Multifamily property has the power to generate cash flow and build wealth. Yet it also has the power to drain you of your free time and become the biggest money pit of your life.
If you’re looking to buy a multifamily property and avoid common headaches, you have your research cut out for you.
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Related: First-Time Homebuyers Guide
What Is a Multifamily Property?
Multifamily property consists of multiple units in a single building. This includes duplexes, triplexes, fourplexes, condominium buildings, student housing, age-restricted communities, low-income housing, and townhomes.
The units in a multifamily property must have separate entrances, kitchens, bathrooms, and utility meters.
Multifamily property investing is more popular than ever. In fact, 2021 saw more than $890 billion in loans originated for commercial real estate, a 45% increase over 2020. Multifamily properties accounted for $376 billion of that.
There’s a reason that individual investors gravitate toward two- to four-unit properties, other than ease of management. Residential loans of 30 years with a fixed rate are available for properties with one to four dwelling units. FHA, VA, and USDA loans are available for those properties if they are owner-occupied.
For five or more units, a commercial loan is required. Commercial loans usually come with a higher down payment requirement, higher interest rate, and shorter-term, meaning significantly higher mortgage payments.
Why Get a Multifamily Property?
Buying a multifamily home can jump-start your real estate investment portfolio. Here’s how.
Income From Flipping
Multifamily homes can be improved and then resold for a profit: ”flipped.” Buying a multifamily property, remodeling, and then reselling can be even more profitable than flipping single-family homes because as you remodel, you can increase rents.
Once you increase rents, the property becomes more valuable, both in terms of monthly cash flow and overall worth.
The ‘BRRRR’ Method
BRRRR stands for buy, rehab, rent, refinance, repeat. An investor buys a property, renovates it, and rents out the newly refurbished units for more money. After that, they can refinance the property to take out extra cash to buy a new property to renovate.
This method works well with multifamily properties because the rehabbing of multiple units can be done while other units that are not being renovated can still bring in some income.
Multifamily homes were designed for cash flow. Space and amenities are optimized to bring in money for the investor. On the other hand, single-family homes are designed for comfort. The added space of a single-family home may not bring as high of a return as a multifamily property.
Quick Portfolio Expansion
Buying multifamily properties allows investors to acquire multiple units with one transaction, so they may have a favorite in the single-family vs. multifamily comparison. Additionally, investing in multifamily properties can allow an investor to quickly generate income, which could be enough to acquire more properties.
A multifamily property lessens risk exposure. When you have single-family homes, vacancies have a bigger effect on your monthly cash flow. With one or more multifamily properties, the risk is spread across a number of properties. In other words, there are units still rented that can help cover the costs of the units that are vacant.
Analyzing the Investment Potential of a Multifamily Property
Investors can use a number of methods to determine if it makes sense to buy a multifamily property or not. Here are some of the most common calculations you can use to make that determination for yourself.
In real estate, cash flow is money that’s generated by the property and money spent on the property. Positive cash flow means income exceeds expenses. You could also call it profit.
Investors have differing amounts that they consider acceptable. Some investors bank on the appreciation of the property instead of the amount of cash flow.
The 1% Rule
The 1% rule states that the gross rents should be 1% or more of the purchase price. The 1% rule is hard to apply in high-income areas where the purchase price of a property is high relative to the rents it generates.
Gross Rent Multiplier
The gross rent multiplier (GRM) compares the gross annual rents to the fair market value of a property. It doesn’t take expenses into consideration and is meant to be a simple calculation to determine if a property is worth exploring further.
The lower the GRM, the more gross rent there is compared with the purchase price.
Cash on Cash Return
The cash on cash return is the annual amount earned compared with the amount of cash invested. It’s expressed as a formula: annual net cash flow divided by cash investment. This is helpful for investors who want to know how much cash is brought in by their cash investment each year.
The capitalization rate, or cap rate, is the amount of net operating income divided by the purchase price. This number indicates how long it will take to get back all your money in an investment.
Recommended: What Is Cap Rate and How Do You Calculate It?
Internal Rate of Return
The IRR measures the rate of return over an amount of time. It takes into account both cash flow and expected appreciation.
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How to Buy a Multifamily Property
You may be able to use 75% of documented rental income to help finance your loan.
And again, multifamily homes with four or fewer units can be financed more traditionally, while five or more units require a commercial mortgage.
Getting pre-approved for a mortgage for your multifamily investment property is one of the best things you can do to get started. After a mortgage officer has examined your finances and greenlighted an amount, you can go shopping for your multifamily investment.
Find a Multifamily Home
To narrow your search for a multifamily property, you’ll want to decide what it is you’re looking for. Keep a few of these factors in mind:
- Location: Do you have an area that you have expertise in? Are you going to manage the property yourself? These are some questions you’ll want to ask yourself to determine if you can buy a multifamily property near or far.
- Price range: After you’ve looked at where you want to potentially invest, you’ll get a good sense of what properties will cost by looking at real estate listings. Keep in mind that you can count 75% of documented rents toward the purchase price for many loan types, so the price you’ll be looking at will be much different than if you were looking for a single-family home.
- Type of property: Are you looking for a fourplex or an apartment complex? Duplex or 55+ community? There are a lot of choices to make between different property types and whether or not they’ll bring you a profit.
- Profit potential: Are you looking to invest for appreciation or cash flow? Many properties with a lower price tag in the Midwest may be better for cash flow, while properties on the West Coast may appreciate more. Take a look at both and decide on your investment strategy.
- Condition: Do you have the resources and team in place to take on a multifamily property that needs a lot of work? Or would you rather have something turnkey? You’ll want to be sure you know what resources you can commit to the project before you get in over your head.
Choose a Loan
The type of property may determine what type of loan you’re able to get. If this is your first rental, you may want to consider living in one of the units so you can qualify for owner-occupied financing, which usually comes with lower rates and down payment requirements.
Choose a lender that can answer your questions about mortgages.
Make an Offer and Close
Working with an agent, you’ll submit a competitive offer for the property you’ve chosen. Some buyers use cash to make the most competitive offer, while others need financing.
Renovate and Get Ready for Your Tenants
No matter what class of property you buy, the rental units will almost always require some work. Whether it’s a simple clean or a major renovation, these things are both tax-deductible and will improve the value, not to mention rentability, of your property.
Create a Management Plan
To make sure you’re running a business, and it’s not running you, you need to have a solid plan in place for how the rentals will be managed. How are repairs going to be taken care of? What’s your process when a rental turns over? How are you going to keep up with laws and ordinances?
Having a plan helps. Even so, you’ll learn as you go and will need to adjust this plan.
Is buying a multifamily property a good investment?
Finding a multifamily property that is a good investment will depend on the investor’s analysis of the property. This can include the price, condition, gross rent multiplier, capitalization rate, and a number of other factors that will make renting the units successfully.
What are the different kinds of multifamily properties?
- Duplexes, triplexes, fourplexes
- Apartment buildings
- Bungalow courts
- Mixed-use buildings
- Student housing
- Age-restricted housing units
- Low-income housing units
What is the best way to finance a multifamily home?
Some would argue that an FHA loan with 3.5% down is one of the best ways to finance a home with up to four units. The owner must live in one of the units to qualify for this type of financing.
How to buy a multifamily property? Do your research and choose a property that you’ll have the ability to finance and manage. Investing in rental properties is not easy, but it can generate cash flow and create family wealth.
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