Questions about multi-family investment

12 Replies

Hello, fellow investors. I have several single-family rental properties and I am in the process to buy my first multi-family property. I am looking for small apartment with 5-20 units (also interested in mobile home park). I have several questions I hope you experienced investors can help me with.

1. Is now the right time to invest in small apartment? I know multi-families are hot and the cap rate has been decreasing in the past few years. Is the price too high right now and thus not a good time to enter market? What stage in the cycle is multi-family at?

2. I will invest out of state. Where can I still find properties with reasonable cap rate (8%?) and cash flow? I am doing research for Tampa/St. Petersburg and Triangle area in NC. I am looking for areas with strong job opportunity and growth potential and where multi-family has not yet peak. 

Thank you very much in advanced for your response! 


Chase

@Chase Gu , You can still find deals in multifamily, especially in that unit range. The biggest problem with that range is finding a good property manager. 

As for what stage of the cycle we're in, no one can tell you with certainty. People said to sell off in 2014. They've been saying it every year since. There's also evidence that we're no where near the top. I was at Joe Fairless' conference in Denver last week, and they had an hour long heated debate on where we are in the cycle. No one knows. 

If you plan on holding forever, just buy right (cash flow now, long term financing, don't max out LTV, cash reserves) and don't try to predict the market, you'll go crazy trying to.

Areas with 8 caps can be found all over. I can find a 20 unit with an 8 cap here in the Phoenix area. If it's your first multifamily, and only 20 units, consider buying close to home. As you go larger, you can move further out. The larger properties can practically run themselves. The smaller ones, not so much. Also, the cash flow of the larger ones can justify your expenses to visit it. On a 20 unit, it's hard to justify flight/hotel to see your property, which are the ones you'll need to visit more often. 

@Chase Gu there's opportunities in every cycle of the market. The problem is most investors won't work hard enough to find them and end up doing bad deals just to get in the game.

I'd be very very leery about trying to invest in out of state, small mfam. The problem is you don't know what you don't know.

Careful about "8 cap" deals right now. The solid deals are typically trading for a lower cap and many investors are buying low c or worse at an 8 cap simply because they don't know better.

Happy Hunting

@Chase Gu - you can’t find a deal if you aren’t looking. It could take a considerable amount of time to find a good deal but doesn’t mean they don’t exist. 

The old rules no longer hold water the way they once did. This low interest rate environment means investors are accepting lower cap rates.

The most important factor to me is cash flow. Does the property produce a positive cash flow? If it does you can afford to hang onto it and you will end up OK. 

If you buy with negative cash flow expecting inflation to bail you out you are asking for trouble. I know there are areas where you have not been able to get positive cash flow in years, and that people have made money there. But the odds are against it.

If you went by this rule you would be buying with confidence at the bottom of the cycle and backing off when prices get nuts. You might miss out on the last 2 or 3 years of a boom but you won't get burned.

Will add that we seem to be entering a period of rising interest rates which means it is to your advantage to lock in your mortgage for as long as possible.

@Chase Gu . There are always deals to be made. You just need to know your numbers and keep using creative approaches to find these deals. And sometimes, the best deal is the one you don't make. 

In addition, nobody can predict the market. Nobody knows when the next economic downturn will come. And even when it comes, we don't know how it will impact real estate investment. The key thing is to make sure to underwrite very conservatively and focus on cashflow. Appreciation would be the cherry on top. 

Happy investing.

@Chase Gu So I'll just give you my thoughts:

1.) If you haven't explore financing or don't know the debt terms for commercial loans, learn them.  They will impact your cash-flow and (potentially) not to a small degree.

2.) Setting arbitrary cap-rate goals is dangerous.  I'll be overly general and say that has cap-rate goes up, desirability goes down.  Since it's your first commercial multifamily deal and you're looking out-of-state you're more likely to rationalize a "D" being a "C" property in the search for yield.

3.) From everything I know (and what I would do) RTP is a very desirable market.  The odds of you finding a good asset, that is an 8-cap, in that market, today, is probably going to be very, very low.  Which goes back to the 2.) about rationalizing the wrong purchase.  I don't know a thing about Tampa.

4.) I'm in the same 5-20 unit space and they are typically owned by "average" folks like me.  We're savvy enough to know what we have but (where I invest) you do find some owners selling in this size range because they want to use the funds for development deals, diversify, etc.  But if owners like me have a portfolio and are selling one piece of it today, it's not our "best" piece.  

