One of the best and safest ways to build wealth is through real estate. But there are many ways to invest. I have bought and sold single-family rentals, duplexes, and triplexes. I have also made forays into vacation rentals. But, far and away, my favorite investment in the real estate space are multifamily apartments. Here are seven reasons why:
Multifamily Apartments Offer Economies Of Scale
With a single-family rental property I have one stream of revenue coming from one resident. I have one roof, one water heater, and one HVAC system for the house. When I buy my properties, I protect myself by buying positive cash flow properties, but often times the cash flow goes right back into the house for these capital items. But what if the house goes vacant? This is the biggest risk of a single-family rental. In that case all my revenue dries up and goes to zero and my cash flow goes negative until I can fill the vacancy. This isn't a great risk/reward situation. My risk decreases when I buy a duplex. Instead of one revenue stream covering expenses, I now have two. The one roof costs about the same of the single-family house, but I now have more reliable cash flow with two streams of income. This reduces the probability of 100% vacancy considerably. Scale this up to a 100-unit apartment complex and the numbers get very powerful. All of the costs of the financing, maintenance and management are now spread over 100 units, instead of one.
Multifamily Apartments Are Managed By Professionals
Most real estate investors start out with one or two rental properties. They might have anywhere from $100 to $600 per month of net income on each of their properties. Since the management cost of a typical single-family house can be anywhere from 7-10% of total rental income, most investors choose to manage their properties themselves to save that expense. Now, it's great that we live in a day and age when there are so many great tools for beginner landlords. It's great to have websites like BP and YouTube to learn from. But I have to be honest. I'm not a great landlord. Besides, with a precious little time I have, I'd rather focus on being an investor. I prefer the team approach. I like to let the professionals do what they do best. When it concerns larger multifamily properties, the skills and tools require necessitate calling in the pros. Stepping out of the management responsibility allows me the chance to quit hacking away at the landlord gig and focus on making deals happen. That's where I want to be, not fixing a stove somewhere or leasing up a unit. Management companies in the multifamily space (especially above 100 units) charge a management fee that is about 30% less than the going rate for managing a single-family rental. That's money in my pocket! Multifamily Apartments give me the opportunity to leave landlording behind and focus on being an investor!
Multifamily Apartments Are Valued Based On Income Produced
When I buy a single-family house in bad shape, I can rehab that house and capture equity up to a reasonable comparable value. This approach to valuation is based on the recent sales of similar properties. No matter how much I rent the house for, the value of the house is 'tethered' to the sales comp figure. I recently sold one of my rentals to a tenant. We agreed on a price that we both felt was fair. After the appraisal came back it showed that the price we agreed on was higher than what the appraiser said the house was worth. This impacts the financing of the deal for the buyer in a negative way. So in order to get the deal done, I lowered the price. There is a ceiling for values in the single-family space. For apartments the valuation is not the "sales-comp" approach, but the income approach. Values are based on the Net Operating Income, or NOI. NOI = Total Rent Revenue - Operating Expenses. It does not include financing. When the NOI increases, so does the value of the apartment community. This allows for the opportunity to 'force equity' into the properties by making upgrades and raising rents. This 'forced equity' increases the NOI and accordingly elevates the value of the property. Instead of hoping for a nice comp to meet our valuation targets, multifamily apartments allow us to take direct action to increase the value of the asset.
Multifamily Apartments Get Optimal Financing
This is one of the most exciting aspects for the multifamily investor. Properties with more the five rental units are considered commercial properties and therefore must obtain commercial financing. These loans are typically 5-10 year loans with all kinds of different features and benefits that are not offered to a typical single-family house investor. For example, the buyer of an apartment building might arrange for the entire first year to be an interest only loan with a low fixed rate after 12 months. A loan like this allows the investor to leverage a very low mortgage payment during the first year of ownership in order to plow the savings into renovating units and increasing the NOI. These loans can be tailored to the specific project and business plan. Qualifying for these loans is based on the asset itself and its income and not the debt-to-income ratio of the investor. This is a big advantage. The investor still needs to be approved and credit worthy, but is not tied down by a debt-to-income ratio that is part of the calculus of single-family investing math.
Multifamily Apartments Do Well In Tough Economic Times
During the Great Recession of 2007-2009 the banks stopped lending on virtually everything in real estate except multifamily apartments. Many people who couldn't afford to buy homes began downsizing and moving into apartments. Occupancies in many apartments actually increased during the recession in some areas. Furthermore, the research shows that more and more in the United States, we are becoming a renter nation. People need a place to live. In a recession they might give up a house, a car, and a lot of luxuries, but they still need a place to live. This makes multifamily apartments a veritable bulletproof investment option if purchased right, in a good area, and run correctly.
Multifamily Apartments Are Tax Advantaged
Real estate is a cash-producing asset with incredible tax advantages over other types of investments. Income for the owner (or partners) is reduced by taxes and depreciation. This is significant because it often means that even though the investor had a positive cash flow into a bank account, the tax and depreciation expense either significantly has the effect of decreasing the net taxable income or eliminating it completely. It’s a nice benefit to experience positive cash flow, but to carry a taxable loss against other types of income on your tax statement. This tax savings is as good as an additional cash flow stream because it reduces your tax bill in real terms. (As a disclaimer I do want to say that am not an accountant, nor do I play one on tv. It’s best to consult with your accountant about how advantageous or neutral a real estate investment might be for your situation. Every persons’ situation is different.) Also, in some cases, and even in the case of some syndications, when the property sells, taxes can be deferred through a 1031 exchange. I won’t go into the details of a 1031 here, but suffice it to say that this is possible in real estate if done correctly, with professional help, and it can save an enormous amount of taxes.
Multifamily Apartments Meet a Real Need in the Economy
This final reason may not be a money-maker but its worth mentioning because this type of investing really can make a difference. Today we’re seeing an entire generational shift toward the multifamily lifestyle. In the United States, (I’m not sure about other countries) we are becoming a renter nation. Investors who take control of these assets have an amazing opportunity not only for a great investment, but to shape a neighborhood and build a community. I love this about multifamily investing. Taking over run down buildings and renovating them is an opportunity to breath fresh life and vision into a neighborhood. I love working with managers and partners who don’t just see the profit involved, but also see the people we get to serve. Many apartment investors these days see themselves as community builders and are adding amenities that foster connection between people and a sense of place. There is a deep joy I feel when I drive by one of our communities and know that we made a better community.
These are just a few reasons I prefer investing in apartments. There are a lot of great books and articles on this subject that go into each of these points in far more detail than I have here. Let me know your thoughts! Are you ready to become a multifamily investor? Keep studying and learning! Cheers and Happy Investing!
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