If you are thinking about getting into real estate investing, one strategy well worth considering is multi-family investing. This refers to the practice of buying multi-family properties, such as townhouses and apartment buildings in which the units can be rented out individually. A popular way to increase revenue streams, reduce vacancy rates and boost your net-operating income. Such a strategy also comes with high overhead costs making it a costly sector.
Today’s article examines this investment strategy, discussing how it works, the pros and cons, and how you can get started with this exciting venture.
What is Multifamily Investing?
Multi-family investing differs a great deal from single-family investing. Instead of buying a single unit that you can rent out, you will be purchasing an entire townhouse or apartment building. The obvious advantage is it allows you to create multiple income streams while also building consistent appreciation in value. You can even choose to live in one of the units and use your income stream from the rental units to reduce or even eliminate your housing costs.
But with all that space comes the extra responsibility and overhead to maintain it. The sheer cost of buying a multi-family property can also make it highly cost-prohibitive for beginner investors. The property management needs can make it a big undertaking that one needs to be fully prepared for.
Of course, that’s not to say that every multi-family investment has to be an entire building with a dozen or more units. For beginners, you can do just as well with a two-family townhouse. You live in one unit while your tenant lives in the other. From there, you can expand your investments further and maybe even make it a full-time job. However, keep in mind that whatever the size of your project, there will be a time lag until it starts generating income. There are also taxes to think about and repairs to make before you start getting any returns.
Buying a Multi-family home For Your Investment
So, with all the above in mind, how should you go about finding a good multi-family investment?
1. Look for specific factors during the property search
As with every property investment, the key thing to look at is its location, a good location – meaning an area that is either developed or developing – is where the best investments are found. This will be an area seeing new construction going up, rising property prices, and plenty of neighborhood amenities and conveniences. Remember, identifying areas like this that still have great growth potential is almost an art as it is a science.
Another key factor to consider will be the size and layout of the property. Look past your perspective; think about what prospective tenants may want and need. For instance, amenities such as laundry rooms and extra storage space tend to be high on the list in City settings. It might also be best to stay clear of properties that have been heavily custom-built to a certain style by the previous owners. Highly unique styles may not appeal to many renters, making resales problematic. This can, of course, be rectified with a renovation if your budget allows it.
Next, you’ll want to gather a massive amount of detail on the neighborhood’s rental market. That way, you can more accurately measure your expected cap rate. To do this, you’ll need the help of industry experts that know the area well. For instance, real estate agents, contractors, architects, and anyone else knows the neighborhood and its history over the last several years.
2. Watch out for red flags
Depending on your plans for the property, there may be several red flags that you’ll want to keep an eye out for. Structural damage would be a big one that even investors with the deepest pockets will think twice about. Start by getting a general home inspection of the property. If they detect any possible issues, you may want to bring in a specialist for a closer look. The key is to know what you’re buying and what the potential costs of fixing it up might be.
That said, if you have a sizeable budget and are already planning to do a gut remodel, then you may not be too concerned with minor issues. Significant problems that should cause concern for any investor to include:
- Foundation issues
- Roof problems
- Excessive noise pollution
- A troubled ownership history with rapid turnover
- No permits for work done
- Open permits for work done or violations
- Being in a flood zone
3. Consider the Floor Area Ratio
Another major consideration will be the floor area ratio (FAR) when viewing different properties. This is the relationship between the total amount of usable floor area that a building has or has been permitted to have and the total area of the lot on which the building stands. A valuable metric for determining how much space you have to work with when extending or adding to the building. You can calculate it by dividing the total or gross floor area of the building by the gross area of the lot. It is important to note that the gross floor area only consists of the livable areas of the building. Areas such as the basement, parking garages, stairs, and elevator shafts are excluded from them.
Properties with low FAR limits are generally less attractive to investors. Those with high FAR limits allow for more opportunities to extend or build upon spaces, leading to an increased valuation and lower per-project expenditures. If a building exceeds its FAR limits but was built before such limitations were imposed, the building’s owner does not have to take any steps to conform to it. However, they cannot develop the building any further. Those properties that exceeded their FAR limits and were built after those limits were set must take steps to rectify them.
FAR remains a worthwhile consideration for investors, even if you aren’t planning to make any extensions. That’s because it can have either a positive or negative effect on the land’s value. Properties with a high FAR limit can be worth more, but they can also decrease the value of neighboring properties if any extensions block their views.
4. Choose the right loan
Whether a property turns out to be a good investment depends significantly on your ability to secure the best possible interest rate. For this, you’ll need a solid credit score and an acceptable debt-to-income ratio (DTI). The general advice is a credit score of at least 670 and a DTI below 43%. However, your exact requirements will depend on the type of loan you are applying for. Chances are, you’ll need to finance the purchase, in which case you’ll need to choose the right loan program and lender.
For instance, both Freddie Mac and Fannie May have different policies related to DTI. Fannie May says that your DTI cannot be more than 50%, while Freddie Mac doesn’t have a set guideline on what an acceptable DTI is. Each case is looked at individually and depends on a range of factors, such as your median FICO score and the size of your down payment.
Fixed-rate VA loans have a DTI of 60%. However, additional qualifying factors maybe if you have a DTI above 45%. One of these factors includes a FICO score with a median of at least 620. A lower score of between 580 and 620 will need a housing expense ratio of no more than 38% and a DTI of no more than 45%. The same applies to FHA loans with scores between 580 and 620.
You can keep your DTI in check using your anticipated rental income to qualify for your mortgage. However, to do so, you’ll need to have a lease agreement already in place with your expected tenants. Some loans also require a special appraisal that considers the rental value of the property’s multiple units.
5. Make an offer
Working closely with your buyer’s agent will help you choose the right property and determine the best offer. Your agent will then meet with the seller’s agent to negotiate and get you towards an accepted offer. Expect a few counteroffers and back and forth before you get there; it’s all part of the game.
Once you have an accepted offer, it’s now time to move through the due diligence process and mortgage application. The average time to close can be anywhere from 30 days if paying all-cash to 60 days if financing.
6. Renovate and get ready for tenants to move in
With the property now closed on, it’s time to start renovating (if necessary) and preparing for marketing to new tenants. At the very least, you’ll want to make sure everything is up to code. Beyond some cosmetic upgrades, a few significant reno-projects in key areas of the property can be well worth the expense, provided your budget allows for it. The best areas to focus on are the kitchens and bathrooms, boosting the property’s value. You will also want to have a maintenance fund to ensure the property stays in good condition.
The final step before finding tenants will be drawing up a day-to-day management plan for the individual rental units. Being a landlord requires a time commitment, and you’ll need to decide how to divide that time effectively between your other duties. You can always hire a property manager if you don’t have the time to oversee day-to-day management. Of course, you’ll want to consider that the cost of this will affect your bottom line. Property managers typically charge from 4-5 of the gross monthly rent in management fees.
Multi-Family Properties are a highly competitive market, and finding a good investment will take a lot of time, patience, and skill. Sometimes, the only thing that separates a successful investor from a failed one is the ability to see the value in a property that someone else misses. Being a successful landlord also requires a lot of work and a detail-orientated approach. You’re now responsible for both your own home and those of your tenants, so you need to be ready for that.
For those that are ready, multi-family property investing can be the gateway to achieving financial independence.
This is not tax or investment advice. It is your duty to consult your own CPA, Legal and Financial Advisors about your individual situation and applicable laws. No appreciation, positive cash flow, or return on investment can ever by guaranteed. All real estate investing entails risk which buyer assumes, it is your duty to do your own due diligence before buying any real estate.
Category: Harbour Group Capital News