Thinking About Buying a Multifamily? STOP! Wait Until You Read This!

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(The following is an excerpt from the new book from BiggerPockets, The Book on Rental Property Investing. If you are looking to buy more rental properties this year, pick up a copy today!)

It’s no secret that I love multifamily properties.

I talk about them on the Podcast.

I talk about them in books.

I talk about them at local BiggerPockets meetups.

 

But are multifamily properties right for everyone?

No. 

Just because some guy on a blog/podcast/webinar says it’s great DOESN’T mean you should go out and buy one. There are pros and cons to multifamily investing over single family.

Therefore, today I thought I’d give you a quick summary of the pros/cons of multifamily investing to help you decide if it’s the right path for you. But first…

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What is Multifamily Property Investing?

Multifamily properties are buildings with more than one unit.

A multifamily could be as small as two units in a duplex or as big as thousands of units in a large apartment complex. Few people ever buy a multifamily to live in (though I do love the strategy of “house hacking,” where an individual lives in one unit and rents the other units out), but instead, most multifamily properties are owned by real estate investors who rent the properties out to those who can’t — or won’t — buy a single-family home of their own.

Multifamily classification is generally split into two categories: small and large.

  • Small multifamily properties are any properties that contain two, three, or four units.
  • Large multifamily properties, therefore, are those with five or more units.

This is an important distinction because of the way these properties are valued and financed. Smaller multifamily properties are considered “residential” to most lenders and are thus seen as no different from an SFR. Large multifamily, however, is considered commercial real estate, and the rules change drastically.

While the value of a residential property (single family or small multifamily) is determined by what the similar house down the street sold for, value on commercial property is largely determined by comparing the ROI one would achieve with that of other commercial properties down the street. More technically, it is based on the ROI an investor would achieve if they did not use a loan. This is known as a “cap rate,” and every location has a different normal cap rate to compare different properties against.

Related: 6 Reasons to LOVE Multifamily Investments Over Single Family Homes

Let’s talk about the pros and cons of investing in multifamily properties.

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Pros of Multifamily Investing

More Cash Flow Possibilities

If purchased right, multifamily properties have a likelihood of producing positive cash flow from day one. In addition, rents can be increased a small amount for each unit or expenses decreased and the ripple effect of those changes can cause huge increases in cash flow.

One Loan, Multiple Units

Trying to get a loan is a long, arduous process that no one enjoys. But it is a necessary evil for most real estate investors. This is a huge benefit of investing in multifamily properties: there are fewer loans to obtain! If you were to go out and buy 20 SFRs in the next few years, that’s 20 loan applications you’d need to fill out, 20 financial statements you need to prepare, 20 “yeses” you need to hear from the underwriting department. Exhausting, isn’t it? Instead, you can buy a 20-unit apartment building and get just one loan—one application, one set of financials, only one yes.

One Insurance Policy

I hate insurance. I understand the importance of it, but the insurance world is just so cumbersome and frustrating. A good amount of my wife’s administrative time is spent just dealing with insurance. We have boxes and boxes of paperwork with nothing but insurance documents. When you invest in a multifamily property, you have one insurance policy on it. It’s so much easier to keep track of and manage!

Math Over Emotion

When investing in multifamily units, I am able to separate emotion from the transaction much more easily than with a single-family home. Multifamily is all about the math, the numbers!

Business, Not Hobby

Furthermore, it’s much easier to treat multifamily investments as a business rather than a hobby because of the nature of the beast. Multifamily properties are designed for investors to own and management companies to run; thus, the cost of hiring such a management company is often figured into the cost of owning the property, leading to less hands-on-management by you.

Income Valuation

As I mentioned earlier, multifamily units with more than five units are not valued the same way as SFRs. If I were to sell you my single-family home, the appraiser would look at a few other single-family homes that were similar and base their appraisal on the selling price of those other homes. Commercial properties, on the other hand, are valued based on the ROI they give their owners. After all, it’s not easy to compare a 24-unit apartment building with another 24-unit apartment building with the exact same returns because you’ll never find that exact similar property. Commercial investments are just too different from one another.

Instead, we rely on the cap rate to base value on. If these three properties that recently sold gave the owner a 10% ROI, then this one should also. So why is this income valuation so important? Because the value can be changed internally, rather than relying on others, by simply lowering expenses or raising the income. Small changes to the income can make drastic swings to the value of the property, and a savvy investor can use this to their advantage to supercharge the wealth building process.

Less Competition From Homeowners

When shopping for a single-family home, an investor is competing against tens of thousands of others looking for a home. Most of this competition is in the form of non-investors who buy property for way too much money because the front porch is “so cute” or the backyard is “perfect for Fido!” This can make competition much more difficult, because you are playing the game with a different objective! Instead, when you buy multifamily properties, you are competing with other investors, which means there is far less competition.

