Am I ready for Multi-fam and Apartment Investing

35 Replies

Greeting everyone!

I would like to leverage this group's expertise to help assess my readiness for multi-fam and apartment investing.

I have been a SFR landlord for 4 years. The properties have been providing decent cash flow and appreciation over the last 4 years. I have taken most of my money out (down payment) through refi and the properties still cash flow positively. I am thinking of selling the properties, taking the cash out and putting it into a bigger project.

I am doing my research now. So far I know I have to have 20% down, 10% in reserve, plus inspection / appraisal / closing cost etc. I should do a 1031 exchange when selling my SFRs and put that towards the multi-fam property. I have a CPA and attorney in my power team to help me when I am ready for a deal.

My questions are:

1. what else do I need to be sure that "I am ready"?

2. what do I need to be ready for when I am going to talk to a commercial lender, knowing that they will look at deals very differently than residential? e.g. will my 4 years of landlord experience and full time RE investor status be good enough? This will be an initial conversation because most likely I won't present a deal (I don't have yet). Rather, I will try to find out what type of property I can do given the amount of down and reserve I have, rate, cost and qualification of borrow(s).

3. any other resources I can tap into to help me get ready? I have been reading posts on this forum and found them helpful.

4. what size of multi-fam project should I look into as my first deal? And what type of lender should I talk to?

Appreciate any thoughts and tips on this!

Cheers,

Helen

1. You seem ready. Probably wise if you are expanding your portfolio to have property management software if you are doing everything yourself. Check out Buildium and Appfolio. I think Buildium is a bargain.

Make sure what you have been doing for maintenance work is scalable to your new purchase.

2. Know what a pro-forma is, know what cap rate means. I don't think multi-family lenders are very difficult to work with. Speak to you local Chase Commercial representative.

3. Nothing specific.

4. If you buy something big enough to support a live-in manager (15+ units?) your life will be easier.

I would talk to an experienced commercial broker that specializes in RE apartment buildings to get a quick idea of how ready you are. Im sure someone like @Joel Owens could help you out

Hello,

In doing the 1031 Exchange you need to make certain with your attorney and CPA that the exchange correlates with the state requirements. Second, when talking with a commercial lender, many(depending) only are looking at the commercial real estate cashflow. You mentioned that the property cashlow is continous,if so then you should have no difficulty using the property as collateral. Last, instead of purchasing Property Management software, perhaps getting a professional commercial property managment firm or company to oversee the property! Its better to have an exceptional property management servicer, than to loss such positive cash flow! Congratulations and the new realm of investment!

Valerie Robinson

Buildium is a bargain; but there's a better one...

Thanks Pete for the vote of confidence.

Hi Helen,

I have many clients from California. I transact all over the United States. Typically most of my California clients are buying in other states because of the yield that is available there with multifamily.

What kind of loan terms you get Is based on the asset itself. I have no clue without knowing what kind of liquid cash you have on hand now versus the equity trapped in your properties you want to sell for 1031 purposes.

You mentioned that you are a full time investor. Do you work a job with an annual salary and what is the amount?? If you don't work a job then do you have a partner that works a regular job with annual income?? These are not required but helpful. You can overcome this if you have substantial net worth and liquidity.

From the economies of scale purpose size does matter to land a full time property manager and a full time repair person. The other part is that if you are dealing with small balance loans under 1 mill it will be a local bank giving a 5 year term and maybe a 20 year amort.

You get longer term loans by moving into larger loans of about 3 million and up. The best part is those tend to be non-recourse against you, the rate is fixed, and the length of loan term is 10 years or longer which helps protect against interest rate shock with a five year loan.

Chase bank was mentioned but I have called them before here locally for another client and they like only a select few markets and really large loans. For instance here in GA they do only SBA loans and no commercial here. I have many sources that are specifically apartment lenders that do the whole U.S.

The 20% down loans usually on the first have a higher interest rate. Better is to get a 75% ltv at a lower fixed rate and then get a seller to hold a 10 to 15% second note at just as good or better terms then the first mortgage. You can then blend the rate down to maximize returns. It's great that you have a tax accountant and an attorney but one of the most important aspects in my opinion is a commercial broker who knows this asset class and is also an investor. There are many stated cap rates out there but the underwritten actual cap rate is quite different than what is shown. Your 1031 proceeds the total debt needs to equal the new property or higher or you will have taxable boot.

