Some investors wonder why anyone would purchase a single-family home when they could buy a 4-or 8-plex. Their thinking is that it is almost as easy to manage a small multifamily property as it is a single-family rental home, and you get multiple times the income stream.
They have a point.
With multifamily properties, investors purchase and manage multiple properties at once, which means there are more renters bringing in income. Multifamily properties also offer investors economies of scale, meaning the total expenses are spread over more units, translating to a higher return on investment than single-family homes. That is why multifamily investing is an appealing option for investors who are looking to maximize their returns.
However, multifamily investing also has its dark side.
What could go wrong for you as a multifamily investor? There is plenty! First, you could have a problem qualifying for a loan. After you have purchased the property, you could discover a major repair issue that costs you a lot of money. You can find that dealing with multiple tenants, especially difficult ones, is a major headache. Interest rates could rise on your variable rate mortgage, making it impossible to meet your mortgage payments (see the BiggerPockets article on this below). Finally, the entire economy could suddenly shift leaving you holding a lot of empty units or a building you cannot sell.
MULTIFAMILY TRENDS: 1970’S TO TODAY
Multifamily real estate investing has been profitable for investors over the past few decades. Its potential for attractive returns and steady rental income has made it an ever-more-popular investment class.
A survey by the National Multifamily Housing Council reports that most new investors purchased onn average between 5 to 10 units.
The Council also found that the number of multifamily units in the US increased from 12.9 million in 1970 to 36 million in 2018. And there has been a steadily growing pool of renters, with the percentage of apartment renters climbing from 34% in 1970 to 48% in 2018 (National Multifamily Housing Council, 2020).
The past two years have been especially good for multifamily investors. According to a Forbes article titled, Multifamily Real Estate Predictions for 2023, “The multifamily space has been performing incredibly well for the past two-plus years with record demands for rentals, surging rental rates, and accelerated demographic changes that have had people flocking to new markets in droves. In aggregate, this helped drive historically high occupancy rates and double-digit rent growth, resulting in historically high returns for owners and investors in the space.”
BUT…WHAT HAPPENS WHEN THE MARKET CHANGES?
Sounds great, right? So, what are you waiting for? Well … things can change.
According to the same Forbes article, multifamily real estate is now facing multiple pressures, including “sharply rising interest rates, lingering supply chain issues, geopolitical issues, record-break inflation, declining consumer confidence, pressures on rent and the looming threat of a recession.”
In another example, this recent BiggerPockets article, WSJ Says a Housing Bust is Coming for Small Time Investors, discusses how some multifamily investors are losing entire complexes due to their exposure of having variable interest rate financing, as interest rates have gone up.
MULTIFAMILY INVESTMENT: ADVANTAGES AND DISADVANTAGES
Understanding the advantages and disadvantages of this asset class will help you make the best investment decision for your investment portfolio.
ADVANTAGES
- Strong Cash Flow
Given the multiple renters paying monthly rent, investing in multifamily properties can provide strong returns and considerable cash flow. The potential return on investment can range from moderate to high when compared to other investments.
- Steady Rental Income
In addition to good cash flow, multifamily real estate also provides steady rental income. Because the total income is not reliant on just one renter (as in a single-family property), there are multiple renters to offset the loss from any one rental vacancy.
Multifamily properties can be more stable than other types of investments due to the rising rental demand, the diversification provided by having multiple units, multifamily investors having a long-term hold strategy and the less-speculative nature of multifamily investments in comparison to other types of real estate investments.
- Lower Cost of Maintenance
Multifamily properties have economies of scale, where expenses like maintenance, management, and advertising are spread across multiple units. This potential cost efficiency can enhance the investment’s overall profitability.
- Loans
Multifamily Loans often have longer terms and lower interest rates than single-family homes, making them more attractive to investors. In addition, access to loans may be easier than single-family home loans. Finally, terms for multi-family loans can be more creative and flexible than other loans.
- Liquidity
Multifamily properties typically have higher liquidity compared to single-family homes. The commercial real estate market often has more active investors, institutional buyers, and specialized lenders. This increased liquidity can contribute to faster appreciation and a more efficient market for multifamily properties.
- Tax Advantages
Multifamily properties also offer great tax benefits. States Bryant Taylor, author of a Forbes article, Tax Benefits of Investing in Multifamily Real Estate, (Forbes, April 4, 2022) “Multifamily real estate investments do have a few tax advantages that single-family rentals don’t. For one, depreciation on multi-family property is often higher, meaning investors can take greater deductions on their taxes.” The article also highlights that investors can benefit from accelerated depreciation, deductions for rental income and expenses, and the potential to defer taxes through 1031 exchanges.
DISADVANTAGES:
Loan Qualification
Multifamily properties are often more expensive to purchase than single-family homes, so they may require more cash up front to qualify for the loan.
In addition, they may also require a larger down payment percentagewise than single-family loans since they are considered higher-risk investments.
They may also require a stricter qualifying criterion than single-family loans (such as a higher credit score, etc.).
Finally, some lenders are reluctant to lend money to inexperienced investors. This means that obtaining the initial capital necessary for investing can be a challenge for new investors.
Managing Complexity
Managing a multifamily property can be more complex than managing a single-family home. This may require a larger, more experienced team and organization on board to maximize profits. Putting together a team like this can sometimes be a challenge for newer investors.
State of Industry
Because the investment is often larger for multifamily units when compared to a single-family home, and many factors are involved in how the units perform, investors must keep a close eye on the overall state of the industry when considering investing in multifamily real estate.
Rapid fluctuations in real estate can impact multifamily investments, so it is important for investors to conduct thorough research and monitor the market before purchasing a property.
Vacancy Rates
Vacancy rates are one of the primary risks in multifamily investing. In some areas, these types of properties, especially those with many units, can be more difficult to fill than a single-family home. A low vacancy rate can have a major impact on your investment’s profitability. This is why it is so critical to understand the property’s location in relation to rental potential.
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So, are you ready to start investing in multifamily properties? Yes, it has been good for investors over the past few decades, offering attractive returns and strong cash flow. However, potential investors need to take the time to understand the potential risks of investing in this asset class before locking down your first deal!
If you have a property you are looking to fund, let us know. We can help you determine the best loan to move your investment property forward.