Okay, multifamily properties sound pretty terrific. So what’s the downside? Let’s find out.

build-wealth-real-estate

Cons of Multifamily Investing

More Expensive

First, multifamily properties typically cost much more to buy than a single-family house. This can be a barrier to entry for many people trying to get started, so multifamily is often not considered until much later in one’s investment career. That said, smaller multifamily properties have some lower down payment financing options, and larger multifamily properties often include raising money from other people.

More Management Intensive

I’ll be the first to admit it, multifamily tenants cause more headaches than single-family tenants. They are generally more “transitional” and thus have much more drama in their lives. Tenants stay for shorter periods of time, which can add significant expense to your bottom line. They call and complain for more petty reasons, have more difficulty paying the rent on time, and tend to be harder on units because they don’t always feel like the place is their real “home.” That said, as I mentioned earlier, multifamily properties are often managed by third parties, so the owner doesn’t need to be very involved in the management drama.

More Savvy Competition

Although there is less competition from homeowners when investing in multifamily properties, the folks you are competing against are far more sophisticated than the average homeowner. They can spot a deal just like you can and generally have a lot more capital with which to buy those deals.

More Complicated

Most people can easily wrap their heads around a single-family investment property, but the more units in a property (and the more expensive that property is), the more complicated it all becomes. Suddenly, you are dealing with 20 moving parts rather than just two or three.

Fewer to Choose From

Depending on where you live, there may be a lack of available multifamily properties from which to choose. While single-family homes are plentiful across the world, multifamily properties may be more sparse in your location.

Government Regulations

Finally, when you invest in multifamily properties and raise money from others to fund it, you enter a whole new world of government regulations that dictate what you can and cannot do while raising that money. If you do it wrong, you might end up wearing an orange jumpsuit and earning $1.38 an hour serving soup to other white-collar inmates.

increase your home value

Related: The Anatomy of an Awesome Offer Package for Your Next Multifamily Deal

So, Should You Invest in Multifamily?

Should you invest in multifamily? Or stick with single family? Or commercial? Or raw land? Or something else?

I wish it were that simple.

I’m not going to be the guy who says, “This is the right path” or “This is the only way to invest!”

There is never one right path, but there may be a right path for you.

My goal is to help you see the pros and cons of each choice and allow you to weigh the options and make the best decision for you and your family. Furthermore, although I believe that focusing on one niche is helpful, it is possible to try to invest in either single family or multifamily and just see which comes up first.

As long as you are willing to do the work and learn to run the numbers on either one, you can pursue both and buy whatever crosses your radar first.

Are you? Let me know in the comments below this post! Why do you want to invest in multifamily? Or why not?  

Remember, your comments will help others who read, so let’s hear your thoughts! 

 

About Author

Brandon Turner

Brandon Turner (G+ | Twitter) spends a lot of time on BiggerPockets.com. Like... seriously... a lot. Oh, and he is also an active real estate investor, entrepreneur, traveler, third-person speaker, husband, and author of "The Book on Investing in Real Estate with No (and Low) Money Down", and "The Book on Rental Property Investing" which you should probably read if you want to do more deals.

27 Comments

    • Roy N.

      Ken:

      Brandon’s “smaller multifamily properties” are really just conjoined wall residential properties (SFH to quadraplex). As such, in both the U.S.A. and Canada they qualify for home ownership programmes {typically an insured, high-ratio mortgage with a smaller (3 – 10%) down payment}.

    • Jay Orlauski

      Ken…typically, smaller multifamily is referring to 1-4 units and large multifamily applies to 5 units or more. 1-4 units can usually be financed with the same type of loan as a SFR, which could include an FHA loan that only requires 3 1/2% down – which is why “lower down payment financing options” may exist for those types. Larger than 4 units typically puts it into the commercial bracket and is no longer considered “residential” and can require 20 – 30% in some cases.

      • Ken Oakeson

        Thank you Roy and Jay,

        I’m looking at 4-plex’s and just always had in my head that it had to be 20-25% down no matter what because it was an investment property. I wasn’t looking at them as a SFR. This little bit of info can be a get in earlier than expected game changer.

      • It has been my experience that if you buy investment property most if not all lenders will require you to put down a minimum of 20%. If however, you are going to owner occupy one side of a duplex, triplex, or fourplex you may be able to avoid the 20% requirement. I think investing in duplexes are one of the easiest and most rewarding options in real estate investing. Building wealth one duplex at a time! Love it.

        • Christopher Devine

          I have 2 SFH properties and have been analyzing and negotiating a fourplex for about 5 days now. This webinar couldn’t have come at a better time. Along the line of financing, every lender I have called or spoke to has said they require a min 25% down. Can you advise of a lender that will accept 20% down on a fourplex?

