3 Tips for Investing in Multifamily Properties
Investing in real estate is a fantastic way to create a stream of income outside of a W2 wage day job. Some people invest aggressively enough to make rental income their main source of income. Alternatively, others see it as a way to support their retirement down the road. Whatever the end goal of investing in rentals is, the hardest part is getting started. Securing and managing that first property is going to be a learning experience. To add complexity, different rental home types have different pros and cons.
If you’ve made a firm decision to invest in rentals, multifamily properties are oftentimes the best bang for the buck. Developers connect multiple units together rather than building individual houses that might not be anywhere near each other. In addition, there are some financial advantages to financing and bookkeeping. Here are three things to keep in mind if you’re thinking about multifamily property investment, even when capital is limited.
1. Look For Beneficial Financing For Multifamily Property Investment
Depending on how many units are in a multi-family property, the cost can be a detractor for potential investors. A duplex and a single-family home with comparable square footage might only be slightly different in price. A four-unit property, on the other hand, could easily be 2-3 times as much as a single-family home.
Unless the buyer has a great deal of income from other sources, a traditional mortgage might not be an option. Mortgages don’t take the prospective income from the property into account. Rather, they assume earned income at the time of application needs to cover the monthly mortgage payment.
Thankfully, there are other options for those without large incomes. A DSCR Loan (debt-service coverage ratio) is available for those looking to buy commercial or multifamily real estate.
These loans take into account how much revenue will likely be generated and compare that against the monthly debt service. At a bare minimum, the buyer usually needs to have a 1.00 debt service ratio, but most lenders require at least 1.25.
Maybe you need to borrow $1,500,000 to purchase a 10-unit property. A 30-year loan at 6.5% interest would have an approximate monthly debt service of $9,480.
Renting out all 10 units at only $900 per month would give you a monthly income of $9,000. That falls short of covering the $9,480 debt service. To get a coverage rate of 1.25, you would need to charge at least $1,185 in rent per unit. If the property cannot support those rates, you are unlikely to qualify for a DSCR loan.
With a high DSCR, you have more bargaining power with your lender. If your monthly income from a property will be five times the debt service, the lender will want your business. This can give you some leverage with interest rates and down payments.
2. Get Creative in Multifamily Property Investment if You Have Limited Cash.
Few people with multifamily property investments have long-term goals of living in one of their units. That doesn’t mean you shouldn’t dismiss the option when you’re first getting started. For some first-time investors, this might be the only way to afford a multifamily property.
Those who finance their multifamily property investments through a traditional mortgage might find themselves strapped for cash when first starting out. Not having an additional mortgage for a personal home could free up some much-needed funds. Also, it can be beneficial if the property needs some upgrades before a justifiable rent increase.
For example, let’s say a married couple buys a duplex in need of some moderate repairs. The owners could live on one side while renting out the other side at pre-established rates. Any upgrades could be done on the owners’ side while they’re living there. It’s an especially handy arrangement if the owners are doing most of the repairs themselves.
Once you achieve an upgrade on one side, you can move into the other side once the tenant’s lease is up. You can raise the rental rate on the upgraded side and repeat the upgrade process on the side you’re now living in.
If it sounds like a nightmare to live through two upgrades, it might be. But for those who cannot afford it any other way, the effort could very well pay off in the long run.
3. Choose Your Level Of Involvement
If you own a couple of duplexes, you can probably keep on top of recurring tasks. Rent collection, paperwork, background checks, and scheduling maintenance get more time-consuming as you add units to your portfolio.
Part of your long-term investment planning needs to include your level of involvement. If you begin accumulating a significant number of properties or units, managing them can be a full-time job. That’s perfect if you’ve planned for that eventuality.
However, if you have a career outside of investment properties and want to maintain that, you might need help. You could hire an individual to manage your properties or engage with a property management company.
If you do acquire management assistance, make sure to thoroughly investigate the competency of whoever you hire. Ask around with other rental property owners. Is there one management company that keeps coming up over and over with a less-than-stellar reputation? If so, don’t ignore that, no matter how big or well-established the company is.
And even if you hand over nearly all the management work to a third party, you still need to check in regularly. Make sure that hidden fees not previously agreed upon aren’t decreasing your profits. Also, look into standard rental rates and compare them with what is being charged at your properties.
Trust in your management partner is a great thing, but you’re ultimately responsible for the profitability of your multifamily properties.