Unlike single-family real estate investing, multifamily real estate could provide you with an opportunity to create multiple revenue streams. That’s because you’re likely to have more tenants paying rent and covering more than just the cost of your property mortgage.
To get started in multifamily real estate, you'll need to be adept at managing tenants and property, be financially secure, and be able to get a good loan on the residential property you want to buy.
Costs for this type of real estate add up fast, so make sure the income you could bring in from your property would be enough to cover your expenses and still earn a tidy profit.
We'll show you how to run the numbers to help you decide if this investment opportunity is right for you.
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Multifamily real estate refers to residential property types that can house more than one family. Think apartment complexes, duplexes, townhomes, condo complexes, and even large houses that have been subdivided into multiple apartments.
If you’re deciding on how to invest in real estate, multifamily properties offer the potential for cash flow from more than one tenant. This is opposed to single-family real estate investing, in which you buy a property designed for one family and work to keep that single unit rented out.
Multifamily real estate allows you to rent out multiple units and potentially reduce your risk related to occupancy issues. However, although there is a potential for higher multiples of income, you also need to account for the increased maintenance and administrative costs of managing multiple tenants.
By contrast, single-family property investing can be less time-intensive when it comes to regular management. This could be as simple as buying a house and looking for a tenant to live in it or moving to a new home and keeping your old house to rent. In the second scenario, you could refinance your old house and potentially increase your profit by getting a lower mortgage.
Either way, the person living in the property is neither the property owner nor mortgagee but will be paying enough rent to cover the monthly mortgage payment. However, the vacancy risk of a single-family rental could be higher since you won’t have other units to make up for lost revenue if you can’t find another tenant.
Here are some pros and cons of learning how to get started in multifamily real estate.
Increased and scalable cash flow from multiple tenants in one property
Reduced vacancy risk (if one unit is empty, there are usually others that are full)
Potential to live in one unit and use the income from the other units to cover your costs
Cash flow could be enough to hire a property management company to take over day-to-day operations
Often need more capital to buy multifamily vs. single-family real estate
More maintenance and upkeep required to manage multiple tenants
Property appreciation is often less compared to single-family real estate
Any time you buy an investment property, it carries risk. Before deciding on a multifamily real estate investment, you should carefully consider your investment strategy, risk tolerance, and financial goals.
Getting started in multifamily real estate investing can be challenging, just like building any type of residual income or cash flow. If you decide this is the right move for you, here is a step-by-step guide you can follow.
Beyond trying to figure out if it’s a good time to buy real estate, property investing is about knowing how much monthly income you need to make the investment worth it. Don’t forget to account for the cost of maintenance and repairs, the cost of advertising vacancies, and the expenses of vetting tenants.
When you calculate how much rental revenue you need to cover your costs, account for a little bit extra. For example, if you know a property will cost you $2,000 each month, you might decide you need enough tenants to bring in $3,000 a month to cover your costs and give you an extra $1,000 cushion.
As you get further along into multifamily real estate investing, here are some terms that you need to understand.
This represents your revenue minus your operating expenses. Add up the revenue you receive from rent and any other fees you might collect, such as parking, storage, or landscaping. Then subtract regular costs of managing the property, like maintenance, property taxes, costs to hire work crews, utilities, and insurance premiums.
Net Operating Income = Total Revenue – Operating Expenses
Here’s an example of how to calculate NOI:
Revenue
Operating expenses
Net operating income (NOI)
The capitalization rate can help you figure out how quickly your multifamily property will provide a return on investment. First, take your monthly NOI and multiply it by 12 months to get your annual NOI. Then divide that number by the property’s current value.
Capitalization Rate = Net Operating Income / Current Market Value
For example, if you have a monthly NOI of $4,000 and the market value of the property is $500,000, you would divide the annual NOI of 48,000 ($4,000 x 12) by 500,000 to get a cap rate of 9.6%.
In general, a higher cap rate indicates that a property will generate a better return than one with a lower cap rate. However, this is just one metric you can use in deciding whether or not to buy a multifamily rental property.
Read more about how to calculate cap rates.
With these numbers in hand, you can begin looking for a multifamily property that meets your needs. Here are some factors that can play into whether potential tenants will find your rental attractive.
School districts: Many families like to be close to high-quality public schools. If you can find a multifamily property near a high-performing school, you may be more likely to attract long-term tenants.
