Multifamily properties have served as an enticing real estate exit strategy for those entrepreneurs looking to generate cash flow, and for good reason: the right multifamily property can make for one of the best investment decisions over an investor’s career. The wrong one, however, could quickly become a nightmare. That’s why it’s absolutely imperative to learn the proper steps of buying a multifamily home. If for nothing else, a good gameplay will help investors decide if the return on investment is worth the mortgage they will ultimately take on.
There are many steps involved in the purchasing of multifamily properties, and everyone has their own opinion on the topic. However, there are six universal steps that can’t be left out. Of course there are intricate details that will vary from deal to deal, but the following steps should be a priority in the event an investor chooses to buy multifamily properties:
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The golden rule of real estate is more relevant today than ever before: location, location, location. The area an investor decides to buy a home in is of the utmost importance, and needs to be considered before buying a multifamily home. In fact, investors are advised to not even start looking at homes until they are confident they want to invest in a respective neighborhood.
Investors will first need to know their own goals. What is it they hope to achieve by investing in real estate? It is impossible to know how well a neighborhood will facilitate an impending deal if the investor is uncertain what they hope to accomplish. At the very least, different neighborhoods are better suited for different exit strategies. A good neighborhood for a rehab doesn’t necessarily mean the same thing for a buy and hold.
For the sake of buying a multifamily home, however, investors will typically view their investment as long-term commitment. The majority of the research will, therefore, consist of an area’s future potential. Buying a multifamily investment property will certainly benefit in an area that is “up and coming.” In particular, prospective investors should look at things like:
Each of these aspects, and many more just like them, are very telling of a neighborhood’s potential. Therefore, investors will make sure they get a feel for them before buying in a respective area.
Prior to even looking for a multifamily home, investors will need to secure financing. That way, they will have a better idea of what they can afford when the time comes to make a purchase. Likewise, securing financing beforehand will save them a lot of time and headaches down the road when the search process begins. There’s nothing more frustrating to investors that find the multifamily property of their dreams, only to find out they can’t afford it. As a result, it’s a lot smarter to know how much you have to spend before you start shopping.
Typically, real estate investors will look to private and hard money lenders for their purchases, as these types of financing offer the perfect short-term underwriting for rehabs. However, buying a multifamily home is different from buying a “fix and flip.” Buying a multifamily investment property will require a long-term loan, not unlike one from a traditional lender. Banks, for example, offer long-term loans with relatively low interest rates at the moment (perfect for a long-term buy and hold). When shopping for a loan, be sure to shop around and pay special considerations to the following:
With the proper financing secured, investors will also want to make sure they receive a pre-approval letter. Doing so will make any future transactions a lot easier on everyone involved.
While many investors are perfectly capable of buying a multifamily home without the help of a Realtor or agent, there is a significant benefit to be had by enlisting the services of another professional. Sure, their expertise will come at a price, but a truly great agent is a wise investment. Working with a good agent could actually end up saving investors a lot of time and money in the long run. Not only should a good agent be able to find and identify the best properties in a given neighborhood, but they should also be able to negotiate better terms and prices. Their expertise alone could end up saving investors more on the home than the cost of Realtor fees.
Again, investors are advised to know what they want out of an investment before they commit to a purchase. That way, they can tailor their search criteria to the things the real estate assets that will be best suited to help them attain their goals.
Once investors know what they want out of a home, they should narrow down their search results based on the properties that best fit their needs. Meanwhile, the previously discussed pre-approval letter will play an integral role in deciding which homes to look at, drastically reducing the pool of potential candidates. Once investors have several viable homes to choose from, they should make their decision based on “the numbers.” Pay special considerations to a home’s net operating income, as it should give investors a good idea of how much money they stand to earn in rent each month.
Once the multifamily property with the most promise has been decided, it’s time to submit an offer. However, instead of submitting the offer themselves, investors should rely on their real estate agent. It is the agent’s job to submit the correct offer and rebuttal with any negotiations that may arise. This is where you will appreciate the cost of their services. After all, a good agent may be able to save buyers thousands of dollars, perhaps even a lot more than it costs to hire them. It is worth noting, however, that multifamily offers tend to coincide with more contingencies than a traditional single-family home. More due diligence is require with more units, especially regarding the asset’s rental history.
In the event an offer is accepted, the only thing left to do is close the deal. At this point, investors will need to finalize their funding—this is where the pre-approval letter comes in handy. Investors will also want to make sure they have everything in order, especially funds, property insurance, and landlord insurance. Next, a closing date will be scheduled where everything will pass through escrow and complete the deal.
