There are tons of articles, courses, bootcamps, and forum posts related to flipping single family homes both on BiggerPockets and all sorts of other websites. For many people it makes complete sense.
Most families want to live the American Dream. They want to buy a 3BR/2BA house (or 5BR/6BA McMansion) in a beautiful neighborhood, move in with their 2.3 kids (average for statistical purposes – I am not advocating having 0.3 of a kid), and gradually pay off their mortgage (or walk away from the house when they get tired of paying).
With such a big market for single family homes, it is natural for all the rehabbers and flippers out there to cater to this large demographic.
But let me propose an alternative. In today’s economy, it seems like fewer and fewer people (although there are still a lot of them out there) are interested in ‘the American Dream’. I think there are a couple of reasons for this:
- Many people have been burned in the past couple of years by buying homes that proceeded to sink in value dramatically
- People have a hard time believing a home is their ‘best investment’ and are starting to see primary residences as liabilities more than assets
- The work force is becoming much more mobile thanks to technology. They like the flexibility of renting
- Younger workers have ever-increasing college debt loads that make them uneasy about taking on more debt like mortgages
Admittedly many of these observations are my own personal viewpoint from reading the news, but I am seeing it in my rental business and talking to friends and co-workers as well.
These same reasons though, provide a great market for people to buy residential multifamily properties.
How to Estimate Rehab Costs!
Estimating rehab costs accurately can make or break your real estate business, and it takes years of experience for even the best rehabbers to master the art. However, you can expose yourself to less risk and get more accurate with your projections by learning how the pros think when estimating construction costs.
Why Flip Small Multifamily Properties
If there are a lot of potential buyers, doesn’t it make sense to become a seller?
Most of my purchases, for both flips and longer-term rental properties, have been multifamily residential units – from duplexes to 4-plexes. I do not have any experience in commercial multifamily properties, and this article is not meant to include apartment buildings. Nor am I saying that the multifamily residential properties are the ‘cat’s meow’ (hat tip to Brandon the ‘Cat Man’) and the only type of property to flip.
But I have made a lot of money flipping several duplexes, and also renting duplexes, triplexes and 4-plexes.
Let me explain why I think these properties are so great to rehab and flip:
1. Exit Strategy
Experienced single family rehabbers and flippers will tell you to always plan your exit strategy well. That’s great advice. Part of that strategy is to determine the ARV or ‘After-Repaired Value’. You need to know what you can sell the place for fully-fixed up in order to figure out a good offer price and rehab budget that ensures you make money.
But they also ask – ‘What if I’m wrong on what I can sell it for?’
Say the market takes a dive, or your rehab budget increases due to some unforeseen large repair? The good gurus (and many other experienced flippers) will tell you to have an alternative exit plan – i.e – be able to rent it out if it doesn’t sell.
With single family homes, many times the rent will barely cover the mortgage payment, including insurance and taxes. Any maintenance items and you might be losing money for that month. You certainly are not making much money.
Residential multifamily properties, on the other hand, can be cash cows. Often you can cover the mortgage payments with rent from one or two units and receive pure profit from the other units. If your multifamily flip doesn’t sell, it certainly won’t break your heart. Rent it out and make some money!
When I flip a duplex, I will put a renter in one unit. That way the buyer won’t have to find a renter and can start receiving rent as soon as they buy the unit.
But there is another advantage to putting a renter in all units but one. Having at least one renter in the building will help defray the mortgage payment for you the rehabber while you are waiting for the property to sell. With a single family flip, the building has to stay empty while it is on the market – and the flipper has to make the entire mortgage payment.
Many areas are seeing a rise in rental rates. The foreclosure crisis has turned tons of people from homeowners to renters. This can make it more difficult on single family flippers. Their market has shrunk over the past couple of years due to the fewer and fewer people who can qualify for a mortgage.
But higher rents mean higher selling prices for investment properties. This is the main contributing factor for commercial multifamily, but it is also a very attractive portion of selling residential multifamily properties.
