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Beginners’ Guide to Multi-Family Real Estate Investing

Posted by Walnut Street Finance Team on Aug 8, 2018

There are a lot of benefits to single-family real estate investing, whether you’re planning to fix and flip or take on tenants. It’s a great place to start out with investment properties, allowing you to learn the ropes in a lower risk scenario. But just about every real estate investor eventually sets their sights on multi-family properties, and for good reason.

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When you own a multi-family property, just about everything is in one place. Regardless of the number of units, there’s only one landscape to maintain and only one place to go to when you’re needed on site. There’s also the potential for a sizable cash flow, and the tax benefits are significant. Read on to learn more about multi-family real estate investing to see if it’s right for you.

Finding Your First Multi-Family Property

Multi-family real estate investing requires a lot of upfront research — you can’t just drive around to see what’s for sale. Your best bet is to get online and first see what is available around the area you’re interested in. Once you find a couple that you like, it’s time to start figuring out the numbers to ensure you’re starting with a solid deal. This means comparing purchase prices, examining the costs (both short and long term), and creating a reasonable estimate of rental costs.

It is only after you have a solid understanding of all the numbers involved in the cost of acquiring a multi-family property that you have a true idea of what it’s actual value is. 

Knowing Your Property Value

To accurately estimate the true property value of your potential multi-family real estate investment, there are several important numbers you’ll need to gather:

  • Mortgage Payment: We all know what this is. Most simply stated, a mortgage payment is paid to the lender against the property loan. Some of the payment helps pay down the loan, and some of it goes toward paying the loan’s interest.
  • Down Payment: Again, an easy one. This is the initial cash payment you put down toward the total cost of the property. If you plan to live in the property or take out a Federal Housing Administration loan, your down payment may be as little as 3.5%. For others, you can expect a down payment of 20–25% of the property’s purchase price.
  • Rental Income: this number simply gives you a solid estimate of what income you will generate monthly from tenants paying their rent. If you can ensure the number covers more than the cost of the monthly mortgage payment, your lender will see the investment as less of a risk.
  • Price to Income Ratio: This number looks at a specific geographical area and compares the median household price to the median household income. As the ratio decreases, housing becomes more affordable.
  • Price to Rent Ratio: This number helps determine the affordability of buying in a specific geographical area versus renting in that same area. You arrive at the ratio by dividing the median home price by the median annual rent in the area you’re interested in.
  • Gross Rental Yield: To get this handy number, determine the total rental income for a year, and divide it by the total purchase cost of the property (including fees, closing costs, renovation costs, etc.). Investors use this equation to estimate the annual income a property will produce.
  • Capitalization Rate: Also known as the cap rate, this equation expands up on the gross rental yield and adds operating expenses into the mix. To arrive at your capitalization rate, simply add up the total expense for your multi-family property (repairs, taxes, fees, insurance, vacancy costs, etc.). Subtract these expenses from your total rental income, then divide that number by the total property cost.
  • Cash Flow: This is a measure of your net income generated by the property you purchase. If you have money left over after all expenses and payments have been made, your cash flow is positive. If not, your cash flow is negative. 

What Should You Look For in a Multi-Family Real Estate Investment?

There are many variables to take into account when it comes to purchasing a multi-family real estate property. Just because you can afford it doesn’t mean it’s the right property. Let’s take a quick minute to examine what makes or breaks a multi-family property.

  • Where is it Located?: Location is especially important when it comes to multi-family investments. Not only do you want your first multi-family property to be near you, but you’ll also want to make sure it is located in high-yield, high growth areas. Look for a property in an area where people want to live (high-demand neighborhoods that are well maintained). A property that needs a little work in a desirable area is generally still better than a perfect property in a part of town where no one wants to live.
  • How Many Units Does it Have?: While it may look like a great idea to start big (20 or more units), it’s best for the first-time multi-family investor to look for something smaller. Have a look at 2-, 3- and 4-unit properties at first. This will allow you to start small while getting a feel for how the whole thing works. After you’ve cut your teeth with the smaller multi-family properties, then you should be in a good place to make smart decisions with a larger property.
  • Who is the Seller?: This may not seem important, but it’s best to know the motivation behind the sale, and that means understanding who is trying to sell the property. For example, if the property is owned by a bank, they’ll be looking to get rid of the property, which means you might get a better purchase price than if the seller were someone getting ready to retire.
  • What are the Tax Incentives: There are a lot of great tax breaks available to multi-family real estate investors, but let’s just focus on two. First of all, your operating expenses (i.e. property taxes, property insurance, repairs, mortgage interest and maintenance) are all deductible against the income of the property. And secondly, you can deduct the depreciation of your multi-family property over 27.5 years, though the value of the land remains unchanged. For example, a property purchased for $20 million with a land value of $2 million can provide a depreciation expense of more than $650,000 per year. 

Are Multi-Family Real Estate Investments Right For You?

In the end, the answer to that question is obviously your call. But with this information in hand, you’ll be able to make a smart, informed decision. A lot of real estate investors are moving in this direction, and it’s possible to make a real, ongoing profit, month after month after month.

 

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