5.) I would happily buy right now in the market that I'm in.  The prices have increased but I'm in it for the 30+ year timeframe.  So I can handle those ebbs and flows along the way because of my time horizon.  I don't know if I'd be as wild about buying today if I had a +/- 5 year horizon.  I don't think a crash is around the corner, looming, etc. but I wouldn't want a time in the future where I had a forced exit.  

6.) @Sam Grooms is right on the money when he talks about 2014.  That year and every single year since people have said the market is overheated.  It's the same with the stock market.  It was overheated back at 17K to a lot of people.  Now, even after the pullback, it's at 25K.  I'm guessing people that pulled a ton of cash off of the table in the stock market are about as happy as people that didn't buy in 2014. :-)

7.) Since you're buying out-of-state you should consider a trade-off.  Look for a 6-cap in a market you believe in with a property that's a little bit nicer.  As other have pointed out, finding good management is a risk.  But it's less challenging to manage a "decent" property than a "rough" property.  And there are plenty of successful managers that just won't touch those rougher properties.  So your quest for an 8-cap might lead you down the road of ending up with a management company that takes the deal because they need the revenue.  It can go downhill from there.

Side note, I'm not saying to literally "not look for an 8-cap" or literally to "go after a 6-cap" but rather to be flexible and not let an arbitrary metric like cap-rate, CoC return, etc. be the sole deciding factor on if you should buy. It's still a hot market so if you find the "unsold 8-cap that is surrounded by 5-caps" I'd be very, very, VERY cautious.

Or just buy on cap-rate only, makes no difference to me :-)

Thanks for your response, everyone! 

I only buy property with positive cash flow and I do my best to be conservative in my assumptions. And I am flexible with cap rate as long as the cash flow makes sense. 

A few follow-up questions:

For a budget around $1M (property value), is 5-20 door a reasonable expectation? Which is better - one small apartment or 3-4 triplex (residential)?

@Sam Grooms @Ivan Barratt   I agree with you that out of state investment in small mfam might not be a good choice. However, I do not find small mfam deals in metro DC area. It is possible (but difficult) to find some deals within 1.5-2 hours of driving. But I still need a property manager. What would you do in my situation? 

What criteria do you use to evaluate a small mfam deal besides cap rate? Cash flow per door? If so, what is a good cash flow per door? I know it is different by market, but is there a good rule of thumb? 

Also what conservative assumptions you use to evaluate a deal (initial screening)? For single family property, I assume one month vacancy and 40% expense (I self-manage) and I look for 150-200 per month after mortgage (Again this is in DC metro). For small mfam, what assumptions do you use? 

A few responses mentioned one needs to work hard to look for deals. That is what I am doing - not sure if it is enough though. I am meeting people from my local REIA. I researched top producing agent/wholesaler in my target market and talked with them and try to build long-term relationship, and also ask for referral. I know it takes time to build relationship - especially for a first time small mfam buyer. Anything else should I do to look for deals? @Henri Meli What creative approaches do you use to find deals?

Again, thank you so much! I know I have too many questions!

@Chase Gu I am not a fan of the mom and pop investor doing it all yourself. You have blind spots and just one person. Plus so much money in one deal.

You other question is pretty broad. Let me know if you want to chat. For what I understand you live in a primary market and cashflow is typically hard to come by.

@Chase Gu

It's all about buying right at every point in the cycle.  Rates are going up, so I assume cap rates should follow.  You need to build rapport with brokers and start to source deals through them.  The deals on line have already been looked through and are very hard to find.

Look in areas of TN, Kentucky, parts on North and South Carolina.

The naysayers will always say it is never the right time. 2008-2010, the economy was horrible and you couldn't get financing. 2010-2015, economy and overall mood of the market was not appealing. Now the market is hot and cap rates are low.

Focus on deals that have value add potential and buy on actual numbers.

Gino

@Chase Gu . A few ways is to become more creative in finding deals could include:

Do some research and become focus on a very particular market (s).

Explore the market in and out.  Know the best streets, the not so good areas, know rent prices, ... etc.

Reach out to owners directly. See if you have any type of common things with them. (Alumni, interests, have you done business with someone they might know...) etc. Brokers (call them: you could find them on loopnet for example, introduce yourself, tell them what you looking for, build rapport with them), and build good relationships. It could take time for relationships to nurture properly.

Network with other investors in your area of interest. Offer them insight into your local market in return for example. See if you can participate in deals.

Joe shared lots of good tips during the Best Ever Conference in Denver.

