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4 Questions Every Would-Be Multifamily Investor Should Ask

Published on Tuesday - May 23, 2017

There may be no more effective wealth-building strategy in the world, aside from inheriting millions of dollars, than real estate investing. And when it comes to generating long-term cash flow, through passive income means, becoming a multifamily investor is often at the top of a redeveloper’s to-do list.

But before you finance your first multifamily investment deal, it’s important you know exactly what you’re getting into. Investing in multifamily housing is not simply a “more expensive” version of single-family investing. It’s vital you understand the single vs. multifamily investing paradigm, and keys to success when investing in multifamily properties, so that you’re primed for success — not left out in the cold when it comes time to make a deal.

Whether you’re a seasoned real estate investor looking to take your game to the next level or a redeveloper newbie wishing to make a plan for long-term, sustainable cash flow, here are four questions to ask to ensure you’re ready for the jump to multifamily investor status.

Are You Ready To Be A Multifamily Investor?

Investing in multifamily properties

1. Do you understand what a multifamily property is?

At its most basic form, a multifamily property is a structure which has more than one unit. Multifamily properties are generally divided into two distinct categorizations:

  • Small multifamily properties: Those that house between 2-4 units.
  • Large multifamily properties: Those with five or more units.

Within this grouping, there is a wide range of property options available. A multifamily building could be as small as a two-unit duplex at the beach or as large as a 1000-unit co-op downtown. The key differences between the two are in how they are financed and valued.

2. Do I understand how multifamily properties are valued?

The value of a small multifamily investment property is often ascertained by comps in an area, not unlike that of a single-family property. If you’re shopping for a loan to buy that duplex you’ve had your eye on, a nearby duplex will help determine the loan-to-value (LTV) ratio for financing purposes.

The value of a large multifamily property, however, is determined by the capitalization rate, or as it’s often called, the cap rate – an indication of the rate of return on the property. This number is determined by finding the net operating income of a property and dividing it by the cost of the property. Or:

  • Gross yearly rent MULTIPLIED BY vacancy rate MINUS operating expense DIVIDED by the cost of the multifamily property.

So, if a large multifamily property brings in $200,000 in yearly rent, has a vacancy rate of five percent, requires $50,000 a year in operating expenses, and costs two million dollars, the cap rate would be seven percent. (Proapod has a handy cap rate calculator you can use.)

The reason this is such an important concept to grasp is that it can make financing large multifamily properties actually easier than single family properties. If the return on investment (ROI) projections are healthy, lenders will be keen to help you with your deal.

Another key advantage to investing in large multifamily projects, unlike with a small multifamily property, is you control the value of the property. By cutting expenses or raising rents, you have boosted the value of your property — without dependency on a single comp.

3. Do you have a location staked out?

Okay, sounds great. Following a multifamily investing blueprint can provide a ton of cash flow possibilities, along with generous income valuation and reduced expenses. So, why doesn’t everybody do it?

Well, for one thing, finding multifamily properties that are a good fit for one’s portfolio is much easier said than done. Locating profitable single family properties can be a challenge, on the best of days, but many regions (even ones you know well) don’t always have a ton of multifamily inventory to choose from. And if you do find a multifamily property, especially in a “hot” market, you might find quite a bit of competition for that property you have your eye on.

The key is gather as much information as you can, such as with the Milken Best Performing Cities report, and focus in on two main factors:

High growth regions: Areas in which employment rates are on the rise. You don’t need a ton of tech start-up companies in the town, but you do want a nice cross-section of businesses to underpin future development. (Depending on one company to do most of the hiring in a region is a recipe for vacancy-rate disaster.)

High yield regions: Meaning areas in which multifamily properties are valued lower than the average income, when compared to nearby markets. Ironically, the “hotter” and “more popular” a region is, the less yield there will be for you, the landlord. The ideal mix is to find a region that is off-the-beaten path, affordable, and filled with plenty of employment potential.

4. Do I have systems in place to handle extra “stuff?”

What extra “stuff” do we mean?

Well, though becoming a multifamily investor can be quite profitable, ensuring success requires far more than simply knowing the difference between single vs multifamily home investing. With expanded income potential comes expanded complexity, and this includes things like:

More capital: There’s no beating around the bush, financing a multifamily property requires more capital than a single family property. Having your network and financing options in place beforehand will help greatly.

More management: The more units, the more problems. From vacancy rates to tenant issues to government regulations, all those tiny streams of passive income can add up to one huge headache if you don’t have systems put in place to handle them.

More competition: When you’re a multifamily investor, you’re playing with the big dogs. This means realizing you’ll encounter a lot more competition. You may have to look at things like foreclosed multifamily properties to get started.

Deep End Of The Pool

Embracing the challenge of becoming a multifamily investor is not easy, and it’s certainly not for everyone — especially if you don’t have educational, financial and entrepeneurial systems in place to handle the extra complexity.

But if you’re able to push through the initial obstacles that come with multifamily investing, you might find the added income potential and generous tax allowances provide most of the wealth-building “rocket fuel” you’ve been looking for.

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