The Ultimate Guide to Multifamily Financing
The past decade has been favorable to real estate investors, especially those involved in fix and flip. But recent market conditions–including a nationwide affordable housing crisis, a decade of rising home prices, and steady rent increases—are leading more investors to seriously consider and turn to multifamily properties.
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If you are new to real estate investing or have only dealt with single family properties, there are important differences to understand, requirements to know about, and a few tips to consider as you look to invest in and find financing for multifamily properties.
What Is a Multifamily Property?
Since many readers may be new to multifamily properties, definitions of a few important terms are as follows. A multifamily property, often referred to as a multi dwelling unit (MDU), is any property or home composed of two or more units, established on a single parcel of land with a common title. For the purpose of financing, a property with two to four units is considered residential, whereas properties with five or more units are treated as commercial property. This classification becomes very important as you seek financing, which you will read about in more detail below.
What to Look for in an Investment
Seasoned multifamily investors already know this, but if you are new to multifamily investing, it is important to understand what to look for in an investment property. Investors in multifamily properties focus on three factors: net operating income, cash flow, and capitalization rate. If you are new to multifamily property investing, make sure you understand how to calculate these metrics and determine how your property pencils out.
How to Find Financing
As mentioned above, conventional lenders classify multifamily properties as residential or commercial depending on the number of units. The type of financing available and the requirements to get approved differ between the two types of properties.
In general, financing sources for multifamily include all of the sources you have for single family, as well as others available only for multifamily. To start, you will learn about conventional loans before seeing some options for less traditional and more creative ways to finance the purchase of a multifamily property.
Investors purchasing a residential multifamily property can apply for conventional mortgage loans that are similar to conventional loans for single family residences. If one of the units will be owner-occupied, a few more options become available. Owner-occupants can choose between Federal Housing Administration (FHA) loans, Veterans Affairs (VA) loans, or conventional financing.
Loans for commercial real estate require bigger down payments and often require shorter repayment schedules. However, the larger the loan amount required to finance a multifamily project often means more financial institutions are interested in talking to you. There are lenders who focus on multifamily and departments within large financial institutions that specialize in these types of loans.
Larger loans mean more fees for the lender, which can work to your advantage. When financing a quality multifamily property investment, you may find that more doors open and you are more likely to get the VIP treatment—or at least get someone to return your phone call.
Financing Options Beyond Conventional Methods
Equity Share Investor
An equity share investor is essentially a real estate investor who will own equity in the multifamily real estate property in return for providing funds for the purchase. The equity share investor is entitled to a percentage (based on the amount invested) of the monthly cash flow and a percentage of the profits when the property is sold. This option is often combined with traditional debt financing (discussed above).
Real Estate Syndication
Real estate syndication can take several forms, but is, at a basic level, a pooling of funds (from multiple investors) that are used to provide investment property financing. Common forms of syndication are as follows:
- Real estate partnership. Each partner gets something in return for their investment. Most common is to share in the equity or receive a return on their investment when the property is sold or upon another means of exiting the investment.
- Real estate crowdfunding. There are at least two options when it comes to crowdfunding. With one, you can “invest” with no money and be the one responsible for managing the investment. The other common option is to invest with very little money and earn passive income.
Borrow From Hard Money or Private Money Lenders
Hard money lenders focus only on the earning potential of a multifamily real estate investment property—not the borrower’s credit history. This can be a good option over conventional loans, especially if you have had credit issues in the past.
A portfolio loan is a nonconforming loan that can be used to purchase a multifamily property. This loan type is especially beneficial to investors who want to finance multiple properties simultaneously.
Multifamily Short-Term Loan
Short-term loans for financing the purchase of a multifamily property typically offer terms that range from six to 36 months and payments that are interest-only. These could be hard money loans or bridge loans.
Investors turn to short-term multifamily loans when they need cash to make property improvements that will allow them to meet the stricter requirements of a permanent multifamily loan. Short-term loans are also used to buy a property while the investor is working to meet the personal qualifications necessary for permanent financing.
Advantages and Disadvantages of Investing in Multifamily Properties
As discussed above, recent market conditions are leading more investors to seriously consider and invest in multifamily properties. But if you are new to multifamily investments, you will want to make sure you understand the pros and cons of this investment type. Use the following table as a guide when considering multifamily investing.
|Cash flow||Pro||More units equal more rent coming in on a monthly basis. Bonus: you can live in one of the units.|
|Control over value||Pro||The more income a multifamily property generates, the higher the value. Investors can make upgrades that will lead to higher rents and more value.|
|Risk||Pro||Multiple tenants mean that risk associated with vacancies is spread out. Investors don’t entirely lose out on rental income when one unit becomes vacant.|
|Scalability||Pro||With just one purchase, you can own 2, 20, or even 200 units.|
|Cost||Con||In general, multifamily properties are more expensive than single family properties. Investors will need more cash, the ability to secure a higher level of financing, or creativity to get in on the multifamily game.|
|Appreciation||Con||Multifamily properties are valued both on the income they produce and the condition of the property. As such, they tend to appreciate more slowly than single family homes.|
As the table helps illustrate, there are definite advantages—and a few potential disadvantages—to multifamily investments. Now may be a good time to invest given current market conditions, but before you do, make sure the deal pencils out.
Run the numbers on net operating income, cash flow, and cap rate. It is also a good idea to start making contacts and building relationships with potential lenders before you need the money.
Are you a multifamily investor? If you’re hesitant to enter the space, what’s holding you back?
Let’s talk in the comment section below.