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MULTI-FAMILY APARTMENTS
With high occupancy rates and rising rents, and property in short supply, demand from investors for multifamily product also may continue to rise. The law of supply and demand may be working in favor of multifamily investors in 2020, with tenant demand for rental property continuing to grow. There is continued pressure to increase the rental housing supply, and there continues to be a push-pull between housing advocates and existing residents who don't want their neighborhoods overloaded with new housing construction. The decline of brick and mortar retail in some markets is starting to result in the conversion of retail buildings and retail zoned land into multi-family rental housing. In California, for example, there is increased legislative pressure from the state for cities and counties to build more affordable rental housing.
Recent surveys show that 32% of rental households don’t believe the American Dream includes homeownership, 26% of people who do own a home wish they were renting instead, and 20% say they never plan on buying a home in their lifetime. The economics of home ownership are being increasingly questioned in the United States society. Many prefer the flexibility of rental housing, allowing for easier relocation, lower monthly costs, and less maintainence responsibilities.
Investing in multifamily real estate will prove to be a unique experience when compared to building a portfolio of single-family properties. Review the tips below to gain a better sense of how to invest in multifamily real estate, and what to keep in mind while you get started:
Find Your 50%
The best way to scan through potential deals is to crunch the numbers and determine (approximately) how much a specific multifamily property can make you as an owner. You do this by calculating the difference between expected income (rent payments, storage fees, parking fees) and expenses (repairs, maintenance, etc.)
When you do not have access to some information, such as a clear neighborhood comp, you can use the 50% rule. Simply take the expected income and HALVE it, this then becomes your estimated expense number. The difference between your estimated monthly income and estimated monthly expense is your net operating income (NOI).
Calculate Your Cash Flow
The estimated mortgage payments are brought into the equation in this next step, by calculating your estimated monthly cash flow. To find out how much money you’ll actually be putting into your wallet on an ongoing basis, you want to subtract the monthly mortgage payment from the NOI of your prospective multifamily property. This calculation will provide you with your cash flow estimate, helping you determine whether or not the investment will be worthwhile.
Figure Out Your Cap Rate
A third critical calculation to memorize is the capitalization rate, or cap rate for short, which indicates how quickly you will get a return on your investment. It’s important to remember two things: one, the cap rate for a “safe” investment, such as a certificate of deposit (CD), is usually in the low 1-2% range. Two, this cap rate you’re about to calculate doesn’t take into account factors such as increases in property value, boosts in monthly NOI, or the many tax breaks afforded to owners of multifamily properties.
To calculate cap rate, all you do is take your monthly NOI and multiply it by 12 to get the annual number, and divide that number by the property’s current market value. The key thing to understand about cap rate is that higher is not always better. A higher cap rate generally denotes higher risk and higher return. While a lower cap rate, conversely, indicates a lower risk and lower return.
A good rule-of-thumb is to shoot for a cap rate in the 5%-10% range. Anything lower and the investment may not have enough yield, anything higher and you want to be sure you understand all the risks associated with the investment.
What To Look For When Investing In Multifamily Properties
Casual window shopping for real estate is nice to do on a Sunday afternoon, but multifamily investing requires much more than browsing your local open house. For investors, it requires a reasonable amount of due diligence that will not only encompass locating a property below market value, but also commencing efforts to analyze and assess its financial sensibility.
Along with the actual hustle of finding so-called property, it takes a combination of things to ensure a quality real estate deal. In most cases, the search will begin by locating a potential property and then comparing purchase prices, short-and-long term costs, and rental estimates. While this will generally forecast a ballpark figure of what investors can expect, it’s up to them to continue their due diligence and refine those numbers to ensure success. Because investing in multifamily properties requires a little more attention than other real estate deals, an investor’s first concern should always be on the numbers. These financial figures will not only expose the true value of an investment property, but reveal its bottom line. In addition to the numbers, there is a selection of underlying factors that can, and will, influence multifamily investing.
For those looking to invest in a multifamily investment deal, the search begins with the following checklist:
The Location
Location is of the utmost importance for real estate investors, and even more so when investing in multifamily properties. With more tenants, each and every unit will need to appeal to renters; location is generally the most desired criteria. investors should pay attention to high-growth, high-yield areas where properties are in high demand, well-maintained neighborhoods when investing in multifamily properties, .
