Multi-family home investments
Multi-family investments are a great stepping stone for residential investors who are expanding their portfolio, or higher net worth investors purchasing one of their first investment properties. Multi-family properties allow investors to take advantage of economies of scale and usually purchase at a lower price per square foot since several units can be financed under one mortgage note, opposed to multiple, which is a very important factor in today’s mortgage environment.
Before the tightening of the credit markets, it was common for real estate investors to have up to 10 mortgages and in some cases more depending on their local banking relationships. In today’s environment, it is uncommon to see investors who have more than 3 or 4 mortgages obtain a loan for additional properties even if the numbers make financial sense.
Typical multi-family investments are duplexes, triplexes (tris) and quadplexes (quads). Multi-family investors often find that their units do not command rents as high as single family homes, nor do they see quite as much appreciation, but for buy and hold investors, or roll your sleeve up investors who are willing to improve a property and raise rents, they can be a fantastic investment.
Location of a multi-family property is one of the biggest factors in it’s future value and rental demand. In areas with higher density such as cities, or college towns, multi-family properties are ideal for rental. Tenants in dense markets do not expect, nor do they usually care about amenities such as a yard or garage that single family home owners desire. They are more sensitive to the rental amount that fits their monthly budget.
Single family homes in dense areas often do not command enough rent to cover the expenses and create a positive net cash flow (this is common in markets such as California). With lower price per square foot and multiple units, multi-family properties will typically allow an investor to generate positive net cash flow, or be close to neutral and take advantage of future appreciation, tax benefits and principal paid by renters.
A popular exit strategy for multi-family property owners is dividing units into individual units and selling them separately to maximize their sales price. This process is called condo conversion and will have different rules and regulations based on the properties location and zoning requirements. In most markets, a property owner will have to have their plans approved by the city council and inspected to meet requirements such as a firewall in between the units of the building.
The owner may also have to work with their lender to determine loan payoff, as they may have a due on sale clause in their mortgage contract. This usually happens when more than 4 units are involved, as properties with more than 4 units will almost always have to be financed through a commercial loan. Commercial loans are held by the banks that originate the note, or what is commonly referred to as “holding their paper”. Commercial loans are more flexible in their terms, but usually have strict requirements about payment upon sale.
Multi-family properties can be a fantastic addition to real estate portfolios depending on location, condition and market factors. Before purchasing a multi-family property, prospective buyers should conduct heavy market research such as average price per square foot, insurance and tax rates, as well as what realistically they demand for rent. If the numbers pencil out and future of the location looks positive, it may be a purchase worth making. Keep an eye in dense markets such as college towns and cities where renters tend to be more conscious about their monthly budget and people tend to rent longer before purchasing.