A multifamily property is any property that has more than one unit. The smallest scale multifamily properties are duplexes, known as “two-families” in some parts of the country. Triplexes and four-plexes are the next step up, having three and four units each, respectively.
Two- to four-unit multifamily properties are a great way for first-time investors to dip their toes into the rental property waters as they are typically financed by banks in the same way as are single family homes. Many investors will begin by owner-occupying a small multifamily property. In other words, they’ll live in one unit and rent the other(s). There are many benefits to doing so.
For instance, owner-occupied properties tend to qualify for more advantageous financing with lower interest rates and less of a down payment. By living on site, the investor can more easily manage the property. Most will even self-manage. This can save hundreds of dollars each month on property management fees. Sometimes an investor will buy a multifamily property without owner occupying it or hiring a property manager, which can make management more time intensive since it requires the owner to visit the unit in person for repair and maintenance requests.
Larger multifamily properties, those with five or more units, start to fall into the “commercial real estate” category. Properties with 5+ units typically qualify for a different type of financing, which is usually more expensive than properties that are considered strictly residential.
Multifamily property can continue to scale to include hundreds, even thousands, of units. Large apartment complexes, for example, and high-rise apartment buildings are other examples of multifamily property. Sometimes multifamily property will cater to a specific demographic, such as students or seniors, but this is not always the case. The majority of multifamily properties are agnostic to demographics (aside from catering to the general local demographic).
1. More Expensive, but a Lot Easier to Finance
In most cases, if not all, the cost to acquire an apartment building will be significantly higher than the cost to purchase a single-family home as an investment. A one-unit rental could cost an investor as little as $30,000 while the cost of a multi-family building can go well up in the millions.
At first sight, it might seem as though securing a loan for a single-family property would be a lot easier than trying to raise money for a million-dollar complex, but the truth is that a multi-family property is more likely to be approved by a bank for a loan than the average home.
That’s because multi-family real estate consistently generates a strong cash flow every month. This remains the case even if a property has a handful of vacancies or a couple of tenants who are late with their rent payments. If a tenant, for example, moves out of a single-family home, that property would become 100% vacant.
On the other hand, a ten-unit property with one vacancy would only be 10% unoccupied. As a result, the likelihood of a foreclosure on an apartment building is not as high as a single-family rental. All of this equates to a less risky investment for a lending institution and can also result in a more competitive interest rate for the property owner.
2. Growing a Portfolio Takes Less Time
Multi-family real estate is also very suitable for property investors who wish to build a relatively large portfolio of rental units. Acquiring a 20 unit apartment building is a lot easier and much more time-efficient than purchasing 20 different single-family homes.
With the latter option, one would need to work back and forth with 20 different sellers, and conduct inspections on 20 houses that are each located at a different address.
Additionally, in some cases, this route would also require an investor to open 20 separate loans for each property. All of this headache could be avoided by simply purchasing one property with 20 units.
3. You’re in a Position in Which Property Management Makes Financial Sense
Some real estate investors do not enjoy the actual management of their properties, and instead, hire a property management company to handle the day-to-day operations of their rentals. A property manager is typically paid a percentage of the monthly income that a property generates, and their duties might include finding and screening tenants, collecting rent payments, handling evictions, and maintaining the property.
Many investors who own one or two single-family homes do not have the luxury of contracting an external manager because it would not be a financially sound decision due to their small portfolio. The amount of money that multi-family properties produce each month gives their owners room to take advantage of property management services without the need to significantly cut into their margins.
A common question we receive from our investors is what do properties marketed as Class A, Class B and Class C mean, and why does it matter? To begin, investors, lenders and brokers have developed property classifications to make it easier to communicate amongst themselves about the quality and rating of a property quickly. For investors, property class is an important factor to consider because each class represents a different level of risk and return. Investors can use these differences about property class types to consider how each property fits within their strategy of investing, such as return objectives and amount of risk they are willing to accept in order to achieve those returns.
Each property classification reflects a different risk and return because the properties are graded according to a combination of geographical and physical characteristics. These letter grades are assigned to properties after considering a combination of factors such as age of the property, location of the property, tenant income levels, growth prospects, appreciation, amenities, and rental income. There is no precise formula by which properties are placed into classes, but here is a breakdown of the most common classes, A, B and C:
These properties represent the highest quality buildings in their market and area. They are generally newer properties built within the last 15 years with top amenities, high-income earning tenants and low vacancy rates. Class A buildings are well-located in the market and are typically professionally managed. Additionally, they typically demand the highest rent with little or no deferred maintenance issues.
These properties are one step down from Class A and are generally older, tend to have lower income tenants, and may or may not be professionally managed. Rental income is typically lower than Class A, and there may be some deferred maintenance issues. Mostly, these buildings are well-maintained and many investors see these as “value-add” investment opportunities because the properties can be upgraded to Class B+ or Class A through renovations and improvements to common areas. Buyers are generally able to acquire these properties at a higher CAP Rate than a comparable Class A property because these properties are viewed as riskier than Class A.
Class C properties are typically more than 20 years old and located in less than desirable locations. These properties are generally in need of renovation, such as updating the building infrastructure to bring it up-to-date. As a result, Class C buildings tend to have the lowest rental rates in a market with other Class A or Class B properties. Some Class C properties need significant reposting to get to steady cash flows for investors.
It is important for investors to understand that each class of property represents a different level of risk and reward. Class A provides investors with more security by knowing that they are investing in top tier properties, with little or no outstanding issues requiring further capital expenditures. However, despite better property conditions, Class A can be sensitive in times of a recession if high income earners suffer from increased unemployment.
Class B and C properties tend to be bought and sold at higher CAP rates than Class A, as investors are paid for taking on the additional risk of an investing in an older property with lower income tenants, or a property in a lower income neighborhood.
The property class investors choose can have a great deal of influence on the stability of an investment over time, as well as its growth appreciation. For investors looking for capital preservation, Class A may be the right investment. For investors looking for capital appreciation, Class B and C may be better investments for that specific risk profile.