If you have the means, investing in a multifamily real estate property makes much more sense than investing in other types of real estate or multiple single-family homes. Over the years, multifamily units have provided better returns than the stock market and other investment classes due to its strong cash flow. The stability and risk-averse environment also make this category among the most lucrative investments you can undertake.
Before explaining why multifamily buildings are so attractive for investment, it makes sense to highlight its stable growth. According to the National Multifamily Housing Council, the average annual return for multifamily units is approximately 10% with the exception of the recession years in 1990 and 2008.
The return does not take into account the increase in the overall value of a property during these years. For instance, if you were to invest in a multifamily project in 1990, the value per sq. feet at the time was $45.03, which surpassed the $200 mark in 2017. It is also worth considering that the recession years of 2008 to 2010 did not make any large-scale negative impact on the investment for long-term investors as the prices only receded $15 per square foot in one year before retracing their path to growth.
Besides the investment value, investors also find multifamily units attractive due to their relative financial stability in the long-run. To substantiate the claim, we can look at the vacancy rates and absorption rate data from NMHC, which is a powerful indication of the investment potential. According to NMHC, the vacancy rate of these units remained somewhat constant even during the worst recession-era of 2008. There was only 1 percentage point difference in the vacancy rate during the worst years. Similarly, there wasn’t any discernible difference in the absorption rate in the recession years as the absorption rate was stable for new multiunit buildings rented within six months. In fact, the multiunit sector didn’t even feel the crunch during the recession in the U.S. in 1990.
The stability and long-term increase in the value of family structures can be associated with the consumer need to look for smaller units in difficult times compared to large houses. Besides, the increasing trend of creating social and community spaces in modern buildings has enticed families to prefer living in the central area compared to houses located on the outskirts of major cities.
These statistics clearly indicate that investing in multifamily is a logical decision due to the ability of the investment to generate quick cash. In fact, there has been a newfound emphasis on the construction of multifamily units since the real estate bubble of 2008. Compared to single housing units, investment in new multifamily builds has expanded from $100 Billion to almost $500 Billion, which is much greater than single-family housing which has only reached $300 Billion.
As the population continues to grow and concentrate around large cities, the dynamics of real estate construction is also conducive to multifamily housing. For instance, in 1993, multiple-unit construction was only 7 percent of the total residential real estate construction. 15 years later, the share has increased to almost 18 percent, which is another testament to the rise of the sector. In fact, if we count the total number of units instead of the entire condominium, the share of construction is almost 38 percent (compared to 17 percent in 1993).
Statistics also show that the growth in multifamily can also be attributed to the growth of renters. As suggested earlier, more and more families are renting condos in residential societies near major cities, 91 percent of newly formed households are renters. While it’s true that most Americans still live in single-family houses, the trend of living in a social environment near large metropolis is gaining momentum. Therefore, it makes a lot of sense to diversify your portfolio through multifamily investments that can offer great returns.
Advantages of Multifamily Properties
While there are a lot of advantages of multifamily investments, we will highlight only a few of the most important facts that make the investment different from other investment categories. Here are three interesting facts that highlight the value of passively investing in these real estate properties.
1. Excellent Price-Value Proposition
Most high net-worth investors shy away from purchasing multifamily buildings and condominium buildings because they think it will be difficult to secure a suitable loan, negotiate the red-tape, and pay a premium over the actual value of the property. Nothing is farther from the truth as financing these types of real estate is much easier than getting a loan for a single-family home.
For instance, financial institutions are always weary of high risks associated with single-family properties. The risk originates from the fear of vacancy. Due to multiple reasons, the tenant of a single-family house can leave a home, which means that the house will be on the market making it useless for the owner or an investor for that particular vacancy period. Similarly, if there is a slump in the housing market or if the house is unattractive due to various reasons including maintenance issues, the vacancy period can be prolonged to an indefinite period of time without any return on investment.
Compare the scenario to a 15- or 20-unit condominium complex and you will see multifamily units are deemed less risky from an occupancy point of view. Whenever a tenant leaves a unit, the occupancy rate only decreases by 5% to 7%, which is much better than the 100% vacancy rate of a single-family unit. Even if some of the units of a condominium are vacant, the entire complex still generates enough revenue for the investor to regularly pay interest to the bank. Therefore, a condo or a multifamily building is always less risky compared to a single-family unit and other such real estate properties.
In fact, investors are likely to get better interest rates due to the less risky environment as multifamily buildings are thought to be more recession-proof than single-family homes. During the recession and hard times, people move from houses to condos instead of moving from a smaller space to a house. During slow periods, a multifamily unit will continue to generate greater cash flow for investors compared to a single unit, which is yet another reason to invest in apartments and condos.
2. Growth Potential
If you’re looking for a long-term investment to build a large portfolio of real estate properties, then investing in multifamily complexes provides excellent growth potential. The growth potential is reflected in the dynamics of how cash is generated.
