- A duplex is a single residential property divided into two housing units, each with a separate entrance. A triplex has three dwelling units within the same property, and a fourplex has four units.
Investing in residential real estate can be an excellent opportunity for investors to generate a steady stream of passive income. Investors can choose from various residential real estate investments, including senior housing and student housing. Another option is multifamily properties, which allow investors to collect multiple rental income streams from a single property.
If you’re interested in learning more about multifamily real estate investing for beginners, you must first understand what a multifamily investment is and what to know before buying a multifamily property. This guide to multifamily real estate investment can help potential investors as they consider this investment.
A multifamily property is a building containing multiple housing units. Compared to a single-family residence (SFR), a multifamily property includes two or more separate dwelling units. Properties with five or more units are considered commercial property. The IRS defines dwelling units as spaces with accommodations like a sleeping area, cooking facilities, and a bathroom. The IRS considers real estate residential if it derives at least 80% of its yearly rental income from dwelling units.
When many people think of multifamily properties, they may think of apartment complexes. Yet this type of residential real estate comes in several varieties, including:
An apartment complex is one or more structures with at least five separate dwelling units. Residents of an apartment complex might share amenities like parking lots, community buildings, and swimming pools.
Similar to a duplex, a townhouse typically has two or more separate dwelling units in the same building. Residents share an interior wall, and each unit often has multiple stories.
Before investing, real estate investors may find it helpful to consider the pros and cons of multifamily properties. The benefits of multifamily investing can potentially outweigh the risks, depending on an individual’s situation. Here are a few multifamily investment pros and cons to consider:
Here are some of the top advantages of investing in multifamily properties:
One of the most significant benefits of multifamily investing is the opportunity for passive cash flow from rent. People always need a place to live, making monthly rental payments a potentially steady income stream. Multifamily properties have an advantage over single-family homes because of their potential for multiple rental income streams. A multifamily property could have two, three, or more tenants paying rent every month. Even with one vacant unit, investors will still have a reliable source of rental income.
The rental market for multifamily properties has historically been robust. The demand for multifamily rental housing increased across several areas in the country in late 2021. In that same period, the value of multifamily lending was the highest in over 15 years, at $487.3 billion.
Another potentially good sign for investors is that the multifamily property vacancy rate has decreased steadily over the last decade. As long as multifamily property investors have a reliable flow of tenants and can easily re-rent units as they become vacant, they have the opportunity to make predictable rental income. Even if one unit in a multifamily property stays vacant for some time, the burden is mitigated across the other units since they still produce cash flow. Since millennials rent for longer than previous generations at a similar age, multifamily property owners may be able to fill vacancies faster.
As with other real estate investing opportunities, multifamily investments are one avenue for generating passive income. Investors in multifamily properties may be able to hire a property manager to oversee their properties. This strategy can provide the benefits of real estate investment while lessening the burden of property management. Since multifamily properties can provide passive cash flow, investing in these types of properties can bring significant, consistent returns.
Investing in multifamily properties can provide investors with several tax benefits. The first tax benefit for investors is depreciation. The IRS allows investors and property owners to depreciate the cost of rental property. Depreciation enables investors to regain the value of the property’s physical structure and reduce their yearly tax liability.
The amount an investor can depreciate depends on three factors — the investor’s cost basis in the property, the depreciation method used, and the property’s recovery period. According to the IRS’s Modified Accelerated Cost Recovery System (MACRS), the recovery period for residential rental property is 27.5 years. If an investor holds a multifamily property for 27.5 years, they may be able to recover the cost of the property.
Investors can begin to depreciate their multifamily properties when they put them in service and stop depreciating when they’ve recovered the cost or take them out of service. The more an investor can depreciate in a year, the greater the potential tax benefit.
Investors in multifamily real estate may also be allowed to deduct expenses like mortgage interest, property tax, operating expenses, and repairs from their taxes. These tax benefits can help offset the costs of managing a multifamily property, which is a significant advantage for investors.
Multifamily properties also qualify for 1031 exchanges. A 1031 exchange is a tax-deferred exchange that enables real estate investors to sell one investment property and use the proceeds to purchase another like-kind property within 180 days of selling the relinquished property. Real estate investors can defer capital gains tax and build their wealth by completing the exchange. These exchanges provide several benefits, including capital gains tax deferral and increased purchasing power.
