Investing in multifamily properties the right way

15 Replies

So me and my fiancee' purchased a fourplex back in february for about 500,000 as owner occupied. Since purchasing we've completed a number things maintenance etc. including raising rents--Unit 1 $1300 Unit 2 $1300 Unit 3 1100...The plan is to wait another 5 to 6 months and then do a cash out refinance and take that money to purchase another property. Dilemma~ If lenders designate 1 to 4 units as residential and residential properties mainly gain value according to comps and capital improvements, should i not focus on raising rents and decreasing expenses and focus on capital improvements i.e. painting, roofing etc? My plan with this property was to raise rents to market rate and install submeters to have tenants pay for utilities all in all to increase NOI. BUT I've read that increasing NOI in a residential '1 to 4 unit' property doesn't increase equity as it does in a commercial '5 + unit' property. So I'm confused as to what i should do. Its more cost efficient and easier for me to raise rents and install submeters, but if its not going to help why bother. right?

Again my goal is to purchase another 4 unit, but preferably 5 + unit and increase NOI to build equity then refinance and repeat the process. 50 units in 5 determined

It makes a lot of sense to me to focus on a combination of both. Any time you can increase the NOI on an investment property you are going to be in good shape. I would look at the sub metering as an investment and see if the additional money spent justifies the additional income gained on an annual basis.

You are correct though in what you are saying about the valuation process. 1-4 units are residential and are mainly having their value based off of comparable sales. However, that does not mean that an offer is going to come in off of comparable sales. Investors are buying those properties and investors offer at investor pricing. 

Do a combination of both. Increase NOI and make sure your property is comparable to the price point you would like it to appraise for.

@Remone Randolph , I'm not sure exactly what you are asking. My initial answer would be "just buy a 5 unit commercial next time" but I don't think that is the answer you are looking for. Also, 5-unit are pretty rare where I'm at. 

Regardless, maybe you're asking how to purchase your next property which will be a 5-unit. 

(1) Find a 5-unit property where you can have some built in equity. 

(2) Use some form of cash to purchase this property. Whether its from your cash out re-fi from the other property or if its private capital. Doesn't really matter how you purchase it. 

I think the most important thing when taking on 9 units so quickly is to make sure you are not over extending yourself. Are there 9 separate HVAC units for these properties? If so, can you afford to have 9 HVAC units replaced at once? The most common mistake I see here is people over extending, taking the cashflow to pay for personal expenses, and then not actually paying down the assets at an accelerated rate. 

Maybe its a personal thing but my strategy is to buy assets, leverage assets, pay down debt on assets, and then keep them payed off. I'm missing out on some extra income I could potentially make because I'm not staying fully leveraged but I've also got some security that others don't. When the rain comes I will be prepared and be able to keep my properties. Some people will not. 

Ken sorry for the confusion, but yes I when I realized the difference between my four unit and a 5+ unit it made me rethink my plan of getting four units as  owner occupied, wait a year and do cash out  refinancing then repeat.  I'm sure it's still a good plan but the increase in equity with commercial units just seems more promising. 

@Remone Randolph - As an investor, I personally would rather buy 4 units instead of 5 for the simple fact that I can finance with a conventional loan. If I'm going to go commercial, I want a much larger building for the economies of scale to make the less attractive financing terms, and inherent risk, worth it. I think you were right to buy a 4 unit, especially as a live-in.

As far as adding value, my guess is that you are more likely to sell to an investor than not. Investors want NOI, so I would definitely focus on rents if there is immediate upside. That will obviously be good for you too while you own it. Increasing gross rent is never a bad thing.

Improvements are nice too, but all investors really care about is that the building is clean, functional, safe and competitive within the market. The best improvements you can make will be those that increase income, such as adding rentable storage; or reduce operating expenses, such as separating utilities or making efficiency upgrades if you pay for heat/ac.

Thanks Mike I was confused about that and my approach to increase noi make capital improvements. I'm not looking to sell my property anytime soon just build a good amount of equity so I can purchase another property. Appreciate the advice everyone 

Residential or commercial the market drives the property value and rents drive the market. Investors always pay for the income regardless whether it is 3, 4 or 5+ unit This is why we target properties with rents below market. SFHs are driven by home owners everything else is purchased by investors and investors pay according to the income.

How much a investor pays for the income is market specific.

Based on your purchase price and low rents at the time I would guess your area is paying a very high premium for income. Therefor you should concentrate on raising rents although with 1, 2 and 3 now at market you really don't have any where to go..

yes Mike that's a good strategy to go for its all new to me and I'm just trying to find the best route and learn as much as I can. Yes Thomas the property is in the surrounding Seattle area so the market is pretty good right now. The rents were all below market $850, 950,1045,1100 all units 2 bdr 1ba w/garage and private backyard. So I've already increased 2 units to $1300 (section 8) and the other unit is on lease until Nov.30 at which I'll increase that unit also and have all units submetered.

@Remone Randolph So maybe a few thoughts:

1.) You are where you are, you own what you own, so you're probably not going to "lose" if you do things like submetering that will increase your cash-flow the next time you turn over the units.  Neither will raising the rents.  All of this does is just help you rebuild your cash position quicker.  Ironically, similar to refinancing out a proportionally larger amount.

2.) If you don't already, you need to look at terms for commercial loans.  Start staring at a 5-year fixed rate with a balloon payment on a 20 year amortization.  I guarantee you that 30-year fixed rate loan (obviously on a 30 year amortization period) is going to look pretty darn sweet.  For fun, start looking at how a 20 year amortization period would impact the loan terms you have on your $500K property today :-)

3.) When it comes to "value" there are two sides. One is what does the bank think that it's worth. That's based on comps because they package up and resell those loans. Investors, however, value properties based on ROI, cash-flow, NOI, cash-on-cash return, etc. In *most* cases that doesn't help you during a cash-out refinance process but will if/when you want to sell.

All of that said, I don't think it makes any sense to do *unneeded* capital improvements for the sake of a cash-out refinance strategy.  I'm guessing that you live in Auburn so as a Seattle suburb a lot of your value is in the land.  Granite slab countertops don't change the land value.  Neither does a 1 year old roof vs. a 10 year old roof.  The dirt is worth what the dirt is worth.  It's why those properties around Seattle have appreciated so much.  It's that pesky dirt.     

Another possible option, once you've done the improvements, see if you can get a HELOC on the property while you're still occupying it. That may be a way to get out cash without having to go through the expense of a refi. In my experience appraisals are somewhat more relaxed when it comes to a HELOC also, but ymmv.

Wow Andrew you've me advice has my mind more clearer now! Hopefully I'm not sounding "spoiled" as I know I'm in a good position just owning property. But knowing the best route to financial freedom is is very valuable. Thanks 

Yes Richard I've been looking and reading about HELOC's, cash out and equity loans to see what the best option would be to re-invest

I think it is best for you to focus on improving both the rent roll and appearance of the property, new buyers might be interested in house hacking it like yourself and they will be incited by the higher rents. In addition the more appealing the property looks the more people will want to rent and own the property, just don't invest too much into to it that you won't recoup those costs. good luck!

yes Dalton your I'm not trying to invest too much but I am planning on painting the property myself for a cleaner look and save a few thousand dollars!