Categories: Education

Multifamily Real Estate Investing for Beginners

Introduction

Real estate, once considered a niche industry, has become a darling among investors of all kinds. One of the reasons people are drawn to real estate investing is because of the asset class’s diversity: you can invest in office buildings, retail centers, hotels, industrial properties, residential homes and more.

For those who are just entering the commercial real estate foray, many will begin by investing in multifamily real estate. Multifamily, as a subset of the broader industry, is relatively easy for the average investor to understand – particularly for those who have owned their own home. Multifamily real estate also has lower barriers to entry than other property types, such as retail or office. First-time investors can dip their toes into the waters gradually, starting with a property as small as a two-unit duplex.

Multifamily, as a subset of the broader industry,
is relatively easy for the average investor to understand
particularly for those who have owned their own home.

Beyond the relative simplicity of multifamily investing, there are other reasons to consider investing in multifamily properties, which we’ll cover in this article. Anyone who has ever thought of investing in multifamily real estate will want to read on.

What is Multifamily Real Estate?

Multifamily real estate is a catch-all term that refers to any type of renter property with two or more units. On the smaller end of the spectrum, multifamily housing can refer to duplexes or triplexes. Multifamily housing also includes mid-sized properties (such as garden-style apartment buildings) and larger apartment communities. Multifamily housing can be further segmented by its audience, such as student housing or senior housing.

An important distinction is to be made between multifamily units with 2-4 units vs. those with 5+ units. Typically buildings with 2-4 units are characterized as “residential property” and therefore, can take advantage of highly attractive financing alternatives. Those with 5+ units begin to fall into the “commercial” realm in which rates and loan terms can become more variable. In general, however, “multifamily” can be used to describe both residential and commercial apartment buildings.

Benefits of Multifamily Real Estate Investing

  • Portfolio diversificationQuestion Mark: Multifamily real estate is a great way for investors to diversify their portfolios away from traditional stocks, bonds and mutual funds. Real estate is not highly correlated to the stock marketQuestion Mark and therefore, the stock market could tumble while real estate values remain strong. Similarly, the real estate industry does not experience the same daily ebbs and flows that the stock market is prone to, therefore making multifamily real estate a fantastic addition to anyone looking to mitigate risk by diversifying their investment portfolio.
  • Low risk investment: Multifamily property is considered a relatively “safe” investment compared to other real estate asset classes. There are several reasons for this, some economic and some demographic. For one, America is in the midst of a prolonged housing shortage. There are simply not enough single-family homes available to meet demand. This has driven the price of existing homes to all-time highs, which correspondingly creates prolonged demand for multifamily among renters who cannot yet afford to buy. Similarly, the U.S. population continues to grow significantly faster than the nation’s housing inventory. As long as these trends continue, there will be demand for multifamily housing in nearly every market.

    Evidence from the past two recessions confirms that multifamily is a relatively risk-free investment. During the Great Recession of 2008-2010, many Americans unfortunately lost their homes and had no choice but to rent—either temporarily or for longer periods while they rebuilt their savings and credit. Going without a home wasn’t an option. People always need somewhere to live, regardless of economic conditions, and more people tend to move into rental housing during and in the aftermath of economic crises. Moreover, during the latest recession caused by the COVID-19 pandemic, multifamily rent collections remained strong. Despite initial fears, many of the hardest-hit Americans were bolstered by stimulus checks and enhanced unemployment benefits that allowed the majority to continue paying their rent largely on time. 
  • Passive income: Investing in multifamily real estate is a great way to generate additional income. Those who own real estate directly can hire a property manager to oversee the day-to-day on their behalf, whereas those who invest in a REIT or syndication will have entrusted a sponsor with their capital – freeing them from the responsibilities of owning real estate.
  • Cash flow: One draw to multifamily real estate investing is for the cash flow these properties generate 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.
  • AppreciationQuestion Mark potential: Those who have a long-term investment horizon will find that typically, multifamily real estate appreciates over time. Real estate values ebb and flow, but over the course of multiple real estate cycles, values tend to continue their upward climb.
  • Tax benefits: Multifamily 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. DepreciationQuestion Mark 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.