In California due to rent control, high income tax, overly compressed cap rates there is not much yield there. I know some clients that had recent appraisal on a small building they own with 12 units for a 3 cap. They are selling and plowing the money into other markets for more promise.

If you just want a long term tax write off with limited to no cash flow and equity build up then Cali might work. There might be some multi cash flow areas there but probably not in nice areas you want to own in.

Medium allworldrealtyJoel Owens, All World Realty | [email protected] | 678‑779‑2798 | http://www.AWcommercial.com | Podcast Guest on Show #47

Thank you all!

@Valerie Robinson , I am actually planning to sell the SFRs to get cash out instead of using them as collateral for the multi-fam purchase. Good point to consider using professional property mgr, although I may want to get actively involved in managing my first multi-fam to learn from it. Also, I think it depends on the size of project and cash flow etc. to see if I can afford a full time mgr and handyman.

@Joel Owens , let's say by selling the SFR properties I am able to get about 400k cash that I can put into the multi-fam property. So for a 75% LTV, I can purchase a property up to 1.2M, right? Depending on what's required for my personal income, I do have a business partner (my husband) who has a full time job with stable income, and a healthy balance sheet should the combined income not sufficient to get a loan. Good point on trying to get owner financing 10-15%, which I will factor in when looking for properties. I have not thought about investing in other States yet at this point. Being my first multi-fam, I hope I am able to find properties closer to home.

Another question is, what can I buy with 1.2M in California? Probably just a 4-plex. LOL

Even if you are going to self manage you need to factor in a PM fee for cost calculations. This way if you do not want to manage later you have built in the cost upfront when purchasing a property and have not overpaid for a property.

The PM duties and amount of work will vary based on quality of the area and tenant base. The more the yield goes up generally the less desirable the area and the more lower income the tenant base becomes.

What you have to DEFINE for yourself is what would be a win for you in a multifamily investment for return??

With 400k you are about right at 1.25 mill. With leverage you can go 2,000,000 putting 300k down at 15%. Lenders generally want to see net worth equal to loan amount and 10% liquidity after down payment.

Other options is to look for an owner financed deal with less finance requirements from a seller.

Medium allworldrealtyJoel Owens, All World Realty | [email protected] | 678‑779‑2798 | http://www.AWcommercial.com | Podcast Guest on Show #47

@Joel Owens right about PM, include that in cost calculation. For my SFRs, I have been using my own PM company to manage them and charge 10% fee, so I can do the same for the multi-fam.

Great question on what to expect in return on multi-fam investment. I honestly don't know. Would a 8-10% return be reasonable? I understand that the expectation on return on investment on multi-fam and SFRs are quite different. For SFRs, I am looking for appreciation more than cash flow, and the value of SFR is determined by market price (comps of similar houses and neighborhood etc). For multi-fam, the value is primarily determined by cash flow (value = cashflow / cap rate). Higher the cash flow, higher the value of the property. So my goal as a multi-fam owner is to try to increase cash flow of the property. Correct?

I would love to hear from multi-fam owners in California, what's your expectation of return?

8 to 10% pre-tax cash flow is easily obtainable in most markets.

With multifamily you have vacant structures, semi- performing, and fully stabilized.

Still value in all 3 types if you buy correctly and analyze properly. You will never catch everything before buying and real estate is an endless learning process but by catching most of the items the small little things won't take down the investment.

Each type requires more or less work for return and a different loan structure.

Medium allworldrealtyJoel Owens, All World Realty | [email protected] | 678‑779‑2798 | http://www.AWcommercial.com | Podcast Guest on Show #47

Originally posted by @Helen Chau :
@Joel Owens right about PM, include that in cost calculation. For my SFRs, I have been using my own PM company to manage them and charge 10% fee, so I can do the same for the multi-fam.

Great question on what to expect in return on multi-fam investment. I honestly don't know. Would a 8-10% return be reasonable? I understand that the expectation on return on investment on multi-fam and SFRs are quite different. For SFRs, I am looking for appreciation more than cash flow, and the value of SFR is determined by market price (comps of similar houses and neighborhood etc). For multi-fam, the value is primarily determined by cash flow (value = cashflow / cap rate). Higher the cash flow, higher the value of the property. So my goal as a multi-fam owner is to try to increase cash flow of the property. Correct?

I would love to hear from multi-fam owners in California, what's your expectation of return?

Hi Helen,

As a commercial broker, I would be on the lookout for deals that have below market rents, deferred maintenance, or a slight combination of both. You're always looking for ways to increase your Net Operating Income, which will carry with you if and when the time to upgrade or exit presents itself. You'll find some mis-managed buildings that have a hard time sustaining low vacancy rates, and if you're willing and able to put in the time and effort to turn these around, you may find yourself on the positive side of things.