On the other hand, if you were to invest in 20 different houses, it will take a lot of time to develop a stable portfolio. Investing in a variety of real estate is time-consuming and difficult to maintain because you will need to deal with a lot of different sellers with different terms and conditions. If an investor is buying 20 different properties, the time and paperwork to conclude these 20 different transactions can be overwhelming for most investors. The entire life-cycle can take many months to generate decent cash flow.
Unlike investing in a condo, apartment, or multifamily building, dealing with tons of paperwork for different single unit properties can also be a daunting task. As each of the single unit building will be located at a different address, communicating will also be an issue. Instead of facing these problems, you can generate a much faster cash flow by investing in an entire complex, making it easier to manage the cash and paperwork.
3. Asset Value and Performance
One of the main objectives of investing in real estate is to earn a substantial income in a short passage of time. When it comes to generating cash flow, investing in multifamily properties makes sense as minor changes can greatly improve the ROI of an asset. Accordingly, investors can reinvest their cash in multiple projects.
For instance, rehabilitation of a single home can only earn limited income. Mostly, the income from a house is dependent on the surrounding value of homes in the area. In contrast, improvement in a multifamily building such as a swimming pool, landscaping, health facilities, and parking space can increase ROI per unit. This is a win-win strategy for an investor as they get a passive income and the potential to increase their income from a single project. They automatically generated revenue help build a great financial portfolio that can be used to buy other properties.
In fact, you can also reposition your property to appeal to different segments to earn increased revenue. A building can be marketed to affluent seniors, assisted living and tech-workers. If you can hire a good management company to take care of your real estate investment, you can spend your time planning your next move due to the greater cash flow. This is something that you cannot do by investing in a portfolio of multiple small and single-unit properties.
How to Calculate the Investment Potential?
If you’re keen on investing in a multifamily property, it’s important to evaluate the income potential of a specific property. Without going into details, here are three simple steps to calculate the income potential, which includes calculating the Net Operating Income, estimated cash flow, and figuring out the cap rate.
To calculate the net operating income, you only need to add income and subtract expenses. Your income will come from rental payments and other fees charged to the residents. Your expenses will originate from the costs to operate the property, including maintenance and repair of the property, taxes and insurance, and utilities. In some cases, the former property manager will be able to help you get this important data. If you can’t get any substantial information, then use a rule of thumb, which suggests dividing your income and expenses in half to arrive at a potential Net Operating Income. Also known as the 50% rule, this is a simple, yet, effective method to start evaluating the worth of your future investment.
Once NOI is calculated, it’s time to evaluate the cash flow. You can easily calculate the net cash flow by deducting any mortgage payment from the monthly NOI. The remaining amount is your net cash flow that will go into your pocket.
In the final step, investors calculate the true potential of the investment by finding the cap rate. You can calculate the cap rate by multiplying the NOI by 12 months and then dividing it by the total mortgage amount. It’s usually suggested that a cap rate between 5% and 10% is the safest investment. Regarding cap rates, anything lower than 5% is not worth it, and anything over 10% is risky. However, these figures can change depending on the appetite of investor and real estate conditions surrounding each property.
What to Look For in an Investment Company?
Unlike smaller real estate transactions, investing in a multifamily complex requires due diligence and proper planning. As a first step, visit the property and talk to the investment firm to evaluate the overall environment and surroundings. Unlike a single property that you can pretty much visit on a Sunday open house, a large property may require more than one visit to appraise its true value.
A good investment company will always provide a clear picture of the sale and its investment potential. Its portfolio comprises of undervalued properties that can provide you a great return on investment (ROI) in the future. While number crunching is one way to appraise the financial pattern, it all starts by following a checklist involving multiple onsite and offsite factors. Most important of these factors include the location of the property, the total number of units, potential income, costs, and the seller. Talk to your investment firm about the calculations so you can have a better idea of the investment.
Great investment companies offer great locations. Experts often suggest that location is the key to financial success in real estate. Location does not mean that your property should be in the center of the city; instead, you want to invest in a property that is in a well-maintained neighborhood that appeals to locals. A well-maintained neighborhood is usually identified by looking at the growth and yields. Any nice building in high growth and high yield area represents a successful investment potential.
A reputable investment firm will always focus on profit per unit and the occupancy rates. The number of units is important as it’s an important contributing factor to success. For instance, smaller unit apartments are known to provide a good safety net as these are always in high demand. Therefore, if it’s the first time you’re investing in the high-end real estate, you should always choose the safest option.
A well-reputed firm will always listen to you helping you find your dream property. If you’re satisfied by the location and the type of property, it’s time to sit with your investment advisor. We have already indicated ideas on how you may come out with important financial figures. If nothing works, try the 50% rule or ask your investment advisor to help you out. Most advisors are very good at determining the future potential; therefore, it doesn’t hurt to spend some extra time understanding the investment deal.
Overall, multifamily buildings are a potential goldmine if you’re looking for passive investing opportunities. Not only do you get a decent return every month, but the underlying value of the property also increases with the passage of time. Future trends such as the potential to live near major cities in community-centered housing is another indication of the bright future. If you are looking for a truly passive investment opportunity, this may be a practical time to look at multifamily units.