  1. Richard Guzman on

    Great article – brought the basics home and easy to understand. I like multifamily properties because of the cash flow possibilities. Operating as a business is key like you said and there seems to be less competition as well. Small multifamily units are definitely on my radar in the next 6-12 months and eventually moving to bigger commercial units.

  2. Jay Orlauski

    I broke my teeth on multifamily – I was too inexperienced to know they are for the more seasoned investors. Luckily, I did my homework and it worked out perfect – It was a duplex that I lived on one side of and rented the other – to make it even better , this particular duplex was actually two completely separate houses on the same lot , separated by a fence , each with their own yard and entrance- no one even know it was a duplex cause it looked and felt like house. It was that experience that lead me to the conclusion that multifamily is where it’s at.( at least for me) I have bought and sold a few more since then, but currently living in a triplex that I rent out – it too has separate buildings and I am hoping to buy another multifamily soon. I think my favorite aspect of plexes is that if one tenant doesn’t pay the rent, then you have other rents to fall back on( typically) – but having everything under one roof like one loan , one tax payment, one insurance , etc. has it’s advantages too. Sometimes I get tempted to buy a SFR, but I’ve been too chicken – I would have to obtain and turn it around for under 40K i think before I would want to ‘buy and hold’ a SFR and that’s only if it’s on the good side of town … so it’s unlikely I will be in any SFR’s anytime soon. Great article on multifamiles – definitely things to look out for when going large.

    • Brittany Wallace

      I am leaning towards using a management company for a duplex I would purchase as an owner occupant. I considered managing it myself, but I travel too much to do so.
      It did cross my mind if I should reveal my ownership to the tenant, but it seems like it wouldn’t be in my best interest… Would you ever reveal that to them?

    • James, I just did the exact same thing. I bought a duplex as an owner/occupier with my VA loan.
      The duplex is close to the sidewalk and street and the property goes 300′ back from the road. Given the size of the lot (and lucky zoning) I am looking to build a 3 car garage with a loft apartment to get a third tennant in the loft and charge the current tenants more to use the garage.
      As a fellow service member have you bought other properties with each PCS? This being only my second duty station I am curious about your real estate empire strategy? How you’ve managed properties or decided to buy in a certain area in the first place,
      Ryan

  3. Andrew Syrios

    Great list! The economies of scale is the big advantage with multifamilies. Although, I would probably add liquidity as a con to multifamily too. It’s harder to sell a 10plex than a house usually. Although I guess it’s easier to sell a 10plex than 10 houses.

  4. David Oldenburg

    I’m not a multi-family guy, because I don;t like dealing with tenants or constant issues, even if there is a property manager who handles a lot of this. However, I have seen several people build tremendous cash-flow, and appreciation by investing in multi-family! If this is your thing, you can make a lot of money and build a lot of wealth over time.

  5. Marty True

    Wouldn’t it be better classified as either “Residential” or “Commercial” rather than “small” and “large”? Because a 5-12 unit complex is still considered “small”. And that is the real difference between a 1-4 unit and a 5+ unit… 1-4 unit is considered “Residential” and anything 5+ is considered “Commercial”.

    • Brandon Turner

      Hey Marty, technically yes, but I find that it confuses folks, because some think of commercial as only office buildings, etc. Because a 100 unit property still houses residents, no? So that’s also residential, technically.

      So, I’m redefining the term a bit (because I can! ;)) So I classify it as “small and large” multifamily. Small multifamily typically uses “residential financing” and large multifamily typically uses “commercial financing” – but even that isn’t always the case (because of creative financing.)

      So yeah, I just find it makes more sense to explain it “large and small multifamily” rather than “residential and commercial.” Make sense?

      (Yes… I realize it’s a bit presumptuous to redefine terms that the real estate industry has used for decades. But… I’m a big thinker!)

  6. Richard G.

    I think sometimes putting the 20-25% down on a multifamily unit is better, if you have it, as far as cash flow and numbers because every 1-4 unit I looked at as far as living in one of the units I was either breaking even or in the red BECAUSE I was staying in one of the units AND either zero percent to 3 1/2 percent down so the numbers didn’t quite work. I guess you have to suck it up for 12-24 months living in one of the units before being able to move out — note taken!

  7. Great post.
    My partner and I have our 1st SFH under contract and we’re working on acquiring a 4 plex, taking over payments.
    Very excited, and also a bit nervous.
    The SFH needs a roof and cosmetic work inside along with new appliances. We paid 30. Repairs about 8. Rent will be 1100. A great return once it’s going.
    The 4 unit needs some work. Seller is holding the note. Once it’s fully rented, we will cash flow close to 800.

