Early Considerations for First-Time Multifamily Investors
In this article we examine the many important considerations investors should make before diving head first into the multifamily investment market.
- Consideration 1: Multifamily Investment Objectives
- Consideration 2: Desired Return from a Multifamily Investment
- Consideration 3: How Much Money to Safely Invest in Multifamily
- Consideration 4: How Can the Property Be Financed?
- Consideration 5: Multifamily Investment Risk Tolerance and Strategy
- Consideration 6: Choosing a Multifamily Market
- Related Questions
- Get Financing
Multifamily investing is not for the faint of heart, and any established investor can attest to the fact that adequate preparation is crucial to a successful multifamily investment. While mainstream media and its obsession with property flipping tends to downplay the actual hard work that must be put in before even choosing a property, those in the industry know that the hard work truly begins with the decision to become a property investor.
Note: This article is about direct, active investment in multifamily, so if you're interested in multifamily syndicated investments — that is, passive investment opportunities — it's a whole different game. You can explore many excellent opportunities on Janover Engage.
Each and every commercial real estate investor, before taking part in any transaction, should first take the time to understand their financial profile and build an investment strategy. After all, success in multifamily investing can depend on a variety of factors, including investing experience level, net worth, tolerance to risk, market attributes, and even personal time constraints.
It can be difficult for first-time investors to figure out just where to begin, so this article walks through the pre-investment process, covering the many considerations investors should make before diving headfirst into the market.
Consideration 1: Multifamily Investment Objectives
Almost every successful multifamily investment began with an investor’s clearly defined investment goals. Before blindly searching for a desirable apartment building, an investor first needs to determine the type of property to purchase — as well as how the operation of the asset will be handled after that purchase is made.
Multifamily is typically loosely defined within the industry as a property with five or more units, but, in a broader sense, it encompasses duplexes, triplexes, quadplexes, townhomes, and most other housing assets that were designed with multiple families in mind. Depending on market conditions, available capital, and operational plans, each property type has its advantages and disadvantages worth analyzing before settling on any one.
While buying a property remains the key objective, investors must also have a clear idea of how to handle the everyday operations of whichever property they do purchase. Being a landlord can be time consuming and take a ton of effort, but many first-time investors and those with smaller properties end up tackling the daily operations on their own. Conversely, larger investors often own multiple properties and cannot stretch their efforts between them all — which leads to the utilization of property management companies, adding a new dimension to expected operating expenditures.
Consideration 2: Desired Return from a Multifamily Investment
At a fundamental level, investors should take great care in determining objectives regarding return on investment, or ROI. Many multifamily investors originally decided to buy apartment buildings because real property can typically outperform most other types of investments, such as stocks and bonds, and even passive real estate investments through REITs.
That said, there is no industry benchmark or standard for outlining a good return — after all, that depends on the personal goals and expectations of an investor. Understanding what metrics such as cap rate, cash-on-cash return, IRR, and equity multiple mean for a potential investment is critical in forming ROI goals. It becomes even more crucial when multiple investors are involved in a deal, as returns are sought and must be fairly distributed between all entities.
Consideration 3: How Much Money to Safely Invest in Multifamily
Apartment properties are not cheap. In general, a low-end apartment building with five or more units starts at a minimum price tag of $500,000, though this varies greatly depending on location. This is why the vast majority of multifamily investments are financed. There are plenty of loan options to choose from, but virtually none with loan-to-value ratios higher than 90% — which is in itself extremely rare. Most commercial real estate loan products have LTVs in the range of 60% to 80%. This means that planning ahead to be able to make a required down payment is one of the most critical steps to take.
As an illustration of this point, consider a multifamily property with an appraised value of $800,000. A lender may be willing to finance the purchase of the asset at an LTV of 75%. This equates to a maximum loan amount of $600,000, leaving the investor responsible for the extra $200,000 necessary to make the purchase.
Consideration 4: How Can the Property Be Financed?
Financing an income property investment isn’t always as simple as choosing a loan product with desirable terms. The reality is that it’s less about choice and more about what loan products an investor is eligible for. In fact, loan eligibility and availability is so important that in many cases, investors actually look for a property that suits the type of loan they want, rather than the other way around.
