Tips for Newbies - Multi-Family Properties

8 Replies

I see so many newbies come on here to BP and say that they want to invest in multies because they are "safer" or "lower risk". I suppose that the general thought process goes something like this: "well, when I have a vacancy, I will still have the other units paying to cover my mortgage". WRONG! What happens when you have multiple vacancies at the same time? Oh, so you don't think that it can or will happen? Ten percent vacancy doesn't necessarily mean that you will always have exactly 10% vacant. It means that you will have an average of 10% vacant. So, if you own a quad for example, there could very well be some months when you have 3 (or maybe even all 4) vacant at the same time and you could still have that 10% average. Then, what happens when you have 2 or 3 vacant AND they leave you with big repair bills and unpaid rent and you have to leave the utilities on while you are getting the units back to rent-ready because it's 10 degrees outside and you don't want the pipes to freeze? Actually, I just recently read a post here on BP where a person had a tri-plex and every one of the units had an eviction at the same time, along with the associated repairs. So do NOT fall into this trap that multis are some how naturally lower-risk investments. Ask me how I know.

Don't get me wrong, I'm not saying that one should never invest in multis. But just don't think that multis are the magic cure to risk.

@Bryan L. this is a timely post. I am in the middle of negotiations on 2 multi-family properties and I am trying to figure out which is the better deal. Maybe you can help. I think they are both good deals. Tell me if I missed something.

Property #1:

· (4) 2 br, 1 1/2 ba, 2 story units

· Purchase price- $90,000

· No immediate renovations needed.

· Rent per unit- $450 (all currently rented)

· Financing- 20 yr fixed @ 5.25% w/ 25% down

See breakdown below:

Purchase Price

$90,000.00

Property Taxes

$1,850.00

Insurance

$1,000.00

Estimated Monthly Rent

$1,800.00

Financing:

Downpayment

$22,500.00

Closing costs

$5,000.00

Renovation costs

$0.00

Cash out of pocket

$27,500.00

Monthly Expenses:

P&I

$454.84

T&I

$237.50

Property mgmt (10% when applicable)

$180.00

Vacancy factor (10%)

$180.00

Maintenance & Repairs (15%)

$270.00

Advertising

$10.00

Total Monthly Expenses

$1,332.34

Monthly Expenses - Debt Service

$877.50

Annual:

Annual Rent

$21,600.00

Annual Expenses

$10,530.00

Annual Expenses (including P&I)

$15,988.08

Net Operating Income (NOI)

$11,070.00

Actual Operating Income

$5,611.92

Cap Rate

12.30%

Cash on Cash Return NOI/C-O-P)

20.41%

Property #2:

· (2) 3 br, 1 ba units

· Purchase Price- $35,000

· Renovations needed- $15,000 (approx.)

· Rent per unit- $500-$550

· Financing- 12 yr fixed @ 7.75% w/30% down

See breakdown below:

Purchase Price

$35,000.00

Property Taxes

$1,000.00

Insurance

$900.00

Estimated Monthly Rent

$1,000.00

Financing:

Downpayment

$10,500.00

Closing costs

$3,000.00

Renovation costs

$12,000.00

Cash out of pocket

$25,500.00

Monthly Expenses:

P&I

Whew, that's a lot for me to digest this early in the morning. Let me just give you a summary. Basically, if your operating cost estimates (not including mortgage) turn out to be less than 50% of your gross rent, then you are possibly estimating too low (I didn't actually do the calculations on your numbers, so I don't know). Also, get independent confirmation on EVERYTHING. Do not trust the sellers or the seller's PM to give you accurate information.

@Bryan L.

Thanks for that advice. I was looking into getting in multi family properties when I got to Tennessee but this makes me take a step back. Not saying I still wont do it, but now I take more time to plan for it instead of wrongly assuming they are safer investments. I do appreciate it.

I think then that the real lesson with multifamily at least when you are getting started is to not overextend yourself. Don't buy that property at the top of your budget. Instead get a property where you can pay the entire mortgage, utilities, taxes, etc. if the property is sitting empty. Also have a good emergency reserve from the beginning, before you even purchase the property.

Also, use a pessimistic outlook when doing your budgeting for maintenance, repairs, etc. It's better to allocate too much than not enough.

I am just getting started in multifamily, but I have already heard from many who are established that you should budget 60% of your gross income to expenses, and then the remaining 40% toward the financing. Whatever you have left is your profit. Using that method, it can be pretty hard to find a good deal.

My experience with multi family properties (not so much duplexes but 4 unit and larger properties) is that there are occasionally negative cash flow events. However, in my experience, these have never been as bad as any of my single family holdings. Typically you still have one roof, one plumbing system etc...

Everytime a SFR goes vacant, it is 100% vacant,...with larger per unit operating costs. Could a duplex go completely dark (100% vacancy)? pretty easy, can a four? Probably but it is less likely. Thats where budgeting comes in. You must must must make reservations of cash flow for vacancy, maintainance items and taxes. Put them in another account if you have to, calculate what your draw is to allow for these items and don't exceed this amount. Plan to leave every dollar that property produces in that account to seed for future events for at least 6-months and you won't get caught flat footed.

Another issue is the need for solid due dilligence. Buy based on sound principles (location, demand, ammenities, employment opportunities) rather than what the most property a given down payment will get. I'd rather save for 2 years than by a dog of a property today.

That being said, is multi family safer or riskier than SFR's? that depends.... From an entry/exit strategy, SFR's have a much broader audience of buyers, are typically easier to liquidate and have more estabilished capital markets to finance. They are typically priced for owner-users and the returns are typcially lower due to higher operating loads. Investment property is valued on cash flow and if you do your homework right, you will be rewarded for your risk.

generally the cash flow is better with multi's

but the exit strategy is much smaller as you can't sell to an O.O. you have to sell to an investor who wants a good deal.

I don't focus on exit strategies as much as others as I'm in to aquire & hold as much as I can so I prefer multi's but have many singles as well.

James Wise, Real Estate Agent in OH (#2015001161)
216-661-6633

I tend to disagree with the exit strategy is smaller theory.

I here this a lot.

My take on it is that many SFR brokers/agents or investors do not heavily work in that space so from the outside looking in it appears there is a limited buyer market for it.

Conversely someone who plays in that space everyday has built the network and knows a ton of buyers for such properties when exiting. The number one mistake is not having your end buyer in mind when buying the property for your exit.

If you know what an investor buyer wants and plans for it then selling down the road is easy with the right network.

Many buyers purchase and have this " Oh crap I overpaid moment due to lack of experience in that asset class " What happens then is when they try to sell they pray for a sucker who will make the same mistake they did and overpay so they can jump off the sinking ship. It's a vicious cycle for many buyers in all asset classes and not just multifamily.

The goal with multifamily for most markets I see is to have a strong cap but with middle market rents in mind. You want what we call the "loyalty factor" in the business. This means the total number of years a tenant stays in the property. Each year you increase rents but stay at the middle of the market which keeps the tenants to stay and reduce turnover which besides paid utility makes up the largest costs. Repairs shouldn't make up the largest expenses unless you didn't inspect properly when buying and didn't plan accordingly.

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