Neighborhood amenities: How close is the property to amenities like shopping, entertainment, and other attractions? Is it easy to get there by car or by public transit? Is it in a walkable area? Consider the type of tenant you want and nearby locations that might be attractive to them.
Property amenities: Depending on the location and property, there might be some amenities that would make your multifamily property attractive to renters. For example, some communities have shared spaces for gatherings or events, and multifamily condo buildings often have a fitness room.
Once you’ve identified a property, there’s a good chance you’ll need a loan to make your purchase. Depending on the type of property you choose, you could have different requirements based on the lenders you choose.
You can choose to get a conventional mortgage or an investment property loan. If you plan to get an investment property loan, you might need to have a bigger down payment and better credit than you would for a regular mortgage.
Investment property loans might be difficult for new real estate investors to get since they require a substantial outlay of capital and a good credit score.
One way to finance a multifamily property that might be more affordable and easier to qualify for than an investment property loan is a technique known as "house hacking." If you buy a multifamily property with the intention to occupy one of the units yourself, you can get a conventional home loan with a good mortgage rate to help you pay for the property.
You might also look into financing with an FHA loan or a VA loan, the latter of which is limited to a property of no more than four units.
Using this technique, you could live in one of the units while renting out the others, which would, ideally, generate enough income to cover the monthly mortgage payment and provide you with cash flow.
Getting approved for a loan ahead of time is important since it can help you move fast if you find a property you like. Work with a mortgage broker who can help you find a loan that fits your needs and has a good interest rate.
Once you find a multifamily property that’s a good fit for your real estate portfolio and you're approved for a loan, you can make an offer on the property. A good real estate agent or broker can help you through the process, especially if this is your first time.
You might need to negotiate with the seller to come to an agreement on the price. Also, be aware of the real estate market. It’s important not to be so caught up in a property that you get involved in a bidding war that raises the purchase price of the property outside your budget.
After the offer is accepted, you can move forward with closing the sale and getting ready for your tenants.
If your property is vacant when you purchase it, you could take advantage of this time to make repairs or upgrades to the units. Doing so at this time is likely easier than it would be when a tenant is occupying a unit. If a property inspection was done before the purchase was completed, it might serve as a starting point for your repairs.
Older multifamily properties might benefit from some upgrades. Minor upgrades could be painting interior walls a neutral color throughout each unit, installing lighting dimmers, or replacing an outdated bathroom vanity, among other things.
Some upgrades may cost a bit more upfront but save money in the long run. This could include installing energy-efficient appliances and low-flow water fixtures, changing flooring from carpeting to a more durable material, or even replacing older windows with newer, more energy-efficient models.
As with any business or investment, you need to have a plan for your multifamily property. Will you have a property management company take care of regular tasks like property maintenance and rent collection, or will you manage the property yourself?
If there are existing tenants, you might want to think about whether you'll renew those leases when they expire. It might be a good idea to research vacancy rates in your area's rental market, as well as rental rates in your area for similar properties.
Be sure to create a financial plan that takes into account expected repairs and improvements. You will eventually need to replace things like water heaters and HVAC systems, or have the roof repaired or replaced, all of which can be major expenses.
Understand the timelines for these events so you can plan for them. It might be worth having a professional inspection done on these fixtures so you'll know what kind of life expectancy they have.
A multifamily property could be a good investment if it fits your investment goals and risk tolerance. In many cases, a multifamily property can provide you with a steady monthly cash flow.
However, if you don’t understand how real estate investing works or you’re not interested in being a landlord, it might not be the right choice for you.
Multifamily homes house more than one family. If there is at least one other separate and inclusive unit on the property, it’s multifamily.
Multifamily units include condo complexes, apartment buildings, duplexes, triplexes, and homes that have been converted to house an additional family in a separate unit.
Multifamily property investors make money from rental revenues. They can also make money from fees related to storage and parking on the property. The idea is that your cash flow from the property should be larger than the expenses of keeping up with the property.
Learning how to get started in multifamily real estate could help you diversify your investment portfolio and provide you with a way to make ongoing revenue. However, you should do your due diligence and consider your own goals and situation to determine whether it makes sense for you.
If you’re not sure about multifamily real estate investing, check out our ideas for making money from passive income sources.
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This article How to Get Started in Multifamily Real Estate [Beginner’s Guide] originally appeared on FinanceBuzz.
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