Multifamily property is considered a relatively “safe” investment compared to other real estate asset classes.

Popular Multifamily Real Estate Investing Strategies

There are many ways to invest in multifamily real estate, ranging from investing in small (20+ unit), stabilized apartment buildings to investing in a syndication or fund planning a 300+ unit ground-up multifamily development. Some multifamily properties are already generating cash flow, while others may take years before generating returns for investors. Depending on how much one has to invest, their time horizonQuestion Mark and risk profile, there’s an opportunity that will meet their needs.

  • Buy and Hold: As its name implies, buy and hold real estate investing is when the owner (either individually or through a partnership and on behalf of investors) purchases a property and then holds it for an extended period of time—often indefinitely. Buy and hold investors may or may not make improvements to the property (a value-add approach described below). The key distinction with a buy and hold investment is that ownerships intends to retain the property for multiple years, during which time investors are paid dividends based on the cash flow the property is generating. Many buy and hold investors also anticipate that the property will appreciate a certain amount during their buy and hold period.

    There are certain tax benefits associated with buy and hold real estate investing. Notably, the proceeds from the eventual sale of buy and hold real estate will be subject to long-term capital gains tax, a rate that is significantly lower than the short-term capital gains tax that property flippers are generally subject to.
  • Value Add: Value-add real estate investing is an alternative multifamily real estate investment strategy in which an investor or group purchases an asset with the intent of making either light or significant property upgrades. A value-add strategy assumes there is room for revenue growth upon the completion of said improvements. A light value-add strategy might entail purchasing a Class C multifamily property and refreshing each unit with new paint, flooring and fixtures.

    A heavy value-add strategy might be going into that same building, gutting each unit to the studs, reconfiguring the layouts, and then finishing each unit from scratch. A heavy value-add strategy often includes making significant improvements to the building exterior, landscaping and common areas and may include adding new amenities to the property. Heavy value-add strategies can be difficult to execute and should be undertaken only by the most experienced and highly motivated teams.

    In general, value-add real estate investing is considered somewhat riskier than buying a stabilized asset, but it can be highly lucrative for those who are able to execute their business plans accordingly. In exchange for the higher risk, investors can expect to earn higher returns.
  • Opportunistic: Opportunistic real estate development is akin to the “growth” category you might find in the stock market. Opportunistic investments are some of the most complicated projects and can take several years before generating returns for investors.

    Opportunistic investing includes ground-up multifamily development, in which the sponsor buys land or a site for redevelopment that must then obtain approvals from the local government before construction begins (a process that can take a year or more on its own). These properties must be fully constructed and leased before being considered “stabilized” and ready for recapitalization or sale.

    Conversion is another form of opportunistic multifamily real estate investing. Conversion, sometimes referred to as redevelopment, is when a property is repositioned for an alternative use – such as a retail center being repurposed for mixed use development, or a hotel being converted to multifamily housing. Hundreds of churches have been converted to condos, and former school buildings are often converted to apartment buildings.

    Opportunistic real estate investing is one of the riskiest strategies and like heavy value-add investing, should only be attempted by the most adept and well-capitalized sponsors who have the means to navigate unforeseen complications.

Some multifamily properties are already generating cash flow,
while others may take years before generating returns for investors.

Multifamily Real Estate vs. Single Family Rental Investments

The primary difference between a single-family home and multifamily home is how many dwelling units are in the property. A single-family home contains just one dwelling unit, whereas a multifamily home has two or more units.

