Why are people building multifamilies?

8 Replies

Being new to the REI world, I've been searching solely for existing multifamily properties. But with new multifamilies properties being constructed like crazy in my area (Ohio), I cant help but wonder; why? Traditionally, isn't there more ROI in purchasing existing multifamilies rather than constructing new ones? With the demand in construction services across the industry (businesses, single families, multifamilies, etc) being so high, how are people that're investing in new multi-families making money?

-Josh 

@Josh Huber - many of the new construction developers I know of do not build to hold, they build to sell to an investor. The CAP rates one new construction are much lower and a lot of times builders will offer move-in specials to get higher rents than the market will support (ex. 3 months "free" rent at 1.25x market rate). This makes their pro-forma numbers look better on the exit.

In addition to this, there are lots of incentives for new development (tax credits, grants, TIF funds, etc.), so depending on the project there could be some degree of subsidization.

ROI does not take into account time/effort. I would rather get a lower ROI on brand new construction than a higher ROI on apartments built in the 60's. You'll have a much different tenant base (think collection rates, vacancy rates, damages, etc.) and a much different expense profile. Different investors have different risk/reward profiles and that's what drives the whole range of the market. The guy buying $20K SFR's in the hood has very little in common with the private equity group buying 300+ unit new construction communities, other than they're both investing in RE.

I am working on two flips right now that will be very small multi-units (2 units each). I converted an SFR into a duplex before too. Why? "Highest and best use" - I am adding value to properties in modest cost areas and forcing the price higher by doing so. Tons of reasons why these little places are popular with buyers... additional income, a place for Mom, a place for that kid that just came back home, Airbnb with a little privacy... I'm really going to try to add an additional dwelling unit to every flip I do going forward.

Something my father taught me about new construction is the logical design of their build to serve a specific purpose, such as buy/hold apartments. Whereas older housing stock can be more difficult to renovate - especially when it once was a large single family that has been spliced into apartments.

If I was to build a Multi-Family property from the ground up, I could control the lay out of the units, where the housing systems were located and their path to and from the basement, I could construct panels to access shower fixtures etc. The infrastructure would be brand new and to my liking. I could also tailor my building for highest and best use in my market area, such as capitalizing on an under supply of 1 bed or 2 bed apartments. 

Reasons such as that has made me a little more exploratory on building my next MF, I happen to have a nice piece of land picked out :) 

I think @Michael Seeker has a great point too about the profile of the investor(s). REIT's and institutional investors will happily take very low cap rates for safety of protecting their capital and ease of management. 

I hope that helps!

Jon

they are getting built cause it pencils out financially but we will overbuild the class as it happens every time we are in this section of the re cycle. Hyper supply followed by increasing vacancies and downward pressure on rents. What i would like to know is how increasing vacancies in a class A apts effects b and c properties.

Also have to remember we are in year 10 of artificially low interest rates, and this financial engineering is INTENDED to rev the stock market and inflate asset values.

And the next logical question is what happens as interest rates go up?

All - Thank you for the insight. 

@Michael Seeker - Your logic makes a lot of sense to me. I've never considered that development strategy before. I appreciate the explination. 

@Teri S. - I should clarify. I'm referencing brand new development. Not BRRRR (buy, rehab, rent) properties. Personally, I see BRRRR as the best method of investing in REI (I'm sure this can be heavily argued). Also, congratulations on your two flips!

@Jonathan Child - Like @Michael Seeker's post, you've provided insight into areas I've never considered. If interested, I'd be interested in hearing about your greatest success story using this strategy. 

@Anthony Gayden - I agree that it makes sense that more multi-families need built. My interest is in how investors obtain descent ROI with the cost of developing new multifamily properties being so much higher than simply buying existing properties.

@Will Grabert - A lot of great points. I'd have interest in hearing theories from other investors as well. 

Time is money, and new construction is often faster than "deep" renovation. We are seeing new construction multi-family's costing $225/SF, completing in 6-8 months. Whereas, renovation projects are costing $150/SF, but taking a year or more. 

In this market, shaving 6 months to market can mean a lot for investor payback, potentially millions to a developer.

Clearly, scale is a factor, as is region as it is directly proportional to low cost labor pools, and/or low cost material sources.

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