There are countless things to consider when evaluating multifamily properties, but real estate professionals and pundits alike are of the consensus that the following factors are among the most important to consider before you decide to strike a deal:
Real estate has become synonymous with one golden rule: Location, location, location. Nothing holds more value in a respective property than the plot of land on which it is situated. More often than not, it’s the location you are paying for, and multifamily properties are no different. That’s why, when you evaluate multifamily properties, one thing should be taken into consideration before anything else: where the property is located.
Remember, you can always change the property—renovations can go a long way in adding value to a multifamily real estate investment. However, for obvious reasons, you can’t change the location. With that being the case, you need to make absolutely certain that the location you buy in is conducive to what you intend to achieve.
There’s no doubt about it: the location will play an integral role to the way things unfold with a multifamily investment property, and those investors that listen to what the area is telling them could find themselves ahead of the curve. In other words, if you know what to expect from the majority of your prospective tenants, you will find reducing vacancies and marketing to be that much easier.
Unit composition, or a fancy way of identifying the amount of units a multifamily property holds, should the second thing you take into consideration when you evaluate multifamily properties—second only to location, of course. Not only will the multifamily building’s unit composition give you a better understanding of what exactly you are getting into, but also a better idea of the type of cash flow one could come to expect from the respective property. If for nothing else, each individual unit will be expected to produce cash flow, and it’s that cash flow that will help justify the purchase price. You see, once you have an idea of just how much each unit may produce in rent (which can typically be calculated by what the market dictates), you will have an idea as to whether or not the cash flow justifies the purchase price.
At the very least, the rent you collect from a multifamily property on a regular basis should be enough to offset the mortgage—and then some. Of course, you will need to account for vacancies (which are inevitable), but rents in America are so high right now that even multifamily properties with a few vacancies can produce enough cash flow to cover the cost of the mortgage, and perhaps even allow you to put some money away for a rainy day.
The “as-is” condition of the multifamily property may not be on par with those comparables. And if that’s the case, you may need to put in a little leg work to make sure your units can compete with others in the area. If you are looking at buying a multifamily property that needs some work, you will need to identify the after repair value (ARV). What would a unit rent for if it was comparable to similar units in the area? Again, the ARV can typically be narrowed down by looking at nearby units with similar traits: Square footage, number of rooms, number of bathrooms, location, etc.
In it’s simplest form, the income potential of a prospective multifamily property can be easily identified by comparing it to what else is on the market. Comparables will merely give you a starting point; there are ways to fine tune your actual rent, but that topic will be reserved for another time. For now, it’s important to know how much each unit has the potential for bringing in, and if that potential is worth the initial investment and monthly mortgage obligation that will follow.
Not excluding the initial cost of the property, investors looking to evaluate multifamily homes need to have a firm grasp on the costs they will incur by taking on the asset. If for nothing else, the purchase price is just the beginning. To evaluate multifamily properties correctly, you need to account for each additional cost. Investors need to be aware of expenses that run the gamut from property taxes to rehab costs, and everything in between. It’s in your best interest to account for every expense and weigh them against the profit potential. If your numbers are in the green afterwards, you may have found yourself a promising multifamily investment deal; if not, you may want to keep looking.
I am convinced that one of the most overlooked factors in evaluating multifamily properties has nothing to do with the property itself, but rather the person managing it. That said, the manager has a huge role in deciding whether or not the property becomes a valuable asset to your investment portfolio. And whether it’s you or a property management company, the one chosen for the job had better know what they are doing. Because even a great property can go wrong in incompetent hands.
Knowing full well that a great property management company can elevate even average properties, I highly recommend aligning yourself with a professional. That’s not to say you aren’t capable of managing the multifamily property, but a trained professional will most likely know how to do everything you already know how to do, and more. There is no reason to believe that the right property management company can’t run every aspect of the property while you sit back and collect rent checks. What’s more, it’s that manager’s assistance that will allow you to pursue and acquire other assets. With the responsibility of running your multifamily property squarely on the shoulders of the manager, you are free to acquire more homes and add to your portfolio. Conversely, if you don’t hire a property manager, you could find the majority of your days consumed by menial tasks that could easily be done by someone else.
If you want to learn how to evaluate multifamily properties, there is no better place to start than with these five fundamental indicators. While they don’t make up everything you absolutely need to know about a property, they can’t be left out. Do yourself a favor and be absolutely certain to evaluate these factors before you decide to make the jump into multifamily properties.