Simply put, a multifamily home is any residential property with more than one housing unit.
These could be duplexes, triplexes, fourplexes, apartment complexes, or really anything that involves multiple tenants living in occupied units on one property. Owners can also live in any of these units, making it an owner-occupied property—something we call “house hacking,” typically done with residential multifamily properties with two, three, or four total units.
Properties with more than four units are deemed commercial, while four and below are deemed residential. This distinction is important for lending purposes, as residential multifamily lending rules differ from those for commercial investments.
In addition to the lending distinction, larger multifamily properties may have different methods for finding, analyzing, financing, and managing the property. For this reason, most investors getting into multifamily start with small residential properties and move into larger multifamily deals once they’ve gained some experience.
Now, let’s review how amazing these properties are and why you need them in your portfolio.
Single-family rentals are often the target of real estate investors, but they don’t realize the power of multifamily real estate investing. With single-family homes, you put all your eggs in one basket with only one tenant. You have tenants, or you don’t; the tenants are either good or bad, and there is no in-between. You don’t have ways to offset any downsides, especially in the long term.
With multifamily real estate investing, you have a larger tenant mix and a lower 100% vacancy risk in your real estate investment portfolio. The chances of having all non-paying or ‘bad’ tenants are slim. While you might have a unit with troublesome tenants, the tenants from the other units may offset it, especially if you have two to four units.
My first rental property was a small two-unit duplex I bought when I was 21. Later I bought another duplex, a triplex, some fourplexes, some apartments, and some mobile home parks. Now I have more than 2,000 rental units across a dozen states—almost all multifamily. This allows me to live where I want, pay all my bills, give generously, and work far fewer hours than most.
That’s the power of multifamily real estate.
Investing in multifamily properties can change your life, whether you want just a few small deals or a real estate empire. It’s similar to investing in single-family houses, but you’re at Costco instead of shopping at Walmart. You’re buying in bulk and can quickly scale up your passive income and net worth faster than you think possible. And hey, it’s a lot of fun!
Simply stated, multifamily properties are one of the easiest ways to climb your way to millions of dollars in real estate and give you the life you’ve dreamed of.
And the great thing is that anyone can invest in multifamily, regardless of location, income, credit, experience, or bank account—if you know what you’re doing.
I love multifamily for a lot of reasons. But since you don’t want to spend the next three hours reading while I lay them all out, let me just give you four good ones.
Cash flow is the name of the game in real estate investing. When trying to get the most bang for your buck, purchasing multifamily homes is a great course to take. Why? Because multifamily properties are designed for cash flow.
Think about it. When someone builds a house, what’s usually the purpose? For someone to live in it for themselves.
A single-family home is not designed for cash flow but for comfort (yes, single-family homes can still cash flow—it’s just harder because they aren’t designed for it). Conversely, a multifamily property is generally built and sold for investment purposes. In other words, it’s designed to make cash flow.
Be careful, though. Just because it’s a multifamily property doesn’t mean it’s going to cash flow. Many different factors determine one’s monthly cash flow. There’s the mortgage payment, insurance costs, property taxes, utilities, repairs, management, saving up for replacing big items (which we call “CapEx” in the real estate world), and more.
Wealth is not built by purchasing a property but by building a real estate portfolio. In other words, it’s not one deal that will get you the wealth and freedom you want, but the collection of many rental units.
Sure, you can buy a house every year or two, but that’s a slow path toward generating enough cash flow to quit your job, travel the world, buy a Tesla, or whatever your goal is. Multifamily housing, on the other hand, can automatically add numerous rental units to your portfolio at once, helping you scale fast.
When you own a house and that house goes vacant, you’re 100% vacant, earning no money from that unit. But if you own multifamily properties, if one unit needs repairs or is vacant, you have other units that can carry its slack for the time being. That makes multifamily units a powerful asset, especially for a beginning investor.
Finally, there’s the power of house hacking, the process by which you’ll live in one unit and rent the others out. Multifamily makes this possible!
For example, let’s say you buy a triplex, and your monthly mortgage payment for the property as a whole is $1,500. You rent out two of the units for $650 and keep one for yourself. Your individual mortgage payment is $200 per month. That’s a bargain!
The first step in finding multifamily properties is clearly defining what type you want. I break down this step into something I call your “crystal clear criteria,” which includes defining the following.
You can better hunt for those deals once you’ve defined exactly what you’re looking for.
However, this is where we need to look at another difference between small multifamily and large multifamily.
Small multifamily deals are usually sold through real estate agents. You can search for them on websites like Realtor.com or Zillow, or even better, get yourself a rock star real estate agent who understands real estate investing to help you get those leads automatically.
It’s also possible to find these small multifamily deals off-market, meaning you directly market to owners of multifamily properties to convince them to sell you their property before they list with an agent. There are numerous off-market deal-finding strategies, but the most common are direct mail marketing, driving for dollars, and networking with owners or wholesalers.
When it comes to larger multifamily properties, while the same off-market strategies exist and can work, most sales happen through commercial real estate brokers.
