Multifamily properties, which are defined as residential rental properties with five or more units (i.e., apartment buildings), are a staple asset class among real estate investors for several reasons.
First, they are a familiar asset class, with minimal complexity as it relates to ownership or maintenance.
Second, they are more resilient to economic cycles, providing more stability versus other asset classes like office or retail.
And third, multifamily properties are universally accepted among virtually every lender, providing a vast array of financing options. It is because of these factors that most real estate investors who started with single family home rental properties often graduate to multifamily investing as their next level.
Whether you’re a novice or seasoned veteran, there are several key factors that you should take into consideration before you make your next multifamily investment.
1. Property Location
When getting involved in any real estate transaction, location of the property is obviously important. First, you should determine what your preferred tenant mix is. If the mix you are looking for is families, the property should be conveniently located to good schools, a playground, or other amenities. If you prefer to rent to seniors, shopping centers, libraries, and other similar amenities may be preferable.
The location is more than local amenities, as the overall neighborhood crime rates, condition of surrounding properties, and the mix of properties is also important. For example, you may not wish to invest in a multifamily property if it is the only rental property in the neighborhood, as it may have problems attracting tenants.
It is important to remember the location of a property will often dictate the rental rates, the types of tenants who will be attracted to the property, and the overall value of the property. The location may also determine vacancies; a bad neighborhood typically has a higher vacancy rate than a good neighborhood.
2. Property Condition
The condition of a property should help dictate your decision about purchasing a multifamily property. This is more than cosmetics; as a buyer, you want to have a property inspected for defects to determine how much money, after the purchase price, you will have to spend to ensure the property can be rented at full market value.
While the looks of the property, including landscaping, paint or siding, and indoor condition are important, there are other factors which are even more important. Buyers should find out the age of the roof, heating system, and electrical system. Keep in mind, these can be big-ticket items which can ultimately cost thousands of dollars to upgrade, or maintain. The newer the units, the less investment you need to make in upgrading the property.
It is also important to keep in mind, the better the condition of the property, the less time will be required to market the property for new tenants should that become necessary. Property which is well-maintained tends to garner higher rental rates, and typically has a lower vacancy rate. This is particularly important to help ensure you have sufficient income to pay your loans, property taxes, and insurance.
3. Rent Roll & Lease Expirations
Cash flow helps ensure the property you purchase can be considered a successful investment. The first way to evaluate the cash flow of the property is to carefully review the rent roll. The rent roll is an itemization of the tenants and the characteristics of their lease, such as the start and end date, monthly rent amount, security deposit, etc.
Properties that are primarily month-to-month leases may be worth less versus a property with one-year leases. However, if the property needs to be upgraded, you’ll probably want month-to-month leases because it allow you to get started on the renovation sooner and allow you to avoid the expense of early termination.
You’ll also want to look at the lease expirations. Ideally, expirations are staggered and not concentrated into a short window, as this will allow you to manage vacancies and keep cash flow consistent. The worst case scenario is that a large number of tenants vacate all at once, leaving you with a cash flow crunch.
4. Tenant Demographics
You also want to look at the demographics of your tenants. A concentrated demographic can be a positive or a negative. For example, an apartment building that has a heavy concentration on older seniors can be positive in the fact that rental income can be stable and secure, but can quickly turn negative in the event of health issues. Properties that qualify for Section 8 (government subsidized rent) provide the owner with steady and timely rent, but could be susceptible to higher crime rates in some cases.
Even an upscale property with young professionals as a primary demographic is vulnerable to risks, such as a vacancy risk from these tenants getting married and moving to the suburbs.
5. Weigh All Factors
It is important to weigh all factors associated with a multifamily property. For example, if rents are below market and the property is ripe for renovations, then it might be a good value add opportunity. But be careful to evaluate how significant the repairs are because these costs will factor into your return on investment.
You should also carefully evaluate the expenses associated with the property. Measure how well the current rents meet these costs, including taxes, insurance, and maintenance. Only when you review your cash flow projections accurately can you determine if the property will meet your investment goals.
Investors also need to be conscious of potential challenges associated with financing the property. For example, a loan with Fannie or Freddie will require 9-months of stabilized income. A property with a high crime rate or in a rural area may make it ineligible for certain loan programs.
6. New Construction
For some investors, a new development may be the answer. In these cases, investors often need to obtain a bridge loan to secure the property, complete construction, and have time to fill the property with qualified tenants.
Some investors prefer a clean start; you can screen your own tenants, you are not tied to existing leases, and worries about property condition are minimized because the project is largely new construction.
There are numerous issues to address when you are thinking about investing in multifamily properties; each property is different, lenders take a different approach to non owner-occupied properties, and hidden defects could mean the purchase price does not tell you the whole story.
When you have identified the right property, whether it is a new development, or an existing multifamily property, the next step will be to identify your funding sources. Because of the complexity of commercial financing, you could spend months finding the right loan. At Raisal, we have taken the guesswork out of financing multifamily properties for investors.