What Is a Multifamily Property?
A multifamily property is a residential building that features more than one unit. Common examples include apartment complexes, condo buildings, duplexes, and townhomes. A building with just one dwelling unit is called a single-family home; a residential building larger than that is known as multifamily. Multifamily investing is quite profitable but also more complex than purchasing single-family homes. So, before you consider this strategy, you should weigh the pros and cons.
Multi-Family Investing Pros
1. More Cash Flow
The biggest benefit of purchasing a multifamily property is the added cash flow. More units mean more tenants are paying rent, which can significantly increase your monthly rental income. In addition, multifamily properties are often more cost-effective than multiple single-family homes because you won't necessarily double the costs. For instance, a duplex is often cheaper to purchase and maintain than two single-family homes because it shares the same lot and basic structure. But you could charge just as much rent as long as the properties are comparable, allowing you to keep more in profit.
2. Easier Financing
It's also usually easier to obtain financing for a multifamily property than for a single-family investment property. Multifamily homes aren't as risky because the cash flow is typically more predictable. So, you will have an easier time finding a loan and will likely pay less interest than a comparable portfolio of single-family homes. But you will still need to meet the lender's financial requirements, which may be strict depending on the size of the deal.
3. Reduce Your Risk
Multifamily properties allow you to reduce some of the vacancy risks by dividing the responsibility among multiple tenants. If your tenant suddenly leaves or stops paying with a single-family home, you lose 100% of your cash flow. Whereas if you own four units and one tenant moves out, you'll only lose 75% of that cash flow, which may be enough to continue to cover the mortgage. The risk of multiple tenants refusing to pay rent or moving out suddenly is much lower than one single tenant, making it a safer investment if appropriately managed.
4. Simplify Your Portfolio
Having multiple tenants under one roof is often much more straightforward than purchasing numerous single-family homes. One property means one mortgage, which is much easier than juggling numerous different loans on more than one property. Plus, performing maintenance and collecting rent is simpler when all your tenants are in one physical location. So, if you are considering expanding your portfolio beyond one or two homes, multifamily investing is the way to go.
5. Tax Benefits
Multifamily properties also offer a variety of tax benefits. For example, owners can deduct everyday expenses like maintenance and repairs, insurance, marketing property management, and more, which can add to significant savings. Plus, the accounting is often much simpler when you have one property and one set of expenses, as opposed to multiple single-family homes with unique needs and cash flow.
Multi-Family Investing Cons
1. More Expensive
Although multifamily properties offer the potential for increased cash flow, there is also a larger barrier to entry. The cost to purchase a multifamily property can range from a few hundred thousand to millions (or even billions) of dollars, depending on the size and location. So, make sure you are prepared to make that kind of investment.
2. Can Be Harder to Manage
Multifamily properties come with their own management concerns. More tenants mean more phone calls and more potential for dispute. Plus, the systems in the building are likely more complex and may require a professional to maintain and repair, which means more expenses and a greater need for more routine maintenance. It all depends on what kinds of systems you put in place to maintain the property, but the added cash flow will likely bring more headaches.
3. Greater Competition
Multifamily properties are highly in demand because of the numerous benefits, which means you may face stiff competition from seasoned investors. This competition may create a bidding war and drive the price, or another investor may beat you to the punch by paying cash. It's certainly not impossible to get your hands on a multifamily property if you have the funds but be prepared to compete with other investors.
4. More Tenant Turnover
Multifamily properties also feature a greater turnover rate than single-family homes. While vacancies won't be as dire, you'll still have to deal with the added expense of consistently cleaning, renovating, and marketing the units. That means paying more to property managers, cleaners, and realtors to keep a steady stream of tenants in your building.
5. Requires More Experience
Although multifamily properties are often more stable than single-family homes, that doesn't mean they are simpler to manage. Multifamily investing can often get very complex, and the cost of entry is much higher. That means there's more on the line if you default, making it a risky strategy for beginners. So, most investors are better off starting with a single-family home and working their way up to multifamily as they gain experience and build connections.