Rates for multi-family commercial have been pretty low as of late, so you'll have some pretty decent options to look at when you're ready. Here in L.A. I have been putting my buyers into several of these types of deals, that on the pro forma appear to have low cap rates and such, but the underlying numbers, which include below market rent, the need for on-site laundry, etc., gives them more confidence to run the deal with upside potential.

Hope this may offer a little insight as to what you'll be looking at ahead in the future, and I hope you find yourself thriving in your new venture!

-Daniel Sanchez

Great advice here. Only thing I'll add is verify ALL utility expenses with the utility companies. For that matter verify ALL expenses, period.

Medium ccg 4John Casmon, Casmon Capital Group | 937‑361‑8072 | http://casmoncapital.com/podcast

Thank you guys! All very good advise... Encouraging...

Next couple of weeks I am going to talk to some lenders. Would be interested to find out what the lenders have to say about my readiness. Will keep you all posted.

Thank you!

Will do, Joe, find the deal then the lender.

Just a quick update, and answer my own question...

Talked to a 1031 exchange officer at a title company, 2 commercial brokers and a lender (the lender reached out to me hearing from my banker that I am going to buy multi-family property).

The 1031 exchange officer seems very knowledgeable about the process. He walked me through the process and marked the critical timeline for my plan.

The lender is a national bank, and their lending criteria are:

1. 3 yrs tax return

2. 75% LTV

3. 1.25 Debt Service Covering Ratio

4. 3,5,7,10,15 years of loan, max 25 yrs amortization, rate 4-5% depending on terms

5. no reserve requirement (I was surprised to find out)

6. unlimited personal guarantee

7. 1% loan origination fee, could do 0.5% for old customers. 3-4k for appraisal.

So, based on the above general lending criteria, I calculate that my target property has to have at least 6% cap rate to cash flow. This could be a challenge here because the listings I saw are mostly 5%.

The 2 brokers I talked to both acknowledged that I need 6% cap to cashflow. Their advise was to find properties that has under market rents and deferred maintenance / upgrade that will help increase the income of the property to bring the cap rate up to 6-7%.

To answer my own question: YES I am ready! And I am excited to see what's out there for me, and ready to dig into numbers and inspections!

@Joel Owens @Tom V. @Pete T. @Valerie Robinson @Daniel Sanchez

Thank you again for sharing your thoughts and advise. I will see you all soon at BP!

Hi Helen,

Small balance loans require a personal guarantee.

I wouldn't want to give an unlimited personal guarantee where the success of the cash flow depending on future events happening. It has to make sense going in.

That is why many are not buying where they live in California. You can get so much yield elsewhere. If all you are going to get is a 5% cap rate then just go buy a triple net property at a 6 to 7 cap where you do nothing but collect a check and then get 2% annual rent bumps yearly.

Doing a bunch of work to get a property to a 6 cap doesn't get me out of bed in the morning. I think in overheated markets like Cali you are dealing with mini bubbles. First to shoot up fast and first to fall down hard. Other markets the rise and fall tends to be more stable and manageable from a risk perspective.

If you are set on the multifamily yourself locally strategy just be okay with it possibly not turning out as planned. All the best.

Medium allworldrealtyJoel Owens, All World Realty | [email protected] | 678‑779‑2798 | http://www.AWcommercial.com | Podcast Guest on Show #47

Hi Helen, 

I think its great that you are jumping into apartment buildings, I am excited for you! The loan terms you provided seem to be appropriate with what the market is these days. You maybe able to find further flexibility with getting a loan from a small community bank instead of a large lender so I would find a few of those and speak with them.

Many on the forums purchase low performing multifamily (below market rent, deferred maintenance, etc) and adding value to the building and operations. One of the biggest negatives with multifamily is that one bad tenant can be like the plague that pushes good tenants out. Also, be weary of reaching for higher cap rates in California in shady areas as many times these properties face higher turnover. Finally, be careful of the pitfalls of a 1031 exchange. Some get caught in not being able to find or close on the property of their choosing within the 180 day time frame.

Good luck,

Johnson

@Joel Owens Yes, I understand what you were saying. I wasn't too happy after doing the math of what 6% cap will do for me. I am keeping an open mind for out of state opportunities.

@Johnson H. do you own multi-fam in CA or you are still looking? What's your expectation of return here?