There are several practical considerations to investing in a multifamily home versus a single-family home, including:

  • Single-family homes are more expensive to maintain. Each property, whether a single-family or multifamily, has a set of “systems” that need to be maintained. These “systems” include the HVAC unit(s), electrical system, roofing, grounds and more. A single-family home has all of these systems but benefits from only one rental payment coming in for that property. Compare this to a multifamily property where multiple units share the same systems and so the cost to maintain each system is lower on a cost-per-unit basis. For example, when you need to repair the roof on a 6-unit apartment building, it’s still only one roof that needs to be repaired. This is less expensive than trying to maintain six roofs from a rental portfolio of six single-family rental homes.
  • It is harder to aggregate a portfolio of single-family rental properties. Whether you’re in a competitive market or not, it can be hard to accumulate a portfolio of single-family rental properties. Each time a property comes to market, you need to bid on the asset, secure financing, fund a down payment, conduct an inspection, hire an attorney, etc. This can be a lengthy and time-consuming process compared to buying a multifamily property, wherein you’re growing your real estate portfolio by multiple units in one fell swoop. Both the purchasing process and later, the property management process, become more efficient when buying multifamily properties compared to investing in single-family homes, where parties are forced to travel from site to site, losing valuable time in the process.
  • Single-family rental properties are more management intensive. One of the reasons why so few investors buy single-family homes as rental properties is because the management of individual properties is incredibly time intensive. A property manager has to travel to and from each individual site for repair, maintenance, to collect rent checks, etc. There are no economies of scale, compared to investing in multifamily properties. The more units within a property, the more cost effective the property is to manage on a cost-per-unit basis. Often, multifamily properties of a certain size will even warrant having an on-site property manager, which makes it easy to respond to issues quickly and efficiently.

    Other economies of scale include the ability to use one leasing broker for all multifamily properties, a single on-site maintenance staff, and the ability to store tools and materials on-site versus in a warehouse or van, which is often the case when managing individual properties in scattered locations.

How to Invest in Multifamily Real Estate

There are three primary ways to invest in multifamily real estate:

1. Direct Ownership

Direct ownership is when someone individually acquires and manages a multifamily property. Multifamily investing generally requires at least 25-30% equity before a buyer can obtain financing, which makes direct ownership a challenge for some investors. Moreover, direct ownership is a form of active real estate investing and does not offer the same hands-off, passive benefits one would realize if investing in a REIT or syndication (see below).

2. Real Estate Investment Trust (REIT)

Investing in a REIT is similar to investing in a mutual fund. Essentially, you are buying stock in a real estate portfolio that is actively managed by the REIT. According to federal regulations, REITs are required to return 90% of profits to their investors. The benefit of buying into a REIT is that you can buy and sell shares at any time, which is a way for investors to preserve liquidity in a way that cannot be done by directly investing in real estate.

3. Real Estate Syndication

An increasingly popular way of investing in multifamily real estate is via a syndication. A syndication is an entity created by an adept real estate sponsor who aggregates capital from individuals and then invest that capital (typically, alongside their own) in a multifamily property. Each syndication may have a different minimum investment threshold, say $75,000 or $100,000 per person. Investors share in the project’s risk and reward, with each being paid out a share of the profits accordingly.

One of the benefits of real estate syndication is that you, as an individual investor, are considered a “limited partner”. The only responsibility of an LP is to bring capital to the table. Meanwhile, the “general partner,” or GP, takes responsibility for finding and managing deals. The GP brings their real estate expertise in exchange for a share of the profits, but is typically paid out only after the LPs have made their profits. This structure ensures that the GP/LP’s interests are aligned.

Conclusion

Real estate investing can be highly lucrative. It is an asset class that has many avenues for investors depending on their individual risk profiles and investment time horizons. Multifamily, more specifically, has several advantages that any investor considering real estate will want to consider. It helps investors diversify their portfolios, mitigate risk, and generate highly tax-advantaged, passive income on a monthly basis.

 

Are you ready to add real estate to your portfolio? Contact us today to learn more about how the Smartland platform provides an important in-road for those looking to invest in multifamily real estate for the first time.


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