Investing in a multifamily property could scale an investor’s portfolio by two or more units at a time, allowing investors to boost their cash flow opportunities. When an investor can scale their portfolio quickly, it enables them to grow their wealth faster than they could with a property that only brought one source of rental income. Another consideration to keep in mind is that maintenance on a multifamily property is easier than owning multiple single-family dwellings in different locations.
Multifamily homes are also physically scalable. Whereas single-family homes only provide investors with one source of rental income, investors may be able to add more dwelling units to a multifamily property and increase their income. For example, an apartment complex may have land nearby or other properties the investor can convert into additional units. Another opportunity could be when an investor owns a three-story duplex. The investor could reconfigure this property into a dwelling on each story, resulting in the chance to collect three monthly rent payments instead of two.
Here are a few of the risks of multifamily property investment:
Investing in multifamily properties can also bring a few unique risks. One of the top cons of multifamily investing is the presence of market risks. Factors like local rental demand and vacancies, population growth, supply of competing properties, and current rental rates may impact an investor’s rental income. Other considerations regarding the larger economy include unemployment, interest rates, and inflation.
Investors must thoroughly research the market and location of a multifamily property before investing in it. Part of the risk of a market downturn on multifamily homes is that many tenants could be involved in the same industry, which could be popular in that location. If that industry experiences a slump, a multifamily property could lose multiple tenants. Investors may reduce risk by investing in a property in an area with a diverse local economy where sudden downturns in a specific field might not impact all tenants equally.
There are also risks associated with investing in multifamily properties for commercial purposes, as the financial investment is typically larger and the property may be more difficult to liquidate. Finding a buyer for an apartment complex could be a greater challenge than finding one for an SFR.
The cost of investment can be a significant barrier in real estate. Multifamily homes are typically significantly more costly to acquire than single-family homes, depending on the location. Investors may need to save more money as a down payment for a multifamily property or find alternative investment vehicles, such as Delaware Statutory Trusts (DSTs).
Investors in multifamily homes might over-leverage a property and acquire too much debt compared to the property’s cash flow. This financial risk could occur if a property fails to generate enough monthly rental income to cover loan payments and operating expenses. Over-leverage could lead to the investor defaulting on the loan and the lender foreclosing.
A multifamily property also poses a financial risk if the investor wants to sell. Buyers for multifamily properties are usually more scarce than for single-family homes, and if the investor can’t find another buyer, the property could be challenging to sell.
Despite these risks, securing a loan for a multifamily property may be less complicated than expected. A bank could potentially see a multifamily property as having less foreclosure risk and less financial risk since a vacancy doesn’t impact the income stream as much as a vacancy in a single-family home. However, the loan approval process for multifamily properties with five or more units is different since these properties are considered commercial.
Another con of investing in multifamily properties is asset risk, which is the risk associated with purchasing the asset. A significant aspect of asset risk is the need for capital improvements. Capital improvements include renovations and updates to the property’s structure and key systems, such as its plumbing and electrical systems. Owners of multifamily properties periodically need to complete renovations and repairs that, if left undone, could negatively impact their rental income. There may also be additional repair costs if tenants damage the unit.
Managing asset risk requires researching the asset and determining whether the risk is worth the potential return. Investors might compare the cost of purchasing and renovating the property with the potential rental income it could generate. Factoring in the possible cost of future replacements and repairs can also help investors better understand the property’s asset risk.
Ultimately, these risks are an unavoidable part of real estate investing that investors can manage but not eliminate. Deciding whether to invest in a particular multifamily property comes down to whether the investor considers the risk worth the potential reward.
Depending on your individual investment goals and financial situation, multifamily real estate might be a good investment. Before you invest in multifamily properties, consider a few factors regarding the particular property you’re interested in buying. Knowing a few tips on how to get started in multifamily investments can help potential investors make more informed investment decisions.
A property’s location significantly impacts rental demand. A property needs to appeal to many renters to fill vacancies. Central areas with high population growth and high rental yield could be excellent options for multifamily properties.
A prime location for a multifamily property is relatively close to local businesses, future developments, and other features that could increase a location’s desirability. The property’s neighborhood is also vital when determining the best location for multifamily investment. A well-maintained neighborhood close to several amenities might attract more people under 30, the largest age group among renters.
One of the most important things to consider before investing in a multifamily property is the potential income it could generate. A property’s potential income is affected by its number of dwelling units, location, local rental rates, and more. Competing multifamily properties in the area could also affect a property’s potential income.
