What is a Multifamily Property?
As the name suggests, a multifamily real estate is a property which has multiple units. It can be categorized into:
- Commercial Multifamily
- Residential Multifamily
While residential multifamily has less than 5 units (such as two plexes, triplexes, four plexes), larger properties including 5 units or more fall in the domain of Commercial Multifamily property.
Types of Multifamily Properties
Small Multifamily properties
Smaller 2-4 units multifamily is a great place for first time investors to start building their real estate portfolio. Some investors start off by buying a multifamily property, living in one unit and renting out the rest of the units, commonly known as ‘House hacking’.
It can be the beginning of a career for some real estate investors. House Hacking has many benefits:
- Tenants essentially pay the owner’s mortgage through the rents, while the owner builds equity in the property, basically living rent free.
- Ease of financing with lower interest rates and lower down payment
- Generally easier to self-manage: save money on property management
Large multifamily properties
Larger multifamily properties, popularly known as Apartment Complexes and Apartment Homes can have hundreds to even thousands of units. A few examples include high rise apartments, garden style apartments as well as townhome communities.
These properties are generally easier to scale due to a large number of units in a single apartment complex, but they are more expensive, require property management and typically qualify for a different financing than the smaller multifamily and single family housing.
Depending on your personal preference, financial situation and the investing journey you choose to pursue, multifamily properties can be a great wealth building tool for many investors.
Now that we have discussed the types and sizes of multifamily units, let’s dive right into the pros and cons of multifamily investing.
Pros of Multifamily Real Estate Investing
Cash flow
This is probably one of the best reasons to invest in multifamily. Unlike a single family property, a large multifamily property generates multiple streams of income from multiple units, minimizing the loss to lease in case a single tenant leaves.
Additional income from different tenants not only accelerates the investor upside in strong markets by bringing the rents to market rents, but more importantly, it protects the investor downside in case a few tenants vacate.
The properties generally tend to have longer term leases of 6, 9 months or 1 year ensuring predictable rents and less unit turnover.
Tax benefits
Multi-family real estate offers tremendous tax advantages.
1. Depreciation benefits: Multifamily properties use depreciation benefits that can offset a major portion of the rental income. Some investors use tools such as bonus depreciation and cost segregation studies, that can allow faster and more significant depreciation benefits.
2. Interest deduction: Since most investors use mortgage in commercial real estate as it can boost the return on the capital invested, Interest deduction can also be taken on a property especially in the initial years, based on the type and terms of loan
3. Some multifamily real estate deals including apartment syndications allow investors to invest through tax advantaged accounts such as self-directed IRA (SDIRA) which can allow your gains to be tax-free or tax deferred, depending on the type of IRA you use.
Roth SDIRA uses after-tax contributions, which means that you can’t deduct the money you invest in the tax year you contribute. However, your earnings will grow tax-free and when you take distributions from the account in retirement, you won’t owe any taxes on them.
Hands off passive investing
Multifamily investing can be a strong source of reliable passive income for an investor in at least 2 different ways:
1. Invest in apartment syndication or crowdfunding real estate deals as a limited partner with a trusted sponsor/ General Partner (GP) who is responsible for day to day operations of a large multifamily.
2. Hire a property manager for your multifamily property if you have a day job, don’t want to deal with tenant communication, have little to no property management experience or if you just want to take a more passive role as an investor and focus on the NEXT BIG THING.
Scalability
One important reason that makes multifamily real estate so lucrative as an asset class is due to its ability to grow much faster where you can buy many residential units at a time, as compared to single-family properties where you have to acquire one unit at a time.
So, it is much more efficient to acquire a multifamily property than to pursue multiple single-family deals.
Better risk adjusted returns
Multifamily is considered a ‘low risk’ asset class compared to other real estate asset classes.
- In a recessionary environment, when some people have to sell their houses, they downgrade to a rental unit such as an apartment. That increases demand for affordable multifamily housing. Compare it to asset classes such as office and hotels which may not do well in an economic downturn or a pandemic outbreak.
- Compare it to a single family where the risk is high: If a single tenant leaves, occupancy goes down to 0% and the house becomes vacant waiting to go again on the market for lease-up. If one tenant lives in a large multifamily housing, the impact to the occupancy as well as gross income will be minimal, thereby lowering the risk.
Cons of Multifamily Real Estate Investing
Higher Operating Expenses
A multifamily property usually incurs higher maintenance costs, including potentially large unexpected renovation and rehab costs. An investor has to be aware of the adequate reserves or adequate cash in hand to deal with such a situation successfully.
Expensive to buy
The initial cost to buy a multifamily property is significantly higher than a single family property. Depending on the type, size, vintage and location of a multifamily asset, it is not unusual to find properties ranging from tens to even hundreds of millions of dollars.
Management Intensive
Property and asset management is one of the most important, if not the most important aspect of a successful multifamily investment. It can not only be capital, labor and time intensive, but it can single handedly determine the outcome of your investment. There can be many road bumps along the way, and multifamily investment is definitely not for the faint of heart.
Competition
Depending on where you invest: primary, secondary or tertiary markets, you might be bidding against multiple players, sometimes even large REITS, pension or endowment funds. It is also not unusual to see you competing against buyers who may be ready to pay all cash. This may prove cost prohibitive to a lot of multifamily investors.
Regulations
Apartment owners have to be aware of the multiple regulations related to multifamily real estate. Laws differ widely between states and sometimes even local jurisdictions. Some states are more landlord friendly than others. Some states may also have rent escalation restriction laws etc.
Multifamily Investing – Summary
Multifamily is a great way to start investing in commercial real estate. Investors can start with a fourplex or an eight plex at a time and as your portfolio grows, you can refinance or sell those to invest into larger multifamily properties.
Multifamily investing generally allows you to scale much faster than a single family investment model and it can truly create opportunities to build generational wealth.
Multifamily can be extremely lucrative and profitable, but at the same time, it can be very capital intensive, requiring large upfront capital as well as expenses for repair and renovations etc.
It can be very challenging to manage at times, and for that reason, some people consider investing in a property management company to avoid the stress and optimize the management experience.
Many busy professionals who have a full time job prefer to invest passively in multifamily real estate, without having to deal with day to day real estate operations can also invest as a limited partner in a crowdfunding real estate which is popularly known as ‘syndication’.
It allows passive investors to not only get the perks of real estate investing, but also the tax benefits of real estate investing.
In short, multifamily property investment is a great way to get started with commercial real estate investing.
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