Single family buyers are not going to pay more because rents are higher in a particular area, but duplex to 4-plex buyers will.
I also hear about flippers trying to sell their homes by advertising monthly payments instead of sales price – like car dealers.
‘Move into your new home for 3.5% down and just $997 per month’
What if you could say:
‘Move into your new home for 3.5% down and $100/month’? Or ‘$0 per month’?
Think the second place might sell faster? I would rather buy those terms than a single family. There are many adventurous souls out there who would be fine with doing a little property management in exchange for having the tenants pay their mortgage.
There are lots of opportunities for buying a residential, multifamily property, rehab it, and sell it to an owner occupant for a price that allows that buyer to live practically mortgage payment free.
3. Residential Financing
Buying and selling commercial multifamily properties involves using commercial financing. From what I understand, commercial financing involves
- Commercial lending rates that are higher than residential
- Higher closing costs and fees than residential
- Higher down payments and possible requirements for equity partners due to higher purchase prices
- Fewer government backed programs to encourage ownership
The government wants to help Joe and Sally Homeowner – the don’t give a hoot about ‘The Donald’. So they have all sorts of programs such as FHA loans, VA loans, HUD sales, HARP programs etc. to encourage people to get into home ownership.
Guess what? All those programs also apply to single family homes AND buildings with up to 4 units. So either a flipper or an end buyer can have all the advantages of a commercial property – better cash flow, spreading risk over multiple units etc. but also keep the advantages, and lower costs of a residential property.
4. Market to Investors AND Homeowners
Once you rehab a residential multifamily property, you can market it to both homeowners and investors. This can create a larger market and potentially drive the price up.
Many successful investors started their careers by buying a duplex, living in one half and renting out the other half. The building allowed them to:
- Save money for their next investment because their tenant was paying their mortgage.
- Introduce them to property management in a very simple manner because their rental was about as close as it could get to their home.
Even is someone doesn’t want to become a real estate tycoon, they like the idea of living rent-free or almost rent-free. In these days where everyone is trying to cut back, a residential multifamily will seem like a great option.
On the other hand, it is possible to sell a fully-rehabbed multifamily to an investor for a healthy profit, and still provide the investor with a nice monthly cash flow. Buying a fully-rehabbed property with cash flow from Day 1 can be very attractive to many investors, especially ones that don’t have a lot of experience with rehabbing.
5. Tax Advantages
Please Note – I am not a tax professional and this should not be construed as tax advice
Buyers of multifamily residential properties, especially buyers who live in one unit, can take advantage of both homeowner and investor tax deductions.
Although the person who lives in their multifamily cannot take depreciation for the entire building, they can take a portion of the depreciation depending on how many units there are. They can also take a portion of the expenses as deductions.
The buyers also receive the mortgage deduction and all other deductions that a home owner receives, including having a portion of proceeds from the sale being tax free.
In addition to the buyers, there is also a good tax incentive for flippers who buy multifamily residential. I have actually rehabbed some of these properties and held them for a year. I rent out all units in the building and then ‘encourage’ one of the tenants to move out at the end of the year. This is normally pretty easy because I buy most of mine near a local university so the tenants don’t stay more than a year in many circumstances.
Then I sell the property.
By doing this, I have several advantages over a traditional flip:
- I receive a year’s worth of cash flow, adding to my profits
- It allows me to spread the rehab over a longer period of time, to make sure I get all the ‘kinks’ out. I also don’t need to have all the rehab money up front.
- I can sell after a year and receive the long term capital gains tax rate, which is a lot better than the regular rate most flippers must pay
As both the real estate and rental markets continue to improve, duplexes through 4-plexes can take advantage of both types of investing – rentals and flips. The tried and true advice of always trying to find the best deal still applies, but these kinds of multifamily investments may be a great way to increase your profits.
What do you think? Have you ever flipped a small multifamily property? Share your comments or questions below!
Photo: simple pleasure