  8. Mohammad (Asad) Asaduddin

    Having self managed 17 rental houses for some time, the idea of hiring a property manager for multifamily is very enticing. I think about a 100+ is more fruitful for a real professional manager. That is why I am trying to make big jump from SFR to large multifamily. I welcome advice on how to prepare from the more seasoned entrepreneurs.

    • Len Grosso

      Wow 17 separate rentals must be a handful. I had 9 rentals and that was a handful.
      A 100+ unit complex is the way to go as far as I’m concerned esp if you intend to have income for a long time. At that point professional management becomes practical and pays for itself. It also gives the owner breathing time.
      Clearly the cost of many units and fewer roofs (etc) is less than the same number of single family dwellings yet the rents are not as far apart. That gives us an asymmetry to use for our benefit.
      For me, the way to get started is to team up with several other investors and a pro team to complete the deals. This way you get to own fractions of many.

  9. Andrew Hansinger

    Question on raising funds and the order in which you do things: I feel like I need to be pre-approved before looking for multi-family units so I know whats in my price range. But… I may also be seeking some capital from private money lenders for the down payment, however, I would only feel comfortable going to these could-be investors if I have a deal and show them the numbers. If I do get their support, my pre-approval is no longer valid, right? Because now i have the ability to purchase beyond what I would have been approved for?

    My question is, in which order should I be completing these steps? How can I make an offer on a home without being pre-approved and how can I ensure I have the funds for the down payment (before pre-approval) without having an offer accepted on a home?

    • Joel Florek

      So the process I am going with on a 16 unit I am trying to buy right now is as follows

      Step 1 analyze the deal. I have met with the owners and presented my story very honestly. I am young, do not have my own capital, but know a number of investors who are interested in these deals and have the capital needed. I need the numbers to present before the investors are willing to get serious.

      Step 2 is to find a serious investor based the characteristics of the deal and the numbers.

      Step 3 is to get pre-approved from the bank under terms that make the deal favorable. (this meeting is happening today for me)

      Step 4 is to agree with my investor on a purchase price based on the banks response and make an offer.

      Step 5, negotiate

      Step 6 close the deal.

  10. Sanjay A.

    Great article. I started by investing as a passive investor in a 100+ units and offered my help wherever I can for free… that helped me learn it first hand!! Anything less than 80 is very difficult to manage yourself… unless you have seen it managed or have some experience, you can’t mange it and be very careful about taking on managing yourself.

    Andrew – Lot of the brokers won’t talk any further unless you have proven financing. One of the key aspect of financing is that in addition to down payment, most banks will require combined net worth of investors be equal to or greater than what you are borrowing. I have seen deals where someone was added to deal just to bring up the net worth up…. So you really need to line up financing first and figure out what can you afford (including your other investors) and then look for deals.

    I am happy to answer more questions and help find deals in DFW area… feel free to reach out.

  11. Joel Florek

    Great article. This is some of the things I have been trying to explain to other young investors who I have been close friends with. I struggle with the idea of buying SFR’s and cash flowing $200 a month out of the gate with traditional financing of 20% down. While there are opportunities for appreciation I would rather flip SFR’s as a way to build up some cash.

    As a current owner of a 4plex I love being able to renovate a unit and only having 25% vacancy while I do it and all expenses are still paid for. Vacancy is something that is put into the plan with the numbers and I do not fear those months of vacancy as long as I don’t go over plan because income is still coming in during those months unlike a SFR.

    I also love how larger multi family properties have significant maintenance budgets available to deal with expensive problems every year. For the $70 to $100 monthly maintenance budget that so many SFR’s have the budget would barely touch what is needed to replace flooring, broken windows, appliances or bigger ticket items like HVAC and water heaters. One item over $800 or $1000 and the entire years budget is gone in an instance. That can happen with one emergency call to the plumber or HVAC tech and get worse from there.

    Most importantly, as the article stated, I love that multi’s are all about the numbers. Increase revenue and decrease expenses. You can build a prudently managed business and put checks in your pocket right out of the gate if you buy and structure your deal right. I’m in the process of trying to close a 16 unit complex and cant wait. Its also one significant purchase that requires only one eye to watch over that over time builds a significant equity position in your portfolio.

  12. Chris Harrington

    Great article – Thanks! I too cut my teeth on multifamily. First deal was a 23 unit found in the classifieds in a less than stellar part of town. Boy were we naive. 8 years later and many, many bruises, we have 66 units across 4 buildings having bought and sold many more using 1031 exchanges to grow bigger. Goal is to have 100+ within 18 months.

    For me multifamily is the way to go – I like all of my headaches in one convenient location! Seriously though, with 66 units I can raise the rent %5 and my cashflow explodes. I can’t imagine the hassle of dealing with a SHF.

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