The Total Number of Units
The next step is to evaluate the property as a whole. Investors should take into consideration the amount of units on the property, including the number of rooms in each unit. Beginner investors should begin their real estate search focused on three types of multifamily properties: the duplex (two units), triplex (three units), and four-plex (four units). These types of properties not only offer the most upside with the least amount of risk for beginner investors, but they are generally more affordable.
The Potential Income
The next step is determining the income a property can accrue. Sites like Rentometer.com or Craigslist are helpful sources for verifying rental prices and income, but investors should practice due diligence, taking everything into consideration.
For those looking to remain conservative, the 50 percent rule is a general recommendation: 50 percent of a real estate investment’s income should be spent on expenses — not the mortgage. While too mild of a strategy for some, it’s a good rule of thumb for beginner investors.
The Costs
Every situation will differ when financing real estate, especially multifamily properties. For example, the investor may choose to live in one of the units while renting out the other, which would allow them to qualify for owner-occupied financing. This means the income from the second unit will be factored into the lender’s qualifying ratio. Investors need to also consider their credit score when contemplating financing options, as this important number will greatly influence the qualifying process. In general, lenders will look at three components: credit, debt-to-income ratio, and down payment.
The Seller
There is one more question when evaluating potential multifamily properties is: who’s selling the place? Because the purchase price can vary greatly depending on the seller and their motivation, it’s imperative for investors to gain an understanding of who they’re dealing with. A bank-owned property is dealt with much differently than a for-sale-by-owner property, which means there’s potential for cost savings.
With high occupancy rates and rising rents, and property in short supply, demand from investors for multifamily product also may continue to rise. The law of supply and demand may be working in favor of multifamily investors in 2020, with tenant demand for rental property continuing to grow. There is continued pressure to increase the rental housing supply, and there continues to be a push-pull between housing advocates and existing residents who don't want their neighborhoods overloaded with new housing construction. The decline of brick and mortar retail in some markets is starting to result in the conversion of retail buildings and retail zoned land into multi-family rental housing. In California, for example, there is increased legislative pressure from the state for cities and counties to build more affordable rental housing.
Recent surveys show that 32% of rental households don’t believe the American Dream includes homeownership, 26% of people who do own a home wish they were renting instead, and 20% say they never plan on buying a home in their lifetime. The economics of home ownership are being increasingly questioned in the United States society. Many prefer the flexibility of rental housing, allowing for easier relocation, lower monthly costs, and less maintainence responsibilities.
Investing in multifamily real estate will prove to be a unique experience when compared to building a portfolio of single-family properties. Review the tips below to gain a better sense of how to invest in multifamily real estate, and what to keep in mind while you get started:
Find Your 50%
The best way to scan through potential deals is to crunch the numbers and determine (approximately) how much a specific multifamily property can make you as an owner. You do this by calculating the difference between expected income (rent payments, storage fees, parking fees) and expenses (repairs, maintenance, etc.)
When you do not have access to some information, such as a clear neighborhood comp, you can use the 50% rule. Simply take the expected income and HALVE it, this then becomes your estimated expense number. The difference between your estimated monthly income and estimated monthly expense is your net operating income (NOI).
Calculate Your Cash Flow
The estimated mortgage payments are brought into the equation in this next step, by calculating your estimated monthly cash flow. To find out how much money you’ll actually be putting into your wallet on an ongoing basis, you want to subtract the monthly mortgage payment from the NOI of your prospective multifamily property. This calculation will provide you with your cash flow estimate, helping you determine whether or not the investment will be worthwhile.
Figure Out Your Cap Rate
A third critical calculation to memorize is the capitalization rate, or cap rate for short, which indicates how quickly you will get a return on your investment. It’s important to remember two things: one, the cap rate for a “safe” investment, such as a certificate of deposit (CD), is usually in the low 1-2% range. Two, this cap rate you’re about to calculate doesn’t take into account factors such as increases in property value, boosts in monthly NOI, or the many tax breaks afforded to owners of multifamily properties.
