Many people decide they want to invest in rental property but aren’t sure where to begin. A logical first step, for many investors, is to buy multifamily property. Multifamily real estate investing is a popular form of real estate investing because it’s an asset class that most people can understand, having rented an apartment or owned a home previously.
People can understand the basics: each unit needs to have a functioning kitchen, bathroom, and some combination of bedrooms and living space. Rentals typically run on month-to-month or annual leases using simple, straightforward paperwork.
In short, for the masses, buying multifamily property is a lot less complicated than investing in office space, retail, hotels and other asset classes. It’s a great way to get started with commercial real estate investing.
Related:The Ultimate Guide to Multifamily Real Estate Investing
What Is a Multifamily Property?
A multifamily property is any property that has more than one unit. The smallest scale multifamily properties are duplexes, known as “two-families” in some parts of the country. Triplexes and four-plexes are the next step up, having three and four units each, respectively.
Two- to four-unit multifamily properties are a great way for first-time investors to dip their toes into the rental property waters as they are typically financed by banks in the same way as are single family homes. Many investors will begin by owner-occupying a small multifamily property. In other words, they’ll live in one unit and rent the other(s). There are many benefits to doing so.
For instance, owner-occupied properties tend to qualify for more advantageous financing with lower interest rates and less of a down payment. By living on site, the investor can more easily manage the property. Most will even self-manage. This can save hundreds of dollars each month on property management fees. Sometimes an investor will buy a multifamily property without owner occupying it or hiring a property manager, which can make management more time intensive since it requires the owner to visit the unit in person for repair and maintenance requests.
Larger multifamily properties, those with five or more units, start to fall into the “commercial real estate” category. Properties with 5+ units typically qualify for a different type of financing, which is usually more expensive than properties that are considered strictly residential.
Multifamily property can continue to scale to include hundreds, even thousands, of units. Large apartment complexes, for example, and high-rise apartment buildings are other examples of multifamily property. Sometimes multifamily property will cater to a specific demographic, such as students or seniors, but this is not always the case. The majority of multifamily properties are agnostic to demographics (aside from catering to the general local demographic).
The Pros of Multi-Family Property Investment
There are several benefits to investing in multifamily property, including:
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- Cash Flow. One of the reasons investors like multifamily property is for the cash flow it generates each month. Rents are predictable and in strong markets, units can be turned over easily and re-leased to ensure steady cash flow year in and year out.
- Passive Income. Investing in multi-family real estate is a great way to generate additional income without lifting a finger. It is easy to hire a property manager who will take on the day-to-day responsibilities for you. This is particularly attractive to those who have little experience owning or managing rental property.
- Valuation Potential. It’d be a fool’s errand to believe that multifamily property will always appreciate in value. Many investors lost their shirts in 2008-2009 when the housing market collapsed. That said, those who have a long-term investment horizon will find that typically, multifamily real estate appreciates over time and are more resilient to economic downturns. Real estate values ebb and flow, but over the course of multiple real estate cycles, values tend to continue their upward climb.
- Lowered Risk. Multifamily property is considered a relatively “safe” investment compared to other real estate asset classes. That’s because even during an economic downturn, people need somewhere to live. In fact, during a recession, many people find themselves forced to sell their homes and move into rental housing, instead. It can take a while for people to rebuild their credit after an economic downturn, which creates prolonged demand for multifamily property. Compare this to office or retail properties, for example, in which demand almost always decreases when the economy slows.
- Fewer Loans. One benefit to owning multifamily property is that it can typically be purchased with one straight-forward, traditional bank loan. Compare purchasing a 10-unit apartment building to buying ten single-family rental properties. The former will require one loan, whereas the latter will require ten individual loans. These loans can be difficult to track and manage over time. Other types of real estate often require multiple loan products that mature on different time horizons, which can be confusing for a first-time investor.
- Insurance Simplicity. Insurance, like financing, is relatively simple when buying multifamily property (at least, relative to other real estate types). Insurance policies will become more complicated as the number of units grows, particularly if there are certain amenities (e.g., a rooftop terrace or outdoor pool) that could increase an owner’s liability. That said, insurance companies tend to be well-versed in multifamily assets and will be able to put together a policy with ease. As you grow your multifamily portfolio, it is also easy to get a single “blanket” policy to cover all of your assets under the same provider.
- Scalability. Multifamily also appeals to investors given the ability to scale one’s portfolio among this asset class. An investor can grow their portfolio two units at a time, if they so choose. It’s much harder to scale your portfolio when investing in strip malls or hotels, for example, which tend to have higher barriers to entry.
