6 Reasons to Invest in Multifamily Properties

Many people see real estate as a great investment towards building wealth. Unfortunately when most people think of real estate investing, they think of buying and renting single family houses and all the work that goes into managing them, or the huge drop in values in 2008. However, there are many other types of real estate, including multifamily, or apartment, properties. Multifamily properties still provide a place to live, but they are a much stronger investment. Here are six reasons to invest in multifamily properties.

Easy to Understand

To start, multifamily properties are easy to understand. You have probably lived in an apartment or know someone who does. You know that the residents pay rent and maybe other fees for things like pets or covered parking. In exchange for the rent, the property owner maintains the property so it is a nice and safe place to live. It's simple to understand how the property makes money.

It's also simple to understand how the property is valued. A property in a nice area within walking distance to shops and restaurants is usually worth more than a property in a run-down neighborhood. Properties with nicer amenities, like a pool, gym, or granite countertops in the kitchens, are usually worth more than properties without those amenities. The nicer properties are worth more because they attract more residents, which allows them to charge more rent and make more money. Multifamily properties, like other businesses, are valued on the money they make, so the owners have control in increasing income and lowering expenses. Compare that to the stock market where it's often unclear why a certain stock is going up or down on a given day.

Income Generation

Making money is the main goal of investing, but multifamily offers the opportunity to receive an income from your investment. Most multifamily opportunities provide monthly or quarterly distributions, or checks, to the investors from the cash flow, or profit, on the property. Instead of waiting years to get your money back when the property is sold, you can make some money each month or quarter to save, spend, or live off of as your primary income. Compare this to stocks, where you have to sell your stock to get any money from the gains, or invest in one of the few remaining companies that provide meager dividends.

In addition, multifamily properties provide higher cash flows with less risk than single family houses. With multiple residents under one roof, a multifamily property can generate tens of thousands of dollars in cash flow each month. A single family house often only generates a couple hundred dollars a month. If the resident moves out of the house, then it loses money because you still have to pay the mortgage. If a resident moves out of a multifamily property with 50 units, there are still 49 residents paying rent to cover the mortgage and other expenses, and generating cash flow.

Forced Appreciation

Besides the income over the period of the investment, a multifamily property can return a profit at sale. Just like with a single family house, you want to be able to sell the property for more than you bought it. With multifamily properties, you do this by increasing the income and lowering the expenses, which is called forced appreciation.

For every extra dollar you make or extra dollar you don't have to spend, you increase the value of the property by more than a dollar. This happens because the net operating income, which is the income minus expenses, is a percentage, or cap rate, of the value of the property. For example, if the cap rate is 10% and the net operating income is $100,000, then the property would be valued at $100,000/0.10 or $1,000,000. The cap rate is different in every market and changes based on market conditions.

So how does an investor increase income or lower expenses? A common way to increase income is to fix up a property that hasn't been maintained well and has below market rents in order to bring the rents up to market rate, or what similar apartments in the area are charging. A common way to reduce expenses is to charge back utilities to the residents if the owner pays utilities. This forced appreciation helps to increase the value and can reduce the risk of a market correction in which rents in the market stop growing naturally.

Tax Benefits

All this income and appreciation is great, but I hear a lot of people ask "what about taxes?" People with stock investments or who have sold a house are familiar with capital gains taxes, which the government collects from your profits. Multifamily properties can provide a major tax benefit through depreciation. Depreciation is a piece of the tax code that allows businesses to deduct a portion of the initial value of their capital expenses, such as an apartment building, each year over the life of the asset.

For multifamily properties, the life of the building is considered to be 27.5 years, not 27 years or 28 years, but 27.5 years. This means that each year the investor can deduct 1/27.5 or about 3.6% of the value of the building from the passive income. That can be significant for multifamily properties, and it can be even better with cost segregation. Cost segregation is a method of splitting up each major piece of the building, such as the HVAC system, wiring, appliances, and structure, and depreciating them according to the life span of that piece. For many pieces, the life span is significantly less than 27.5 years, so you can receive a larger deduction in the first few years of owning the property.

Of course at sale there are still capital gains taxes to pay. Usually they will be long-term capital gains because the property will be held for more than 12 months, which are taxed at a lower rate than short-term capital gains. But there are still opportunities to eliminate or defer some of the capital gains tax. Some of these gains may be protected by depreciation that is left over from a previous year. With cost segregation, it is common to have more deductions than income, so on paper it looks like you lost money even though you made money. Those extra deductions can't offset your W-2 income, but they do stick around until you have more passive income, including profit from the sale of the property, to offset using the deductions. It is also possible to defer the taxes using something called a 1031 exchange. Ask your tax professional about the details of a 1031 exchange if you want to know more since it's too complicated to cover in this article.

Stability

Multifamily properties have historically performed better than other asset classes. In the recession in 2008, the rate of default of multifamily properties was around 0.4% while single family houses jumped to around 4%. Many multifamily properties continued to cash flow through the recession as people lost their houses and were forced into more affordable apartment housing.

Multifamily real estate also has less volatility than the stock market, which can shoot up one day and crash the next. These properties can provide stable and reliable income so you can sleep soundly at night.

Many trends today point to continued strength in multifamily properties. Many millennials are choosing to rent apartments than to buy a house. Some choose to rent to have the flexibility to move around the country and switch jobs. Others are unable to afford houses due to the rapid increase in home values in recent years and the burden of student debt.

It's not just millennials who are choosing apartments. Many baby boomers are looking to downsize to apartments that provide good amenities, walking distance to restaurants and shops, and an affordable and predictable cost of living. Combined, these generations make up almost half of the population in the US, and present a strong pool of demand for apartments.

Community Improvement

At the end of the day, we're not just here to make money. We also want to give back and make the communities we invest in better places. Multifamily investing gives us the opportunity to improve old properties to make them places the residents want to live in. We can also provide stable jobs for the staff who manage and maintain the properties. Few other investments allow you to make a direct impact on a community in this way.

Summary

These six reasons make multifamily properties great investments, especially when compared to other investments, such as stocks or single family real estate. Although past results do not guarantee future returns, there are many signs pointing to a strong demand for multifamily housing in the years to come. Of course multifamily investing is not risk free, and I encourage you to learn more about it by reading the other articles on this site and reviewing the abundance of podcasts and books on this subject.

I'm not an accountant, attorney, or financial advisor, so please consult with your financial professional about the information above. They will be able to advise you on your particular situation.