Of course, lenders only reinforce this. In general, the better the property condition is, the higher LTV, lower debt service coverage ratio requirements, and lower rates an investor is able to get — which eventually equates to higher overall returns. For example, most banks, CMBS, and agency lenders only offer loans for properties that are stabilized and in good condition. Criteria like this often leads investors on a hunt for properties with at least 85% to 90% occupancy and a golden DSCR of 1.20x just to have a better chance of securing good financing.
Consideration 5: Multifamily Investment Risk Tolerance and Strategy
Investing in higher-quality Class A or Class B properties may enable investors to get the best financing available, but that doesn’t automatically translate into a perfect investment strategy. Class C properties, for example, are still viable investments for some investors, but it all depends on the level of risk an investor is willing to take on.
There is always money to be made when it comes to income-producing properties, but each investment strategy has its own level of risk. Having a deeper understanding of market trends and the performance of each different asset class in a given market can go quite a long way, and pairing that knowledge with an understanding of return metrics (and the right financing) is a straight-up cocktail for success.
Consideration 6: Choosing a Multifamily Market
Many first-time investors purchase properties close to home, mostly to be able to manage or keep a close eye on the asset. While this approach does work out much of the time, it can be extremely limiting — particularly if properties in that area are overpriced or there is a low supply. If it is possible to do so (i.e., property management can be arranged in the event that the owner can’t handle those responsibilities), investors should scour multiple markets in multiple regions in search of the ideal environment to chase those original multifamily investment goals.
In a way, a lot of the issues with finding a property, or finding a loan for a desired property, or simply finding an investment too good to pass up, can be remedied by shopping around in different markets. The U.S. is a huge place, but honing in on at least five to six major markets — and maybe even two to three submarkets within those larger markets — can be a huge boon to an investor’s selection process. One simply never knows where a great deal will pop up.
Related Questions
What are the key factors to consider when investing in multifamily real estate for the first time?
When investing in multifamily real estate for the first time, there are several key factors to consider. First, it is important to determine the type of property to purchase and how the operation of the asset will be handled after the purchase is made. Multifamily properties can include duplexes, triplexes, quadplexes, townhomes, and other housing assets designed with multiple families in mind. Each property type has its own advantages and disadvantages, so it is important to analyze these before settling on any one.
It is also important to consider how the everyday operations of the property will be handled. Many first-time investors and those with smaller properties handle the daily operations on their own, while larger investors often utilize property management companies. This adds a new dimension to expected operational expenditures.
Choosing the right market is also key. Many first-time investors purchase properties close to home, but this can be limiting. It is important to scour multiple markets in multiple regions in search of the ideal environment to chase the original multifamily investment goals.
What are the most important financial metrics to consider when evaluating a multifamily investment?
The most important financial metrics to consider when evaluating a multifamily investment are cap rate, cash-on-cash return, internal rate of return (IRR), and equity multiple. These metrics are important because they help investors determine their return on investment (ROI). Additionally, understanding these metrics is crucial when multiple investors are involved in a deal, as returns must be fairly distributed between all entities.
In terms of loan products, the better the property condition is, the higher loan-to-value (LTV), lower debt service coverage ratio (DSCR) requirements, and lower rates an investor is able to get — which eventually equates to higher overall returns. For example, most banks, commercial mortgage-backed securities (CMBS), and agency lenders only offer loans for properties that are stabilized and in good condition. Criteria like this often leads investors on a hunt for properties with at least 85% to 90% occupancy and a golden DSCR of 1.20x just to have a better chance of securing good financing.
What are the advantages and disadvantages of investing in multifamily real estate?
The main advantage of multifamily investing is that it provides investors with the opportunity for a steady stream of income. With this type of investment, investors are able to rent out the units to tenants and receive a consistent, ongoing return on their investment. Multifamily investments also offer the potential for a higher return on investment than other types of investments, including single family homes, with less risk.
Multifamily properties also perform better in a recession. While different assets across the quality spectrum will behave differently, people always need a place to live. As multifamily homes generally have lower rents per unit than a single-family home, occupancy generally tends to hold steady even in a downturn. One exception to this, of course, is if a property is overpriced or in a state of disrepair.
