Many investors start their journey in real estate with single-family homes. It is a great place to start, but soon after, many investors want to move onto the next big thing. The next step for investors is often multi-family housing. In this blog, we will talk about the pros and cons of multifamily housing and what you need to consider before making the jump.
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Multifamily Housing – What is it?
At its most basic level, a multifamily property is a structure with multiple units where multiple families live. Sometimes you will see this referred to as a multi-dwelling unit (MDU). This structure could be a duplex, townhouse or condo, or an apartment building.
One of the first questions people often ask is what makes a multifamily housing property a commercial property. Generally, anything larger than 5 units (or doors) is often considered commercial real estate. If the property qualifies as a commercial property, it will require a commercial loan.
The Benefits of Multifamily Housing
Economy of Scale
The economy of scale is one of the biggest advantages of multifamily housing versus single-family housing.
This economy comes in a number of areas:
- Time: The time and energy to grow your business focusing on multifamily will be far less than going the route of single-family homes. There are many individuals who have amassed large numbers of units in a relatively short amount of time. The work of locating a property, running the numbers, completing the due diligence, and closing is not insignificant.
- Management: It is simply far easier to have 8, 10 or even 50 tenants all in one location rather than dealing with the same number of tenants spread out over a large geographic area. Not to mention with a large number of units in the same locale, you increase your negotiation power with your property manager.
- Maintenance/Repairs: From the moment the paperwork is signed, there will be things that need attention. With multifamily housing, everything resides under one large roof or area. Not only do you save time with travel, but there is the expense side as well. The cost of repair or replacement for a roof or other big ticket items will be larger. But the cost will be far less than replacing these same items individually.
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Lowering your risk profile is another significant benefit with multifamily. With a single family rental unit, it is either occupied or it is not. That means, if you have a mortgage, you will need to cover the cost of the mortgage (and other expenses) without a rent payment coming in to offset the expense. With multifamily, there are more tenants to cover your mortgage and other expenses. If you own a 12-plex and 3 tenants have moved out, there are still 9 paying tenants. This provides protection for the investor.
Appreciation is yet another great benefit of multifamily investing. In the single-family arena, you are highly dependent on how the properties around your property are valued, even if you do substantial improvements to the property. With multifamily, more options exist and they are under your control as the owner. A good cost-benefit analysis is needed for this activity and perhaps even conversations with your tenants. But if you are able to identify areas of improvement that allow you to charge more for rent or bring in additional streams of revenue, then you have improved your net operating income. And, if you continue to maintain your multifamily unit, it will retain its value.
Considerations with Multifamily Housing
Tenant Disagreements and Turnover
Because tenants will live close to one another, the likelihood of tenant disagreements rises substantially. This will come in any number of forms – noise, clutter, smells, parking. Part of this can be mitigated with good tenant screening, but no matter what, this will be a thing that will occur and it can contribute to turnover.
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Down Payment and Cash Reserves
Multifamily properties generally have a much higher price tag than a single family home. As a result, it means it will require a larger down payment. It is not uncommon to expect to put down 20-25% on the property. The payment is also larger because you are not living in the property and lenders see that as more risk. Additionally, you must be prepared with cash backing or cash reserves. In most situations the conditions just mentioned apply, but this is not always the case. There are other great opportunities in the area of creative financing that could require very little or no money out of pocket. Those are really hard to find, requires you to think outside the box, and they may not apply to everyone. But, this is the focus of another future blog.
Market Size for Multifamily Housing
The National Multifamily Housing Council (NMHC) released an updated report in November 2016 that there are nearly 27 million households that rent a multifamily unit. That is 61% of households as compared to 35% renting a single family home. The growth in multifamily housing development is growing. Freddie Mac reported that Multi-family development building in 2016 was at the highest levels since the 1980’s. The growth of this sector is expected to continue in 2017 but at a slightly slower rate. Vacancy, highly dependent on the region, is overall expected to rise slightly throughout 2017 to around 5%.
Multifamily Housing – Is it for You?
Do your homework. Research and verify all areas of past performance. Prepare a list of the potential areas for improvement and assess the value those improvements would bring. Bounce your concerns off of skilled colleagues who have done this before. Make the right decisions going in.
Pros and Cons of Multifamily Housing
|- Economy of scales|
- Lower risk profile
- Control for appreciation and value
|- Potential for tenant disagreements
- High price of entry
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Also published on Medium.