Why Multifamily is a Gateway for First Time CRE Investors

Multifamily investments have outperformed almost every other commercial real estate property sector. Even in challenging economic conditions, vacancy rates are reaching all-time lows while rents continue to rise. 

Although multifamily investing requires some homework, it’s more straightforward to buy multifamily buildings than other types of buildings for sale. Let’s take a look at why multifamily buildings are a growing gateway for first-time multifamily investors.

What is Multifamily Property?

A multifamily property is a residential building that has more than one unit. Common types of multifamily buildings include:

• Duplex (2 units)
• Triplex (3 units)
• Fourplex or Quadruplex (4 units)
• Townhouses and row houses
• Apartments
• Condominiums
• Cooperatives or Co-ops
• Student housing
• Mobile home parks
• Senior housing
• Assisted living facilities

Multifamily vs. Single Family Investments

First time CRE investors often opt for single family investments without considering other rental property options such as multifamily or apartment buildings for sale. While there are pros and cons to each, there are several distinct characteristics to know about multifamily property. 

For example, every unit in a multifamily home has a unique address and usually a private entrance. Multifamily units have individual kitchens and bathrooms, living rooms, and at least one bedroom. On the other hand, some multifamily buildings may offer less privacy to tenants because of shared walls or common areas such as a central laundry room or parking lot.

Multifamily Asset Classes

Multifamily property is generally categorized in one of three asset classes:

• Class A multifamily property is new buildings with state-of-the-art amenities in the best locations. These properties cost the most to buy but also generate the highest rents.
• Class B multifamily buildings are in good condition with average amenities. Apartment buildings like these often lie in middle-income neighborhoods. They provide a decent balance of risk and reward, with at-market rents and a lower acquisition cost than brand new property.
• Class C multifamily property is basic housing with minimal amenities located in lower-income areas. Also known as “cash cow”apartment buildings, Class C rental property offers below-market rents and is the least expensive for an investor to purchase.

Top Benefits of Multifamily Real Estate

Multifamily real estate can provide unique benefits to first-time and experienced commercial real estate investors. 

Scaling up a real estate portfolio is much simpler with multifamily buildings thanks to their multiple units or “doors”. Dozens of tenants, rather than one central tenant, make financing easier than other commercial real estate types, and property management fees are spread across multiple units instead of a single house.

• Investors can choose from a variety of multifamily product types, from finding a 4 plex for sale in small neighborhoods to bigger apartment buildings, as well as niche multifamily property such as student housing.
• Investors receive multiple cash flow streams from multifamily real estate because one facility generates rental income from each unit.
• Value-add multifamily investing is easier since units can be renovated individually and generate incremental revenue from things like appliance rental or amenity upgrades.
• There’s less risk with multifamily property than other CRE types: people always need a place to live, and renting a multifamily home is cheaper than renting a house.
• Multifamily’s passive income creation is streamlined by hiring a local property manager to handle the day-to-day responsibilities and is perfect for the first-time CRE investor with little experience owning or managing a rental property.

Potential Drawbacks to Multifamily Investments

While there are plenty of benefits to investing in multifamily real estate, there are also some potential drawbacks. 

• Buying a multifamily investment requires more up-front capital because property prices are usually higher. However, the cost per unit of a multifamily building is often less than buying a single family house.
• The amount of money needed in a CapEx account (capital expenditure) may also be larger to ensure emergency funds are available if multiple units require repairs at the same time.
• Competition from other investors for well-positioned multifamily property can be more intense in some real estate markets. For this reason, many first-time CRE investors focus on small two- or three-unit multifamily buildings to add to their portfolios.

How to Finance Multifamily Investments

Many beginner multifamily investors are surprised to learn that lenders are more likely to approve an apartment building loan than one for a single family rental. That’s because banks focus on the monthly cash flow a property generates. 

If the tenant in a house leaves, the vacancy becomes 100% with zero cash flow. On the other hand, if one unit goes vacant in a 20-unit apartment building, the vacancy rate is only 5%, with plenty of cash flow remaining to pay for operating expenses and the mortgage.

Here are some options for financing multifamily investments:

• Conventional loans can be the best choice for buying small multifamily buildings with two to four units.
• Government-backed mortgage loans for multifamily investments from Fannie Mae, Freddie Mac, and the Federal Housing Administration (FHA) are good options for small multifamily property and buildings with five or more units.
• Portfolios loans are non-conforming loans that offer multifamily investors more flexibility in loan terms and conditions. Investors can use them to finance multiple multifamily properties at the same time.
• Short-term multifamily financing options such as hard money loans and bridge loans are best for investors buying multi-unit residential property. These are especially useful if a building requires significant renovation or the owner is repositioning other types of commercial real estate, like turning a hotel into a multifamily property.

Top Markets for Investing in Multifamily Properties

Some real estate markets are better than others for buying multifamily property. Cities where population growth is strong and the economy is diversified should perform best in the years ahead.

The 2021 Emerging Trends in Real Estate report from PwC and the Urban Land Institute identifies the ten top cities for multifamily investors based on current market performance and long-term fundamentals:

1. Raleigh/Durham
2. Tampa/St. Petersburg
3. Salt Lake City
4. Austin
5. Boston
6. Boise
7. Nashville
8. Charlotte
9. San Antonio
10. Columbus

Multifamily Trends for 2021

The multifamily asset class has outperformed almost every other category of commercial real estate. Looking ahead, there are three key trends to consider when investing in multifamily property:

• Construction delays of new multifamily developments in some cities are being pushed back, creating an imbalance between supply and demand. Investors can expect prices to rise over the next several years due to demand from tenants and other real estate investors.
• Millennials are a vital renter demographic and may increasingly turn to multifamily property as a place to live as rents continue to rise across the country and single family homes become more expensive.
• Secondary markets can offer more affordable multifamily property to buy with better yields and cash flows. Inbound migration to small cities from expensive urban areas are keeping population growth healthy and local economies robust.

Although multifamily investing may seem complicated to first-time CRE investors, the exact opposite is usually true. Multifamily buildings come in all shapes and sizes and can be easier to finance than other income-producing real estate types. Buying multifamily property is also one of the easiest ways for new commercial real estate investors to start and grow a rental property portfolio.