The answer to whether almost anything is a good investment is “it depends”. If they weren’t a good investment, we wouldn’t have so many of them being lived in all across the United States.
But, that doesn’t mean that they’re for everyone.
Let’s look at some general information first, then we’ll break down the pros and cons of having a multifamily property.
How Much Is A Multifamily Property?
The answer to this varies depending on what size that you’re looking for. A duplex counts as a multifamily property, so the cost could be almost as low as a single resident home of the same square footage.
But, it could also run into the millions if the property houses many tenants, such as an apartment building.
How Much Will The Expenses Be?
Your expenses will be everything from emergency repairs, general maintenance, different types of insurances including landlord insurance, cleaning units whenever a tenant moves out, replacing carpet, and more. It’s recommended to spend 2% of a property’s value per year on maintenance.
You also can’t forget about expenses such as property taxes and you need to have an attorney on retainer to deal with legal issues that may crop up.
If you want more predictable costs that you don’t have to calculate yourself, you can use a property management company to take care of much of the issues that will come up. You can expect to pay them anywhere from 8 to even 20% of your property’s gross revenue.
Calculate your property’s net operating income (NOI) by subtracting your monthly estimated expenses from your estimated monthly property income.
Monthly Est. Expenses – Est. Mo. Income = Net Operating Income
What’s Your Cash Flow?
Your cash flow is calculated by taking your property’s monthly NOI and subtracting the monthly mortgage payment. This will give you a good idea before you purchase a property whether it’s going to be worth your while. Decide where your acceptable amount of cash flow is and stick with it.
What’s Your Cap Rate?
Your capitalization rate is how quickly you’re going to be able to get a return on your investment.
To calculate your cap rate, you’ll do the following:
Annual NOI / Property Value.
Be aware that your cap rate can be misleading in that a higher rate doesn’t necessarily mean that it’s a better deal. A high rate generally means that you have a higher amount of risk in this property. How much risk you want to deal with is up to you. Before you get into properties that have a cap rate more than 10% or so, you want to have experience dealing with lower rates.
Benefits of A Multifamily Property
Everything is in one location
When you’re dealing with a multifamily property, you have multiple tenants in the same building. This can be great if you don’t want to have to drive all over the place to collect the rent or if you have multiple maintenance issues to look into at the same time.
Another positive aspect to everything being in one location is that you only have one loan payment to deal with every month instead of having to deal with loans that add up to the number of rental units that you have. If you have a fourplex, then you have 1 mortgage payment to deal with instead of 4. One payment and one loan company to deal with every month instead of 4 loans and maybe even 4 different lenders to deal with.
This is the same concept with insurance. You only have one insurance policy to cover the entire property instead of having to have multiple insurance policies for each rental that you have.
More Units = More Cash Flow
Because you have more units, you’ll have more cash flow than if you had just one. Even though you may not make a higher ROI, you’ll have more cash flow to deal with issues than you would if you only had a single family residence.
Rarely Ever Completely Vacant
When you have multiple tenants, you’re not likely to have the property completely empty for any significant period of time unless there’s a natural disaster of some kind. You’ll almost always have a full house, especially if you have tenant-friendly rental policies.
Because you’re not likely to have multiple tenants move out at the same time, you’ll have at least part of your loan payment every month and you won’t have to come up with as much on your own. This is opposed to having a total loss of cash flow for a single family residence when a tenant moves out.
Easy To Find Tenants
Tenants are easy to find for these properties most of the time. They’re easier for lower income people to get into than single family homes. You’ll most often be renting to young adults with roommates, single people just starting in life, and middle aged people who rent on a permanent basis.
More Long Term Money To Be Made
Single family residences are often priced to sell based on how aesthetically pleasing the property is combined with the amenities available. Neighborhood by neighborhood, this can vary a lot and it can vary again in the same neighborhood from year to year. Multifamily properties are priced for their long term income generation potential, such as number of units available to rent. The property value goes up more consistently as long as it’s maintained properly.
You can live in one of the units
Living in one of the units has its own benefits, like the fact that you’re there to oversee what’s happening at the property, plus it can save you money on your own housing versus having to pay for a separate living space.
Finance As A Residential Loan If It’s 4 Units Or Less
Multifamily properties with 5 or more units are classified as commercial properties and can be more difficult to get a loan for. If you’re just starting out and need to finance, you want to stick to 4 units or less to make it easier to get into.