Be patient.

Originally posted by @Chase Gu :

Hello, fellow investors. I have several single-family rental properties and I am in the process to buy my first multi-family property. I am looking for small apartment with 5-20 units (also interested in mobile home park). I have several questions I hope you experienced investors can help me with.

1. Is now the right time to invest in small apartment? I know multi-families are hot and the cap rate has been decreasing in the past few years. Is the price too high right now and thus not a good time to enter market? What stage in the cycle is multi-family at?

2. I will invest out of state. Where can I still find properties with reasonable cap rate (8%?) and cash flow? I am doing research for Tampa/St. Petersburg and Triangle area in NC. I am looking for areas with strong job opportunity and growth potential and where multi-family has not yet peak. 

Thank you very much in advanced for your response! 


Chase

As my buddy @Gino Barbaro knows (since we talk about this once/month), I am a bit more bearish than he is. It's my nature.  So take what I say with a grain of salt.

Usually the top of the market draws in a lot of new investors.  They have been watching people profit for years, and they finally feel it's safe to put a toe in the water.  They think it's safe now because they have been watching people making money for a long time.  Seems like a good time.

But the people taking profits now are the ones who purchased when other people were afraid to buy.  Back in the period from 2009-2013.  Back before Bigger Pockets took over the world.

The people buying now who will be okay are the seasoned investors like Gino who understand how to weigh the risks and are investing for the long run.  Gino expects ups and downs and is preparing for them accordingly. so his investments will be alright.

The danger is for people who believe that real estate always goes up and that will make it all okay.  Perhaps you are right that, in the long run, real estate goes up over time.  But that does not mean that it goes up ALL the time.  The upward slanting line is not straight and smooth.

There are two risks that you need to prepare for if you are investing right now.

The first risk is the end of the real estate cycle.  Given that cap rates are at historic lows, that the bull market in property is one of the longest in history, that completions are at a 30-year high, and that inflation (and higher interest rates) may be on the way, suggests that the cycle has mostly run its course.  Does it have a little room left to run?  Probably.  Does it have a lot of room left to run?  Probably not.

This first risk you can deal with if you invest in cash flowing properties with a lot of margin of safety.  You can look at a cap rate as an indicator of your margin of safety.  The lower the cap rate, the lower the margin of safety, so if you are buying at low cap rates you need to be sure that the deal is commensurately low-risk.  Right now, I am not sure that the cap rates are commensurate with the inherent risk.  However, if your properties are cash flowing, then a rise in cap rates after you buy will not affect you.  You will lose money on paper, but as long as you do not have to sell or refinance while cap rates are still high, you will be fine.  The key here is to lock in long-term debt at fixed rates.  If you have a strong margin of safety then you will continue to make your debt service and the temporary fluctuation in cap rates won't harm you.  You just  wait until the next period of cap rate compression to sell or refinance.

The second risk is harder to deal with.  That is the risk of recession.  People are saying the risk is low, because we are at full employment.  However, the risk of recession is highest at full employment, because that is when wages rise, the Fed starts to worry about inflation, and it raises interest rates, which causes the economy to contract.

While inflation is good for rents, economic downturns are not.  Vacancy will spike in a recession, and the way that our economy has changed, it means that unemployment (and vacancy) will spike disproportionately among C-class renters. 

This is a danger because, if you are buying a property at a very high price relative to NOI (i.e., a low cap rate), you are locking in a very high level of debt service. The higher vacancy rises, the more difficult it will become to meet your debt service. The owners who lost properties in the Great Recession did so because they loaded up with debt and, when vacancy spiked with unemployment, they could not make their debt service. The fact that cap rates rose had nothing to do with it.

It's said that rental property does well in a recession, but that is not technically true.  During the recession, vacancy spiked.  AFTER the recession, when many people lost their homes, they moved into rentals and rentals did very well.  That won't happen again, because we won't see a foreclosure crisis next time of the magnitude we saw last time.  The people who lose their jobs in the next recession will take a long time to find new ones, and they won't be replaced by displaced homeowners who still had jobs (by definition they had jobs, or landlords would not have rented to them).

So, if you are buying now, you need to make doubly sure that the property can withstand a large spike in vacancy for several months if there is a recession.  There is very little room for error right now.  Very little margin of safety.

How about investing in Cincinnati, OH?

I can give you leads over there.

Send me direct message.

Create Lasting Wealth Through Real Estate

Join the millions of people achieving financial freedom through the power of real estate investing

Start here