So you’ve resolved to leap and invest in commercial real estate – congrats! Now, where to get started? There are diverse opportunities to pick from!
Commercial real estate is a catch-all term for describing many distinct types of income-generating property. The primary product categories include multifamily, office, retail, hospitality, industrial, and land development. Each product type has its nuances, and each can be equally lucrative. It is essential to identify the variations between these before choosing to invest in one product type versus another.
There’s a sturdy, often more worthwhile category known as multifamily investments. This class of investing incorporates all sorts of assets that you contract to varied residential and tenant groups, including apartment complexes, condos, duplexes, townhouses, mixed-use buildings, and the rest.
We’re biased to multifamily for each of the grounds outlined below.
Multifamily real estate is relatable.
Most investors have either lived in an apartment or owned their own home at some point in time. Many have done both. Therefore, it’s comparatively simple to understand the mechanics of multifamily real estate. Find a property. Run the numbers. Be sure the monthly rents exceed the net operating expenses (i.e., be sure there’s a profit). Ascertain whether there’s room for further upside. Make renovations as needed. Show units to prospects, lease and collect rent checks accordingly.
Sure, that’s a gross oversimplification of multifamily real estate. But you get the point! Multifamily is probably the most natural product type for folks to understand. Units all include a kitchen, bathroom, and some mixture of bedrooms and living rooms. Straightforward enough. There are HVAC and other building systems to maintain, but these aren’t all that dissimilar than those in our own homes. Pay taxes and insurance, just like you would a single-family home. Multifamily is exceptionally logical, whereas the subtleties of other product types can be much more challenging to grasp.
The potential revenue is high and stable.
Money talks with multifamily properties. Although the original investment is higher with more significant communities, the reoccurring revenue is much healthier to counterbalance it. If you do your analysis and advertise well, your earnings capacity will be considerably elevated well beyond that of a single-family unit. Run the numbers on a property, and you’ll promptly see the potential profit. You can also check out this thorough guide to the profitability of owning multifamily property.
The lease structure makes it easy to add value.
Multifamily leases are typically short-term, running either month-to-month after a lease, 6-7-9 months, or year-to-year. Infrequently do apartment lease agreements exceed one year without front-end incentives. Compare this to office, retail, or industrial, for example. Leases for these other product types usually begin at five or seven years, often running upwards of 30 years or more.
One of the advantages of holding real estate with short-term leases is that it becomes easier to add value over time. As units turn over, you can apply the throttle and inject capital before re-leasing the unit. This allows an owner to add value in a cyclical manner where, unlike the other product types, you might have to wait 5-10+ years before going in and making improvements that will enhance the property’s value—and when that time comes, the improvements must be done all at once, which can prove cost-prohibitive for some owners.
Many short-term leases lower risk.
Not only do multifamily properties have short-term lease options, but they also have many existing short-term leases. This is advantageous for several reasons. First, you aren’t putting all of your eggs in the basket of one or very few residents the way you might be with other product types. If one resident defaults on their rent, you still have many others carrying the mortgage payment. Compare this to a single-tenant office building or anchor tenant in a strip mall. If that tenant has a bad month and can’t pay rent, the owner has to foot the entire bill in the meantime. Imagine a scenario where the tenant in a single-tenant property can’t pay rent for months on end? We see what has happened to many malls across America. Retailers have declared 8,600 store closings or abandonments in 2019 alone. An owner can quickly lose the shirt off his back!
A perk of having multiple short-term leases is that it decreases risk. If there’s a resident predicament, it’s easier to evict that resident when you know rents are coming in from other units. Worst case, the lease will only last through the year, in which case you can elect not to renew the lease and bring in a new resident in their place. Residents will come to you with some effort on your behalf, making it easier to keep your units occupied and your profits high. Intelligent property managers also keep applications on file so that if vacancies arise, they have a list of likely prospects to fill them immediately. Multifamily is one of the only product types to offer such flexibility.
There are plentiful tax incentives for this investment class.
Tax benefits are virtually identical for any income asset. You can subtract mortgage interest, associated costs, and depreciation. Because of the scope of the investment, the tax breaks are more stout. Depreciation transpires over 27.5 years for any property. That number is sufficiently higher for a more substantial for a high-value asset, shielding your yearly expenses from this huge hit.
Furthermore, handling taxes for multifamily homes are typically uncomplicated. You don’t have to separate tax bills or need to produce duplicated returns for multiple single-family units—you just have one for the complete building.
Multifamily is easy to underwrite.
For anyone weighing investing in commercial real estate for the first time, multifamily is an excellent choice because of how straightforward it is to underwrite. While we usually suggest you do more than a “back of the envelope” calculation, most multifamily numbers can be run with great simplicity. An excel spreadsheet is all you need to create a basic pro forma. There are fewer, less involved inputs than other asset classes. Multifamily comes down to fixed expenses (such as taxes and insurance), variable costs (interest rates, maintenance), and projected incomes (rents + any income from ancillary sources such as laundry, parking, valet trash, etcetera.). These numbers can be easily be totted up to project cap rates, the internal rate of return (IRR), cash-on-cash returns, and more. For a circumspect investor, starting with multifamily is an exceptional way to become more accustomed to the numbers behind a deal.
The price per unit is reduced as related to single-family units.
Savvy proprietors will distinguish the price per unit when working with multiple property investments. Those who have numerous single-family units will discover that it’s much more costly to sustain each home than it would be to manage a single building in a community. That’s resources that leave your pocket.
When tallied together, the charges for maintenance, landscaping, property taxes, insurance, and other associated fees will be significantly higher than a single multifamily unit. This is due to multiple factors, including travel time for your maintenance and landscaping partners, rises in property taxes for particular neighborhoods, disparities in hazards calculated by your insurance company, and the like.
Multifamily buildings appreciate faster.
Several determinants contribute to the overall value growth of a residential unit, but you’ll find it more effortless to accelerate the appreciation of a multifamily building vs. a single-family residence. With the last-mentioned, you’d want to make costly improvements to the property such as windows, siding, roof, exterior paint, bedroom or bathroom additions, etcetera.
With multifamily properties, these updates can be of benefit, but they’re not always required. In many cases, you can boost the value of a property by merely improving the net operating income (NOI) each year. Contingent on the cap rate in the area, you could advance your property income ten times the value that you increased your NOI.
Everyone needs somewhere to live.
Multifamily is an elastic product type. Despite where we are in an economic cycle, people need somewhere to live. During a healthy market, people are willing to pay up for new multifamily buildings more so than they might be during a down market. Yet even in a down market, people need somewhere to live. One of the reasons multifamily holds its value so well is that even in a down market, demand for multifamily remains strong.
Consider the Great Recession. When the housing bubble burst in 2007-2008, hundreds of thousands of people lost their homes to foreclosure. Those who would otherwise have owned their real estate were then pushed back into the rental market, creating further demand for multifamily. When the economy recovered, it took some time for these folks to restore their credit to repurchase a home. Some decided to forego homeownership altogether. This confluence of factors continues to drive multifamily housing to this day.
CONCLUSION
As you can see, there are numerous reasons to invest in multifamily as a product type. This isn’t to say that multifamily is foolproof—quite the contrary. For example, some may argue that multifamily is much more management intensive than the other product types. But a strong management structure, including a property management team and their vendors, can result in a highly lucrative investment.