Cons of A Multifamily Property
For each benefit owning a multifamily property has, there’s nearly an equal and opposite con. You’ll have to decide for yourself just how detrimental the following list will be to your investment endeavors.
They’re More Difficult To Find And Finance
As mentioned above, multifamily properties with 5 units or more have to be financed as commercial properties. If you’re determined to get a property that fits this criteria, you’re likely to have a hard time getting into it as a beginner.
Not only will you have a harder time financing a larger multifamily property because of their classification, you’ll also have a more difficult time finding multifamily properties of any classification available. There aren’t nearly as many of these types of properties available as there are single family residences. The workaround for this is to buy a piece of property and have a new construction built, but this is generally not a step beginners will want to or be able to take.
All Your Eggs In One Basket
Even though having all of your tenants in one place can be a great thing that makes management easier, it also amounts to having all of your eggs in one basket. If something happens to the property or if you fall behind on payments, you can lose it all in one go.
They’re Harder To Sell
Just as these properties are more difficult to get financed, they’re also difficult to sell because there are a limited amount of people who are willing to buy them.
More Tenants Means Drama
You’re going to have noisy tenants, tenants who smoke cannabis, tenants who drink, tenants who party, tenants with bad pets, etc.
Not only do you have more individual tenant problems, but your tenants live together in the same location and are likely to be prone to getting on each other’s nerves. It’s going to happen and the more tenants you have, the more issues you’ll have like this.
Management Is A Steep Learning Curve
There are many different facets to managing property. You’ll have to:
- Be very familiar with landlord/tenant law in your location
- Be able to deal with tenant issues, like tenants complaining about other tenants
- Know who to hire to do repairs correctly
- Collect rent
- Process evictions
- Arrange to have vacated units cleaned
There’s a lot to learn to get all of this done quickly and correctly and still be able to make a profit.
When Should I Bypass A Multifamily Opportunity?
Knowing when to not buy a property is just as important as knowing when to scoop one up. Here are a few tips on how to tell whether a multifamily property is a good deal or not.
Not Enough Money To Be Made
If you run the numbers and there isn’t enough profit in the going rent price for the area, skip it.
The Seller Can’t Give You Numbers
If the seller of the property can’t give you a history of the property’s rental vs vacancy rates, the rent amounts, the amount of profit that’s been made in years prior, then it probably isn’t a property you should be interested in acquiring. Make sure you get real numbers on this and not just guesses. If they can’t provide the property’s income history, move on.
On The Market Too Long For Too Much
When a property has been on the market for a long time and the seller won’t lower the price at all, that’s a red flag. There’s more to the story that you need to find out before considering a property like this any further.
Properties in High Crime Areas
Properties in these areas are often called “class D” and they’re something that only experienced investors should be dealing with. These properties are very neglected, often uninhabitable as-is, and will require much in the way of repair before you can even consider letting tenants in.
The good thing is that these properties are typically very cheap, but you’ll have trouble finding tenants who are both reliable and willing to live in a high crime area. Build some experience with higher class properties before attempting a class D rental.
You need to get a reliable building inspector that you can trust to look over the property and let you know of any potential issues. Badly done repairs can cost you more money than you think, because you assume that an issue was taken care of and find out later that it was only covered up.
This is a particularly difficult problem with things you can’t see, like the inside of walls. Building codes generally require that if you open a wall and the contents aren’t up to code, it has to be brought up to code immediately before it can be lived in.
Artificially High Rent
Check into what the property rental rates have been historically in the neighborhood you’re shopping in to make sure that the rent isn’t currently significantly higher than it’s been in the past. You don’t want to buy a property expecting to maintain one level of rent to have it suddenly drop off in the future due to a recession.
You Can’t Afford Property Management
If you’re purchasing a multifamily that’s larger than 4 units, you’ll want to seriously consider getting a property management company to run it for you. If you can’t afford property management, you’re going to have to perform all of this management yourself, from dealing with having repairs done to collecting rent, performing evictions, dealing with tenant complaints, and more.
The more units your multifamily has, the more hectic it can get to manage. If you’re serious about having a larger multifamily property as an investment, you need to calculate the cost of a property management company in when you’re making the decision to purchase the property.