- Tax Benefits. Multi-family real estate is highly tax advantaged. Most investors use a mortgage to finance the property. They can then take a deduction for mortgage interest paid during that fiscal year, which tends to be higher in the first years of ownership as the loan begins to amortize. Multifamily properties can then be depreciated over a 27.5-year period, even if the property technically appreciates in value. Depreciation can be used to offset a significant portion of the rental income collected each year, making this a highly attractive asset class for investors of all kinds.
- Diversity of Product Types. While we refer to “multifamily” as a single type of real estate asset class, the sector is actually huge and offers investors the opportunity to buy several different product types. For example, you can invest in small, neighborhood-oriented duplexes or triplexes. You can choose newly-renovated properties or opt for a more opportunistic investment, such as buying a value-add apartment building.You can invest in private, off-campus student housing or 55+ retirement communities targeted toward seniors. You can buy a multi-family property with the intention of renting on a traditional, year-long lease or you can invest in one that you then list on Airbnb or another short-term rental platform. Multifamily provides tremendous optionality given the many product types that make up this sector.
- Multiple Investment Mechanisms. Another reason people are drawn to multifamily property is because of the myriad of ways in which to invest. You can purchase a multifamily building individually, or you can partner with others. You can invest via a syndication, which allows you to reap the benefits while taking on a more passive role in the partnership. You can invest in a multifamily fund that has broad reach to invest in multifamily properties across the country, thereby diversifying the location of your holdings (and therefore, providing some risk mitigation). Alternatively, you can invest via a real estate investment trust (REIT), which preserves liquidity as REIT shares can be purchased and sold as easily as stocks. These are just a few of the ways to invest in multifamily property, which is why the asset class is so attractive to such a diverse group of investors.
Related: How to Value Real Estate
The Cons of Multi-Family Property Investment
Despite the many benefits of investing in multifamily property, there are also some downsides. A few of the cons are outlined below:
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- Management Intensity. Although property management can be outsourced, that doesn’t mean that multifamily isn’t management intensive. In fact, it’s quite the opposite. A multifamily property means dealing with many individual leases, different tenants who have various repair and maintenance requests, tenants who prefer to communicate in different ways, pay their bills differently, etc. Compare this to leasing a 10,000 sq. ft. office space to a single tenant. In this case, you’d only be dealing with a single entity. And with commercial leases, many of the routine repair and maintenance obligations fall to the tenants – not the owner, which makes management less intensive for the investor. That said when comparing management intensity of only residential property types, managing a multifamily property can be considerably easier than managing a disparate portfolio of single-family rentals. There are efficiencies that come with managing a single multifamily asset, including the ability to hire an on-site or live-in property manager, depending on the size of the property
- Cost. Depending on where you’re looking to invest, multifamily property can be really expensive. In fact, this is one of the largest barriers to entry for most investors. A two-unit apartment building in San Francisco, Portland, New York or Boston can cost well over a million dollars. Most banks will want to see the investor put down at least 20% as a down payment (if not more), which would mean at least $200,000 on a property that sells for $1 million. Coming up with that cash is no easy feat for the average investor, particularly in a bull market where many investors compete for the same multifamily property, thereby driving prices even higher. Single-family homes are often less expensive for those looking to buy residential rental property, but as noted above, single-family homes have their own management challenges to consider.
- Competition. As noted above, multifamily property tends to draw interest from more experienced investors. This can create intense competition for multifamily property, and effectively, shuts many novice investors out of the market. Experienced investors are often able to pay cash and are willing to waive all purchase contingencies (such as the inspection and/or financing contingencies) which make their offers, even at a lower price point, more appealing to some sellers. First-time investors are often best served by partnering with more experienced investors as they get begin to learn the ins- and outs- of the multifamily product type.
Conclusion
Anyone who is interested in buying rental property will certainly want to take a hard look at multifamily investments. The asset class is one that investors can begin investing in gradually, with just two or four units at a time. Some may even employ the strategy of owner-occupying the property initially, as a way of truly “living” the property management lifestyle before investing in larger multifamily properties.
Remember, the most important aspect of real estate investing is just getting started. Investing in small multifamily properties is a great way to do just that.
Over time, as your portfolio grows, you can sell the smaller units and roll the proceeds into larger multifamily investment opportunities through what’s known as a “1031 exchange”. Those with a buy-and-hold strategy might instead hang on to their smaller multifamily homes while the tenants pay down the mortgage and values appreciate. Eventually, these investors will be able to leverage the equity in their multifamily portfolio to invest in larger multifamily properties.
Both of these tried-and-true approaches are how some of American’s wealthiest individuals have got to where they are today – which is why, in sum, we can’t help but love the potential offered by multifamily investing.
Related: The Role of the Multi Family Industry in the Housing Shortage Scenario