Hi Helen,

That is why investors are looking elsewhere to invest for cash flow. Those tight caps there at 5 just do not make any sense. You are doing a gamble play that value add and rent increases will eventually get the asset cash flowing.

If it doesn't you just are trapped in a tax write off property.

Some investors love speculating but I am not one of them. In other states you can land a quality property for an 8 to 8.5 going in or better. Their are other properties throwing off above 10 cap rates but I wouldn't recommend those investing from afar because of intensive management to keep the asset performing.

Medium allworldrealtyJoel Owens, All World Realty | [email protected] | 678‑779‑2798 | http://www.AWcommercial.com | Podcast Guest on Show #47

@Helen Chau - I am in the same boat as you, I have a few SFH that have appreciated and I am looking for my next step. I decided to hold on to my SFH but still purchase an apartment building and I am looking around California. I am looking at about a 7 cap that I can add value on but it is slim pickings.

Hi @Helen Chau ,

I am about 10? or mebe 100? steps behind you and @Johnson H. , I know I need to do something about increasing cashflow but haven't made any decisions about what to move to or if I will try 1031 or cashout refi.

I am slowly gathering info and found @J. Martin numbers that he generously shared on his new Oakland purchase very helpful. IMHO these are "best in class" cashflow for my definition of local.

I was also very interested to also read @Joel Owens cap rate guidance in this thread.

My first major difficulty and where I am stuck is that I know I don't want to invest in a zero appreciation play, so I think this means I have to assess (1)cashflow + (2)forced appreciation available through property/tenant improvement + (3)future appreciation to analytically compare any potential purchases.

I would be interested in how you (and others @Amit M. ) think about this... do you just ignore (3)... or settle on a locale based on (3) and then use (1) and (2) for deal comparison within that locale?

Helen, I was thinking that this appreciation question might be of interest to you too as a fellow CA investor. Apologies if I am wrong.

@Helen Chau  Congratulations on accumulating the equity.  As another investor from Cal I know it is difficult to find deals that make sense.  Rather then putting all of your eggs in one basket, you may consider splitting up your funds and still be able to buy larger properties with a partnership.  In this way you are spreading out your risk to multiple properties/markets.  Connecting with an experienced mf investor could also help you to qualify for the loan. 

If passive investments are of interest to you, most will provide you with a higher return than what you would receive in a 5 cap deal as an active investor.

Full disclosure: We do sponsor syndicated MF purchases.

Medium sig  3 Jeff Greenberg MBA, Synergetic Investment Group, LLC | [email protected] | 805.372.1799 | http://www.synergeticig.com | Podcast Guest on Show #115

I was thinking about getting into apartment as my next move, but now I have to revisit that strategy. My initial motivation was to diversify my assets and consolidating its management. Also there was some "coolness" factor of owning a building as oppose to owning multiple SFR's. But this thread and people I've talked to had talked me out of apartment buildings because of Cali's low caps and limited returns. It makes sense.

Now I just want to be cool maximizing my returns elsewhere (like flipping). I'll follow this thread just to be sure I've made the right decision. Thanks @Helen Chau for starting this thread! Very timely here!

depending on where your SFH's are located, I'd think twice about exchanging them into a multi family bldg. SFH's in general (and usually in CA) appreciate more than MF. So if yours are in decent to good locations, why not refi or get a HELOC and buy another home or two? That could be the best appreciation play, especially if you believe that we have at least a couple of good appreciation years left in this RE cycle.

If that scenario compromises cash flow too much, then getting a CA MF with upside would be another option, as discussed above. If you find the right one on Cali, you will increase it's value by increasing its cash flow with the tenant turnover, renovations, added amenities, etc. that you will perform. Finding an up and coming area, where there is a transition in the tenant base, can yield even better results. But that may be easier to determine/find in more urban areas. Oakland or San Jose are probably good examples. I know less about the Central Valley for gentrification plays. 

I'd opt for one of those scenarios over buying MFA in a fly over state with higher CAP rates. You intrinsically have less knowledge about those communities. And most likely they will not only have less likelyhood of future appreciation, but may not necessarily provide stable income. You really need to learn the location well, to feel comfortable that the nice CAP rates stays that way 3-4 years from now. New buildings going up, competing low priced SFH's, employment stability, etc., etc. all come into play in areas that are easy (and cheap) to build in. And from what I'm hearing, the people above intrinsically know those myriad of factors better in CA than some unspecified location in middle America.

That's my 2c :)