To calculate cap rate, all you do is take your monthly NOI and multiply it by 12 to get the annual number, and divide that number by the property’s current market value. The key thing to understand about cap rate is that higher is not always better. A higher cap rate generally denotes higher risk and higher return. While a lower cap rate, conversely, indicates a lower risk and lower return.
A good rule-of-thumb is to shoot for a cap rate in the 5%-10% range. Anything lower and the investment may not have enough yield, anything higher and you want to be sure you understand all the risks associated with the investment.
What To Look For When Investing In Multifamily Properties
Casual window shopping for real estate is nice to do on a Sunday afternoon, but multifamily investing requires much more than browsing your local open house. For investors, it requires a reasonable amount of due diligence that will not only encompass locating a property below market value, but also commencing efforts to analyze and assess its financial sensibility.
Along with the actual hustle of finding so-called property, it takes a combination of things to ensure a quality real estate deal. In most cases, the search will begin by locating a potential property and then comparing purchase prices, short-and-long term costs, and rental estimates. While this will generally forecast a ballpark figure of what investors can expect, it’s up to them to continue their due diligence and refine those numbers to ensure success. Because investing in multifamily properties requires a little more attention than other real estate deals, an investor’s first concern should always be on the numbers. These financial figures will not only expose the true value of an investment property, but reveal its bottom line. In addition to the numbers, there is a selection of underlying factors that can, and will, influence multifamily investing.
For those looking to invest in a multifamily investment deal, the search begins with the following checklist:
The Location
Location is of the utmost importance for real estate investors, and even more so when investing in multifamily properties. With more tenants, each and every unit will need to appeal to renters; location is generally the most desired criteria. investors should pay attention to high-growth, high-yield areas where properties are in high demand, well-maintained neighborhoods when investing in multifamily properties, .
The Total Number of Units
The next step is to evaluate the property as a whole. Investors should take into consideration the amount of units on the property, including the number of rooms in each unit. Beginner investors should begin their real estate search focused on three types of multifamily properties: the duplex (two units), triplex (three units), and four-plex (four units). These types of properties not only offer the most upside with the least amount of risk for beginner investors, but they are generally more affordable.
The Potential Income
The next step is determining the income a property can accrue. Sites like Rentometer.com or Craigslist are helpful sources for verifying rental prices and income, but investors should practice due diligence, taking everything into consideration.
For those looking to remain conservative, the 50 percent rule is a general recommendation: 50 percent of a real estate investment’s income should be spent on expenses — not the mortgage. While too mild of a strategy for some, it’s a good rule of thumb for beginner investors.
The Costs
Every situation will differ when financing real estate, especially multifamily properties. For example, the investor may choose to live in one of the units while renting out the other, which would allow them to qualify for owner-occupied financing. This means the income from the second unit will be factored into the lender’s qualifying ratio. Investors need to also consider their credit score when contemplating financing options, as this important number will greatly influence the qualifying process. In general, lenders will look at three components: credit, debt-to-income ratio, and down payment.
The Seller
There is one more question when evaluating potential multifamily properties is: who’s selling the place? Because the purchase price can vary greatly depending on the seller and their motivation, it’s imperative for investors to gain an understanding of who they’re dealing with. A bank-owned property is dealt with much differently than a for-sale-by-owner property, which means there’s potential for cost savings.
Contact:
Derek Morris, MBA
Licensed California Real Estate Broker #00616923
The Derek Morris Company
Santa Barbara, California
derekmorrisco@gmail.com
805-613-7770
Derek Morris, MBA
Licensed California Real Estate Broker #00616923
The Derek Morris Company
Santa Barbara, California
derekmorrisco@gmail.com
805-613-7770
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COPYRIGHT (C) 2020 DEREK MORRIS COMPANY
COPYRIGHT (C) 2020 DEREK MORRIS
ALL RIGHTS RESERVED
COPYRIGHT (C) 2020 DEREK MORRIS
ALL RIGHTS RESERVED
Note: We have obtained the information on this site from sources believed to be reliable. However, no representations of any kind, whether expressed or implied, are being made regarding the accuracy of this information. All references to income, expenses, investment yields, capitalization rates, loan rates and terms are approximate only. Buyer should conduct their own independent investigation of all pertinent property information. We bear no liability for any errors, inaccuracies or omissions.
