If you were thinking about investing in real estate but not deciding if you want to purchase a single family property of multifamily property, you are in the right place. Specially, Are multifamily properties good investments? Yes, multifamily can be a good investment!
Investors moving from the single-family realm into multifamily properties need to understand the differences between the two asset classes, which I’ll discuss in this article. Specifically, I’ll dive into each of the following topics:
- What is Multifamily Property?
- Pros of Multifamily Investment
- Cons of Multifamily Investment
- Options to Begin Investing in Multifamily Properties
- Will Multifamily Property Work for you?
- Final Thoughts
What is Multifamily Property?
To start, what differentiates a single-family home from a multifamily property? As the name suggests, a multifamily property includes multiple families. However, duplexes, triplexes, and quadplexes (two-, three-, and four-unit properties, respectively), generally fall under the umbrella of single-family homes.
As an asset class, multifamily properties begin at the five-unit threshold, though these projects can include 10, 50, 500 or more units, depending on available funding and the scope of a given deal.
And, from an investor’s perspective, the transition from single-family homes to multifamily also entails another key change: lending type. With up to quadplexes, borrowers typically use personal mortgages, that is, your standard 30-year mortgage taken out in your name.
Once crossing into multifamily properties, investors transition to commercial mortgages. Whereas lenders typically avoid lending directly to a separate legal entity (e.g. LLC or LP) for personal mortgages, this represents the only option for commercial lending (though most first time commercial borrowers typically still need to personally guarantee a commercial loan, as they lack established commercial borrowing history).
In addition to requiring different borrower financial qualifications, the other major difference between the two types of loans includes term/amortization alignment. With a personal mortgage, a 30-year term means a 30-year amortization, or payback period.
With commercial lending, you’ll typically receive a shorter loan term with a longer loan amortization (e.g. 10-year term, 25-year amortization), meaning that at the end of the first loan term you’ll still owe a large payment. This final payment necessitates either a cash payoff or, more commonly, a re-finance, which poses the potential for interest rate risk.
Pros of Investing in Multifamily Properties
Having provided an overview of multifamily properties, investors should see the clear advantages to this approach.
Take advantage of the economics of scale
Specifically, a multifamily property allows investors the advantages inherent to economies of scale, that is, you spend more in absolute terms while spending less proportionately.
For example, when you build a duplex, you need to buy two refrigerators, stoves, water heaters, etc. But, if you build a 10-unit property, you’re buying ten of all those items. While an appliance store won’t provide a discount for buying two of something, you’ll likely command a sizable discount for buying ten items.
Allows for On-site management with cheaper price
Additionally, this scale allows for the potential for on-site management, a significant cost-saving and tenant-satisfaction measure of large multifamily properties.
Assume an on-site manager receives a salary of $50,000. If you own a duplex, that salary would equate to $25,000/unit in management overhead – a wildly expensive sum.
On the other hand, assume that the same manager works on-site at a 250-unit property. The per-unit overhead has now been reduced to $200/unit – an expensive, but far more reasonable amount.
Cons of Investing in Multifamily Properties
Investors also need to understand the cons of multifamily investments. However, these really represent less cons and more barriers to entry.
A larger loan for multifamily
First, when you apply for a commercial loan for a multifamily property, you apply for a single loan, not individual loans for each unit. This makes multifamily loans relatively large, depending on the size of the deal. And, the larger the loan, the better the required credit, a reality that can preclude many investors from commercial loan approval.
Large down payment
Second, and related to the size of the loan, commercial lenders generally require at least 20 percent down (and at times up to 30 percent). For an investor looking to purchase a $1,000,000 multifamily property, this means needing to come up with $200,000 to $300,000 cash, a massive obstacle for most new investors!
Strategies to Begin Investing in Multifamily Properties
While the above barriers to entry exist, investors can also use the following creative solutions to overcome these barriers.
Act as a Sponsor in a Syndication
Though commercial lenders require large down payments, that cash doesn’t need to be yours. If you have significant real estate experience but lack capital, acting as a sponsor in a syndication deal allows you to pool the capital of other investors while actually managing the day-to-day operations of the deal yourself. While sponsors inherently give up a portion of their returns by bringing in other equity partners as LPs, they typically command fees or higher returns for their active role.
Act as a limited partner
On the other side of the spectrum, you may have cash but not experience. As such, you can enter the multifamily investment world by acting as an LP in a syndication deal. Two major advantages exist to this approach: 1) you begin earning passive income; and 2) you can use this investment as an opportunity to educate yourself about multifamily investments, potentially becoming a deal sponsor down the line.
How to Decide if Multifamily Investment Works for You
After outlining the above considerations, investors need to ask, does multifamily property investing work for me?
I recommend asking two more specific questions.
Do I have the required experience to take point on a multifamily deal?
If you answer yes to this question, you need to then determine if you also have the cash to make a deal happen. If you do, yes, begin investing in multifamily properties with your own deal! Or, if you have the experience but not the capital, entering the market as a multifamily deal syndication sponsor makes more sense.
Do I have the money to finance a multifamily deal?
If you answer yes to this, the next related question involves experience. If, for instance, you also have significant multifamily experience, take point on your own deal! Or, as discussed above, use your cash to become an LP in a syndication deal, gaining the advantages of both passive income and increased multifamily experience.
As the above article makes clear, you don’t need to view multifamily investing as an all-or-nothing strategy. That is, the fact that you don’t have hundreds of thousands of dollars (or more) in seed capital should not preclude you from getting your feet in the figurative door of multifamily investing.
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