happen if:
- Major employers leave the area.
- The school system falls in ranking and performance.
- Taxes significantly increase.
- Infrastructure is allowed to deteriorate.
If the timing of your investment plan causes you to sell a real estate asset during a downturn, your investment returns could suffer.
Over time, added competition from newer apartment complexes could make it hard to keep or increase acceptable rent levels.
Short-term real estate investing involves purchasing property at below market values, improving it to increase market value (value add), and selling it right away. This is called property flipping or fix and flip investing.
Short-term property flippers don’t like to have their funds tied up long-term. If done successfully, a short-term investor can turn their capital over multiple times a year, increasing it with every project.
The keys to property flipping are finding properties in good markets at below-market prices, knowing how to conduct an accurate appraisal of a multifamily property, inspect its condition, selling it without delay, and having enough capital.
Flippers don’t derive income from the property during their ownership to help pay for the project. If a short-term investor misjudges the condition of a property and they don’t have the capital to fix unforeseen problems, they can get stuck with the property and lose money.
Short-term property flippers can use some of the tax advantages from operating expenses, but they don’t hold the property long enough to declare depreciation.
What Kind of a Multifamily Home Is a Good Investment?
Let’s look at how to invest in multifamily properties.
The best kind of multifamily property for you to buy will depend on your market and how much money you have. Examine potential markets to find their need for rental housing. Without adequate need, you’ll face strong competition from other properties.
Match this to your available capital and ability to borrow. If the greatest need is for high end properties and you can’t afford a higher priced property like that, it may not be the right market for you.
Which Market Is Best For You?
First, look for growing areas. Consistent population growth means that people are relocating there from less desirable places.
Search for growing incomes. Declining incomes show a market in decline that will not be a good source of renters in the long term.
And finally, you want to see a lower median age. Young people starting out in the workplace typically rent for a while before they buy.
Next, calculate the area’s Home Price to Rent Ratio. This tells you whether it makes more sense for residents to rent than buy. Take the Average Home Value for that market and divide it by the annual Fair Market Rent for 3 bedroom apartments.
The higher the Price to Rent number, the more households that are being priced out of the homebuying market. Those households are likely renters. A ratio number of more than 20 is a high number, 16 to 20 is a moderate number, and 15 or less is low.
Housing and population data is available for investors on the US Census Bureau, Freddie Mac, and HUD websites. Information on population growth, the number of renting households, and Average Home Values can be found on the Census Bureau website. Fair Market Rents are shown on the HUD site.
Smaller markets adjacent to desirable cities can offer multifamily properties at reasonable prices.
Large vs Small
Simply put, larger properties have more economy of scale, better diversity of income sources, and larger cash flow. But they cost more.
Smaller properties like duplexes cost less and are easier to purchase for beginners.
2-4 unit rental properties have helped a lot of investors get started. Besides the smaller price tag, there are conventional mortgage loans available if you live in one of the units. You usually have to live there for at least one year.
Some investors have started that way and then moved into another property after a year. This allows them to build a portfolio of properties.
You can only do that for so long. Most lenders won’t make a residential loan to someone who already has 4 such loans. For that reason, the growth opportunity for these investors is limited.
One growth strategy is to sell your entire portfolio of smaller assets and use the proceeds to move up to larger apartment properties.
These assets cost more, but they generate a lot more cash.
More units mean that you’re spreading your vacancy risk more effectively. If you can beat your projected vacancy rate, you can outpace your return calculations.
Many experienced investors report that with today’s property management software platforms, managing larger properties is no more difficult than managing smaller properties. If that’s the case, why spend more time making less money?
Larger properties are good for those who are looking for a passive investment. The stronger cash flow allows you to hire a property management firm and still realize a good return on investment.
Commercial financing is available for investment properties like these.
The level of incomes in the market will dictate the type of property that will be successful there. You need to consider which type of property you want to own.
Low incomes don’t mean that there aren’t multifamily opportunities in that area. Government subsidy programs such as HUD Section 8 housing assistance have given landlords a stable source of rental income. These properties may also qualify for Low Income Housing Tax Credits which can help you finance the purchase.
Moderate income apartments are usually classified as Class B or C properties. These properties are 20 to 30 years old and showing some deferred maintenance. The better the condition of the property, the higher the price.
Lower priced moderate apartments are the sweet spot for many investors. Properties in a good location that need manageable repairs or updates can be upgraded to a higher classification. This means higher rents and better returns. You may be able to finance some improvements into your mortgage.
High end properties are newer with more amenities. They will command higher rents, and the highest price.
Like all housing, residents want to be able to access dining, shopping, entertainment, grocery, and medical providers. Low income properties will need to be situated on public transportation routes.
If a potential investment property has high vacancy rates, be careful to determine whether that was caused by the location. Sometimes the area around the apartment complex has gone downhill and you can’t fix that.
Full Financial Disclosure
It is a big red flag if the seller doesn’t provide complete financials on the operation of the apartment including up-to-date rent rolls.
- You need to know:
- Are rents at or below market.
- Actual vacancy rates.
- How many tenants are current on rent payments.
- Are there added income sources (coin-op laundry, etc.).
- Accurate operating expenses.
You’re looking for properties that you can improve upon without a complete rebuild.
Avoid High Vacancy Rates
You need to have at least enough tenants to pay for ongoing expenses. The rule of thumb for many investors is 70% occupancy. Properties for sale that have less than 70% occupancy will take a lot of capital. You’ll have to subsidize the operations while you make repairs and improvements to attract more tenants.
Good Selection of Units
You want to see a variety of units in the complex. 1, 2, and 3 bedrooms, and studio apartments are a good mix of units that will attract a good mix of tenants.
Ability to Add Value
The best property to find is one that can be upgraded without breaking the bank. Properties that have fallen into disrepair because of poor management can be a great opportunity.
Improved landscaping and amenities, a fresh coat of exterior paint, minor upgrades to the units, improved wi-fi, anything that can justify you raising rents over time is a good investment.
To start with, determine if the rents being charged are less than rents for similar apartments nearby. It’s easier to turn a “C” class property into a “B” class property if you’re in a “B” market to begin with.
Look for ways to add income sources. Laundry rooms and small car wash stations that are coin-operated are good supplemental sources of cash flow.
If the property doesn’t already have them, look into starting pet fees. It’s difficult these days to prevent renters from having pets. It’s only prudent to shore up your reserves for indoor damage they might cause.
Hopefully, by now, you have already decided whether or not multifamily property investing is for you. If it is, read our guide with tips for beginners on how to buy your first multifamily apartment building or complex.
Where to Find Multifamily Apartment Buildings 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 properties 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.