Buying multifamily is a more involved type of investment and may be more stressful and expensive than purchasing a single family home (SFH) as a rental property. That’s why a lot of investors decide to start with buying SFH and work their way up to MFH. However, if you want to cut down your learning curve and are planning to scale down the road, it might make sense to consider jumping into MFH investing from the get-go.
Multifamily housing (MFH) consisting of one to four units is considered residential, while more than four units is generally classified as commercial property. Residential MFH can be less expensive, as applicable laws and tax structures differ compared to commercial.
To be sure, larger MFH takes more preparation and can be overwhelming to a new investor. But no matter what an investor decides, there are several necessary steps to take prior to jumping in.
10 Things to Think About Before Jumping Into Multifamily Housing
1. Know the Area
Research and know the geographic area where you are seeking to invest in MFH. The geographic area can play a large part in the cost of the property and the amount of rent that can be charged, as well as the type of potential tenants you will be getting. This, of course, affects the bottom line of every investor, and if you have a certain budget that you must work within, it is wise to find a geographic area that fits this budget.
Certain areas are much more expensive for ALL types of housing than others, and this must be kept in mind when researching where to purchase. Cost of living expenses per geographic area are a good indicator of the amount of investment needed before considering purchase. Certain geographic areas simply have higher costs of living overall, and housing prices can vary tremendously.
2. Establish a Team
Real estate is a team sport, so at a minimum, you want to have an attorney versed in real estate; a property manager; a mortgage broker and insurance broker; and a general contractor already chosen and ready to work. A partner can hold more than one role and can be an attorney themselves or a general contractor.
You can “kill two birds with one stone” with a multi-tasking partner, who might be a contractor and therefore do repairs or manage the property themselves. Or if an attorney is a partner, the legal factors will be done routinely.
While it is not a hard requirement to have a partner, who can also perform one of these roles, it is always a bonus when it is the case. Whichever methods work best should be chosen, either a team or partner approach—or even both—as there are many facets to successful MFH investing.
3. Perform Due Diligence
Keep in mind that MFH has more of a profitability margin because of the increased number of units and hence scalability. Prices of residential properties are based on the comps, whereas commercial designation pricing is based on the net operating income (NOI). This includes all expenses and any necessary repairs or upgrades. This does not include taxes.
Higher interest rates can exist for MFH, and banks may have stricter lending requirements. Due diligence of the highest degree is needed for this type of investment, since lenders will want a precise valuation on the part of the investor before proceeding to lend. Most commercial lenders typically require minimum DSCR of 1.25X.
Related: The Ultimate Guide to Due Diligence
4. Define Your Strategy
You must have a defined strategy when buying MFH properties. The choice of property, whether residential or commercial, the amount of down payment, the return on investment, and overall amount of time needed to ensure profitability always must be considered—as is approximately how long to hold it for.
Planning not just how to pay initially but also the overall profit picture years down the road should be considered. Closing costs and needed repairs to the property in question should be factored in.
5. Get Your Finances in Order
Deciding whether you would want to sell a property soon or refinance should be done up front. While this will only be an estimate, it will help you plan out how much financial resources and time you will need to put into one property until you buy another. Whether an investor keeps a property forever or is looking to resell somewhere in the future, there needs to be some type of strategy for this also.
Enough working capital to sustain the investment property until sale must be maintained, and a profit margin upon sale should be estimated beforehand. Property values go up and down, and selling in a down market won’t lead to as much sales profit. So, always prepare ahead financially for unforeseen circumstances.
6. Hire an Underwriter
Every property purchase must have a thorough underwriting. Most banks and other financial institutions are strict in the process of underwriting, as the lenders are truly taking on the responsibility for the property in case of casualty or default. So, for someone with no experience with commercial property underwriting, it is advisable to hire an experienced analyst to underwrite for you.
7. Research Lenders
Perform a thorough research into loans and mortgage solutions. Percentage rates can go up and down based on variable factors, such as time of year, location, length of mortgage and loan, and other factors. It does help to speak in-depth with several dependable potential lenders. It may be helpful at least at the beginning to enlist the help of a commercial mortgage broker to help you find the best solution.
8. Gather Financial Statements
Make sure all financial statements are the most recent—not just the pro forma. The financial history of a possible investment is just as important, if not more so, than the predicted future earnings, which are pro forma. Income and expense statements, as well as the actual rent roll from the past, must be supplied by the seller in order to make an informed decision before purchasing any MFH investment.
9. Consider Taxes implications
Taxes should be a part of the equation when purchasing any MFH investment. These must always be factored into the total yearly costs of the property acquisition.
Taxes will vary by location, and some geographic regions have many different types of property taxation—from municipal, to state, to even school district taxes. The amount of tax depends on the millage requirements based on the price of the property.
In general, taxes usually do not go down—but they can. The reality with taxes is that they either remain the same or can go up based on the rates established by the local tax jurisdiction. There are ways to establish the history of taxes in any geographic location, and that is to inquire at the local tax assessment office, where all records of such type will be kept.
10. Appeal Taxes If Necessary
If a property owner feels that the taxation is too high, then they may appeal through the local tax assessment office. While the reduction is not guaranteed, it may be worthwhile. A knowledgeable real estate attorney can advise here.
It is always wise to research the history of the taxes to determine if an appeal would assist. Any renovations that are done by a previous owner may have led to a tax increase, and knowledge is power in an appeal situation. Many individuals each year appeal their taxes, and it can be worth the chance to do so.
Some municipalities and states have only certain times of the year when “tax appeals” can be done. And again, a trip to the tax assessment office or a discussion with an attorney who will do this is almost a must-have before purchase.
The Bottom Line
Overall, it might seem a complicated undertaking to purchase an MFH investment, but it is not. Having a “team” and/or partner on your side is a big step in the right direction and can streamline the process. Again, due diligence and a well thought out, complete strategy before purchase will reward a wise investor with a source of stable income down the road for many future years.
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