Calculating the rental income you’ll need to make from a multifamily property per month to cover the mortgage payment, potential repairs, and other costs can provide an accurate idea of whether a particular property is worth the investment.
Real estate investing in any asset class has a fairly high cost of entry, although properties vary widely in price. When you apply for a mortgage, lenders typically consider your income, credit score, debts, and other assets. Other costs to consider when investing in multifamily properties include renovations, repairs, taxes, and fees. Knowing when and how the property was constructed could also help you predict costs.
Investors will also typically need to pay a higher down payment for a multifamily property mortgage than an SFR, especially if the property has five or more units. These requirements vary by lender, so investors may want to compare financing options, if available.
Another essential aspect of investing in a multifamily property for investors to consider is the property’s seller. The seller’s motivation can significantly impact the purchase price. For example, a bank’s motivation for selling a foreclosed multifamily property is likely different than a for-sale-by-owner property. Understanding more about the seller could provide some insight into the value and condition of the property itself. If the seller has a history of caring for the property poorly, there could be expensive issues to repair.
Managing a multifamily property requires a significant time commitment. Many of these properties have property managers to oversee the daily operation of the property and handle repairs. A property manager and their team also handle tenant applications and complaints. Proper management can boost tenant retention, maintain the property’s condition, and improve the investor’s return on investment.
Investors might consider hiring a third-party management company to handle leasing and maintenance instead of managing the property themselves. For a monthly fee, this strategy can relieve an investor’s administrative burden and increase the success of their investment.
Investing in multifamily properties can provide investors with several tax benefits. The first tax benefit for investors is depreciation. The IRS allows investors and property owners to depreciate the cost of rental property. Depreciation enables investors to regain the value of the property’s physical structure and reduce their yearly tax liability.
The amount an investor can depreciate depends on three factors — the investor’s cost basis in the property, the depreciation method used, and the property’s recovery period. According to the IRS’s Modified Accelerated Cost Recovery System (MACRS), the recovery period for residential rental property is 27.5 years. If an investor holds a multifamily property for 27.5 years, they may be able to recover the cost of the property.
Investors can begin to depreciate their multifamily properties when they put them in service and stop depreciating when they’ve recovered the cost or take them out of service. The more an investor can depreciate in a year, the greater the potential tax benefit.
Investors in multifamily real estate may also be allowed to deduct expenses like mortgage interest, property tax, operating expenses, and repairs from their taxes. These tax benefits can help offset the costs of managing a multifamily property, which is a significant advantage for investors.
Multifamily properties also qualify for 1031 exchanges. A 1031 exchange is a tax-deferred exchange that enables real estate investors to sell one investment property and use the proceeds to purchase another like-kind property within 180 days of selling the relinquished property. Real estate investors can defer capital gains tax and build their wealth by completing the exchange. These exchanges provide several benefits, including capital gains tax deferral and increased purchasing power.
Investing in a multifamily property could scale an investor’s portfolio by two or more units at a time, allowing investors to boost their cash flow opportunities. When an investor can scale their portfolio quickly, it enables them to grow their wealth faster than they could with a property that only brought one source of rental income. Another consideration to keep in mind is that maintenance on a multifamily property is easier than owning multiple single-family dwellings in different locations.
Multifamily homes are also physically scalable. Whereas single-family homes only provide investors with one source of rental income, investors may be able to add more dwelling units to a multifamily property and increase their income. For example, an apartment complex may have land nearby or other properties the investor can convert into additional units. Another opportunity could be when an investor owns a three-story duplex. The investor could reconfigure this property into a dwelling on each story, resulting in the chance to collect three monthly rent payments instead of two.
Although investing always carries some risk, commercial multifamily investment can provide significant yields for investors. At 1031 Crowdfunding, we are a real estate investment platform for alternative investment vehicles. Investors can view our extensive selection of vetted real estate properties, including multifamily properties and several other asset classes. Investors also receive guidance from our expert team as they perform their due diligence.
The management team of 1031 Crowdfunding has a combined 115 years of experience in real estate and has facilitated a combined $2.2 billion in real estate transactions. With our expertise and experience in real estate, we help make real estate investment easier for investors. To learn more about how 1031 Crowdfunding can help you invest in multifamily properties and view our full offerings, register for an investor account today.
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