The primary disadvantage of multifamily investing is that it requires more capital upfront than other types of investments, apart from other, large commercial assets. Multifamily investments often require a larger down payment than other types of investments, as well as larger monthly mortgage payments.
Additionally, multifamily investments can require a significant amount of time and effort to maintain, as tenants must be screened and managed, and repairs and upgrades must often be made to keep the units in good condition. While a property management company can help with all of these operational aspects, this comes at an additional significant cost.
Finally, multifamily investments can be subject to a number of legal and regulatory issues, such as zoning and landlord-tenant laws. Investors must be aware of applicable laws in their area, and may need to consult with an attorney or other legal expert before investing in a multifamily property. Additionally, investors may need to obtain the appropriate licenses in order to rent out the units, which can add to the complexity and cost of multifamily investing.
What are the tax implications of investing in multifamily real estate?
Investing in multifamily properties comes with several tax incentives. It’s possible to deduct operating expenses and maintenance costs, including management fees, insurance, and marketing costs, or any legal and professional services, such as property management companies. Additionally, investors should be aware of potential capital gains taxes when investing in commercial or multifamily property. Strategies such as 1031 exchanges, investing in an Opportunity Fund, and tax-loss harvesting can help investors save money on taxes.
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What are the most common mistakes made by first-time multifamily investors?
The most common mistakes made by first-time multifamily investors include not having a clearly defined investment goal, not researching the market, not understanding the financials of the property, not having a plan for managing the property, and not shopping around for the best deal.
Not having a clearly defined investment goal is a common mistake made by first-time multifamily investors. According to this article, before blindly searching for a desirable apartment building, an investor first needs to determine the type of property to purchase — as well as how the operation of the asset will be handled after that purchase is made.
Not researching the market is another common mistake. Investors should scour multiple markets in multiple regions in search of the ideal environment to chase those original multifamily investment goals. According to this article, if it is possible to do so (i.e., property management can be arranged in the event that the owner can’t handle those responsibilities), investors should scour multiple markets in multiple regions in search of the ideal environment to chase those original multifamily investment goals.
Not understanding the financials of the property is another common mistake. Investors should understand the financials of the property, such as operational expenditures, before making a purchase. According to this article, operational expenditures are the costs associated with the day-to-day operations of a commercial real estate property.
Not having a plan for managing the property is another common mistake. Investors should have a plan for managing the property, such as hiring a property management company or managing the property themselves. According to this article, many first-time investors and those with smaller properties end up tackling the daily operations on their own, while larger investors often own multiple properties and cannot stretch their efforts between them all — which leads to the utilization of property management companies.
Finally, not shopping around for the best deal is another common mistake. Investors should shop around for the best deal in multiple markets. According to this article, many first-time investors purchase properties close to home, mostly to be able to manage or keep a close eye on the asset. However, investors should scour multiple markets in multiple regions in search of the ideal environment to chase those original multifamily investment goals.
What are the best strategies for financing a multifamily investment?
The best strategies for financing a multifamily investment depend on the investor's individual needs and goals. Generally, the most common ways to finance a multifamily property include conventional loans, FHA loans, and private money loans. Each of these financing options has its own advantages and disadvantages, so it's important to do your research and understand the terms of each loan before making a decision.
Conventional loans are typically the most popular option for financing a multifamily property. These loans are offered by banks and other financial institutions and usually require a down payment of 20-25%. They also typically have lower interest rates than other loan types, making them a good option for investors who are looking for long-term financing.
FHA loans are another popular option for financing a multifamily property. These loans are backed by the Federal Housing Administration and are available to borrowers with lower credit scores and down payments as low as 3.5%. They also have lower interest rates than conventional loans, making them a good option for investors who are looking for short-term financing.
Private money loans are another option for financing a multifamily property. These loans are offered by private lenders and usually require a down payment of 10-20%. They also typically have higher interest rates than other loan types, making them a good option for investors who are looking for short-term financing.
It's important to do your research and understand the terms of each loan before making a decision. You can find more information about financing a multifamily property on the websites Multifamily.loans and Apartment.loans.