Rental properties are relatively safe investments. People always need a roof over their heads and will continue paying rent. Rent increases in most areas due to inflation, population growth, and other factors. This environment helps multifamily property investors generate passive, stable income from their rental units.
Buying a multifamily property isn’t the same as buying a personal home. While homeowners look for a home that suits their needs, real estate investors focus on the numbers. They focus on real estate investments that can generate positive cash flow and appreciate in the future. We’ll discuss how to buy a multifamily property and reasons to get started.
What Are Multifamily Properties
Multifamily properties are real estate assets that can house more than one tenant. Duplexes have two units in the same building, while apartment complexes can have hundreds of units in the same location. These real estate properties rely on rent payments to survive, and this income source stands to grow in the years ahead.
Consumers are increasingly looking to rent instead of own. Pew Research concluded that more U.S. households are renting now than at any point in 50 years. Pew Research revealed this conclusion before the pandemic drove up housing prices. The New York Times published a more recent article confirming this same analysis: single-family rentals are in while homeownership is declining.
As consumers gobble up units, the declining supply invites higher rent prices. Multifamily investment properties positioned in growing locations stand to benefit significantly from these shifts.
Reasons To Buy Multifamily Properties as Investment
Multifamily properties can turn into great investments. We have outlined several reasons to gain exposure in multifamily property investing.
Expand Your Investment Portfolio
Multifamily property investments provide you with additional income streams. Each unit is its own income stream, and some tenants will stick around for years. You won’t have to worry as much about recruiting new tenants as long as you maintain the property. Multifamily properties give you a new location. In addition, the cash flow and equity from one multifamily property can help you invest in additional assets. Some investors continue adding multifamily properties to their portfolios and bask in the consistent cash flow.
Generate Passive Income
After securing a great tenant, the income from that unit becomes passive. You can expect to receive a monthly rent payment from each occupied unit in your building. Some people generate enough passive income from their properties to quit their day jobs.
Passive income can exceed earned income and grow faster. Landlords can raise the rent on tenants each year. Each state and county has different rules on how high you can raise rents, but you guarantee yourself a raise each year. The national median cost of rent jumped 17% year-over-year in 2021. Imagine asking your boss for a 17% raise and then asking for another raise the following year. Real estate creates this opportunity.
Valuation Potential
Many multifamily property investors have held onto their properties for decades. Some intend to pass the property onto their heirs and create generational wealth. The mortgage may be gone when this happens, and rental income will be much higher because of the annual price hikes. However, you will also benefit from valuation potential.
It’s no secret that multifamily properties are one of the best ways to generate passive income with real estate. Fewer available properties lead to higher demand. As more people rent and abandon homeownership, these properties will become far more desirable. Combine these trends with a desirable location, and your property can double in value within 10-20 years. You’ll continue generating cash flow as the property appreciates. Some investors look for undervalued, neglected properties to increase their profit potential.
Easier to Finance/Fewer Loans
Some multifamily property investors buy assets with little or no money down. While most loans require a 20%-30% down payment, you can raise funds from investors or get an FHA loan which has a down payment of 3.5%. Many investors begin their multifamily investing journeys with duplexes. If you live in one unit and rent the other, you can qualify for an FHA loan. If in case your credit score is above 580, you can acquire the property with a 3.5% down payment.
As you accumulate more multifamily properties, investors will take notice. You can get equity investors to team up and help finance future acquisitions.
Scalability
Some multifamily properties have over 100 units. These units are located in the same place, making it easier to manage each unit or hire a property manager. You can have one multifamily property or over 100 single-family homes. Having that many single-family homes can create a management nightmare. You may not find 100 available single-family homes in the same location. Driving to each home and communicating with tenants becomes more difficult.
It’s easier to scale multifamily property growth. You can build up to a few 100+ unit apartment complexes or buy 100+ single-family homes. Focusing on multifamily investments provides you with fewer properties but more units in more desirable locations.
Steps To Buy Multifamily Properties
Does passive income excite you? We will share the steps you can take to buy multifamily properties.
Choose Your Deal/Investment Option
Investors can choose from several types of multifamily properties and investment options. Buying a duplex and living in one of the units is one of the easiest ways to start. You can also get more ambitious and buy a multifamily home with several units.
Some investors shy away from multifamily complexes because of the required capital. Investors need to save enough money for a down payment and keep up with monthly payments.
Reach Out To Prospects
Investors may find several multifamily properties that fit their criteria. Reach out to the property owners to learn more about the investment. You can ask for essential details about the property and have an inspector review the premises.
Analyzing Income Statements
Investors prioritize the numbers, and an income statement reveals most of what you need to know. This statement discloses a property’s income, expenses, and net operating income. You can request income statements from several years ago instead of exclusively relying on last year’s numbers. Some investors will spot opportunities to expand revenue. They may make the complex pet-friendly to increase pet fees. New investors can also raise rents at a higher rate if rent hasn’t increased for a while.
Investors can also review expenses to see if they have a sufficient margin of safety. Some investors will consider which expenses they can trim, while others may check how future costs can impact the profit margin. You can explore ways to increase income and lower expenses, but income statements give you a glimpse into the current business model.
Calculating The Cap Rate
The income statement provides you with net operating income, a vital metric for calculating the cap rate. Many investors use cap rates to gauge risk. Investors arrive at the cap rate with this formula:
Cap rate = Net operating income / Property Value
Take the net operating income on the balance sheet and divide it by the property’s asking price. For example, if a property makes $100,000 in net operating income and gets listed at $1 million, the cap rate is 10%. Investors compare the cap rates of similar properties in similar locations to determine if they’re getting a good deal.
A lower cap rate across the market indicates an undervalued property. For our previous example, if the location’s average cap rate is 8%, then a property with a 10% cap rate is undervalued. However, a market average cap rate of 12% suggests the property with a 10% cap rate is overvalued. You can set a lower asking price based on the average cap rate.
Settling Your Selling Price
Most multifamily property investors do not consider an exit strategy. These long-term investors want to buy and hold the property for many years and continue collecting rent. However, selling at the right price can provide a significant return and give you more funds to invest in other properties. Selling a multifamily property can also mitigate risk if you have several properties.
You can establish a selling price based on cap rate, personal preference, or another parameter. Multifamily property investors receiving monthly rent from tenants have less urgency to sell their property. If the right offer comes along, it’s something to consider. You can do multifamily investing on your own or get help from a private equity firm.