How To Calculate Value of Multi-family Property
Multifamily properties are valued using the income capitalization approach, which takes a property's net operating income and divides it by the desired cap rate. This valuation method is ideal for multi-family homes and other investment properties as it can quickly help you understand your return on investment. For example, the value of a 10-unit multi-family property that has a $200,000 NOI in an area with a 6% cap rate would be $3,333,333.
How Much Down Payment For Multi-Family Property
The down payment requirements for multi-family properties range from 3% to 25% depending on the type of loan you are using and the size of the property you are purchasing. If you are using a conventional loan to purchase a duplex or other two-unit multifamily home you will partially occupy, the down payment can be as low as 3%. However, if you are purchasing a larger multi-family property, you can expect a 25% down payment requirement.
Multi-Family Investing Tips for Beginners
1. Understand the Risks
Before deciding to purchase a multifamily property, it's essential to understand the risks. It's a significant investment with many variables that can affect your bottom line. So be prepared to crunch the numbers and do some serious due diligence before purchasing. But, as long as you're willing to accept the risks and do the work, you should have a very lucrative investment.
2. Use the 50% Rule
According to the 50% rule, your operating expenses should equal about half of the property's gross rent. This can be a good rule of thumb for estimating how much it will cost to maintain a property if you don't have the numbers available. So, to determine rough operating expenses, take the gross rent and multiply it by 50%. Although you'll need to do more in-depth research to verify that this figure is accurate, it's an excellent shortcut if you want to understand an investment's profit margins.
3. Calculate Cash Flow
You should also attempt to calculate the cash flow to determine how profitable an investment could be. To determine cash flow, multiply the number of units by the average gross rent in the area. You can usually find this information on the internet, or you can look at listings of comparable units and calculate a rough average. It may get more complicated if there are multiple types of units in the building. But this can help you determine approximately how much rent a building will bring in each month.
4. Determine the Cap Rate
The cap rate is the expected rate of return for a real estate asset based on the net operating income. It is written as a percentage calculated by taking the net operating income and dividing it by the property's value. A reasonable cap rate for a multifamily property is usually around 4-10%. Understanding cap rates and how to use them to calculate the return of a property is critical to making a wise investment, so make sure to understand this principle thoroughly.
5. Hire a Property Manager
While many landlords can self-manage a single-family home, multifamily properties get more complicated. Not only is there more rent to collect and more tenants to manage, but the maintenance can be much more complex. Especially if you plan to purchase a large apartment complex or condo building, you will want to hire a professional to keep up with rent collection and respond to tenant complaints. Hiring a property manager will save you time and energy that is likely better spent on expanding your portfolio or taking care of other responsibilities.
Multi-Family Property Bottom Line
Investing in multi-family property can be a great way to make passive income, but you need to be prepared and know what you're doing. If you start small and use conservative valuation methods, you can make a lot of money with multi-family homes. However, if you rush into things without learning about multi-property investing, or if you overestimate a property's cash flow, you risk paying too much for a property or getting in over your head.
Multifamily Real Estate Investing FAQs
Are Multifamily Properties Safe Investments?
Yes, multifamily properties are generally safe investments, but that doesn't mean they are without risk. They often offer more predictable cash flow than single-family homes because the mortgage is not dependent on one tenant. But they are also a significant investment that can become a severe liability if not properly managed. So, do the proper work and research before making a purchase.
What is a Good Return on a Multifamily Property?
Typically, a good return on a multifamily property is anywhere from 8-12%, although it can vary depending on the location and experience level of the investor. Investors just starting in the game with a small apartment building or duplex may only expect an ROI of 5-8%, especially if the demand for rental units is slow. In contrast, a seasoned investor who purchases a luxury condo building may see returns of 20% or higher.
Is Now a Good Time to Invest in Multifamily Real Estate?
Yes, now is a good time to invest in multifamily real estate. With interest rates rising and average home prices at an all-time high, there will be increased demand for rentals for those who can't afford to buy a home. Plus, real estate is often a good hedge against inflation, and multifamily properties can provide a consistent return that will help your money keep pace with the buying power of the dollar.