These brokers are constantly networking with multifamily owners. When an owner decides to sell, the brokers will put together a fancy sales packet and attempt to find a buyer for that deal through their buyer clients. If they can’t find a buyer directly through their personal network, they may list the property for sale online through a commercial real estate sales portal such as Loopnet or Crexi, which you can visit to look through potential deals.
The key to finding multifamily properties is creating a consistent funnel of leads to pursue and then running the numbers to determine how much you can afford to offer. But how do we “run the numbers?”
When investing in multifamily real estate, there are many factors to consider, including the following:
Purchase multifamily real estate in areas with a large need for rentals. Also, look for properties next to amenities, such as public transportation, retail stores, and other necessities, to attract suitable tenants.
Know the property’s condition and any necessary work to bring it up to par to ensure you have rental properties renters want to live in.
Assess the area’s demand. Purchasing multifamily real estate in areas where renters don’t look won’t yield the rental income you desire.
Assess all current property expenses, such as property taxes, insurance, utilities, and any other expenses you’ll incur as the property owner.
Determine if you can manage the property yourself or if hiring a property management company is best. If so, consider the costs. If this is your first property, shop around to get an idea of the different rates each property manager charges in the area.
Look at the current market rental rates, the area’s vacancy risk, and what comparable properties get for rent, considering any differences that would increase or decrease your potential income.
I often say that deal analysis is the most important skill an investor can have. When you know how to do the math, you’ll avoid buying bad deals, have an easier time using other people’s money to buy those good deals, and achieve your financial goals faster with far less investment risk.
But not everyone likes math, and understandably so. It can get complicated, especially with multifamily.
Unfortunately, it’s hard to make good investments without crunching numbers. After all, investing is just one big equation. Rather than saying, “I don’t know how to do the math, so I’ll just wing it,” let’s take the time to learn.
Experienced multifamily investors typically prefer “underwriting” to “analysis.” They are basically the same concept, but underwriting is the industry term, so be sure to use it if you want to look smart.
Underwriting involves two distinct parts.
When I say “collecting the data,” I mean understanding what you are dealing with.
Most of these data points can be learned by talking with the broker involved in the sale or by asking pointed questions of the seller. Additionally, at least for on-market, listed properties, the broker will assemble this data ahead of time and place it into the sales document. But be warned—these sales documents are meant to sell you on the deal, so never trust them. Verify each point to be sure it’s not an overly optimistic estimate or a flat-out lie.
The key to data collection is wrapping your head around the entire project so you can make the best-informed underwriting. You wouldn’t want to buy a multifamily property only to find out later that the city has a special monthly fee that will cost you thousands of dollars a year.
In just a moment, we will analyze a hypothetical multifamily deal, so let’s go ahead and create some hypothetical data points now.
What are we looking at here? When investing in multifamily deals, I look for several key metrics.
In the case of our example property at 123 Main Street, we can see that this property is projected to produce more than $200 per month per unit in cash flow (which is above my metric goal), 7.46% cash-on-cash return (which is just slightly below my minimum), and a five-year annualized annual return of 16.85%, which is above my goal.
Now, if I want to achieve all three of these metrics, I have a choice: I can give up and go back to the drawing board since this property only works for two of the three, or I can simply lower my purchase price slightly to determine at what price I will achieve my goal.
This is how underwriting works. You find the number that works, and you go after it. You keep out the emotion. You stick to the math. And you pursue the deal based on the metrics you’ve defined as important.
A good ROI for multifamily real estate depends on several factors, including the area, market value, and asset classes. A good ROI, however, is 12% to 18%. What’s good for you depends on your investment strategy. For example, some multifamily property investors may accept a lower ROI for a lower vacancy risk, while others prefer a higher risk and higher ROI, including higher monthly income.
The key is to determine if you prefer higher returns or lower risk. Residential real estate isn’t always high-risk, but any investment strategy in the real estate market has risks, including a total loss in extreme situations.
Now this is a loaded question.
First, as with all things in a capitalist society, something is worth what someone else is willing to pay for it. But that’s a lame answer, so let’s go deeper.
What’s it worth to you?
In other words, what price can you pay to make your deal turn into a solid investment for you? For example, if your goal was an 8% cash-on-cash return, the deal above should pencil out above that number at a purchase price of $970,000. But is it actually worth $970,000?
Well, let’s go one step further in terms of valuing a multifamily property and look at how an appraiser would evaluate the property.
First, this is another distinction point between small and large multifamily. Smaller, two- to four-unit properties are generally valued the same way single-family houses are: by looking at what similar properties have sold for. An appraiser would look at recent sales (“comps”) and assume that the target property will be worth around the same amount.
When we’re talking about larger multifamily properties (five units or greater), appraisers have a different way of determining value.
Because it’s hard to find identical properties to compare one’s large multifamily to, appraisers instead look at the profitability of the investment and compare that to other commercial real estate investments in the area. This concept alone is enough to write a whole chapter on, but simply stated, the value of a large multifamily property can be determined using the following formula:
Net Operating Income (NOI) / Cap Rate = Value
So, if a property’s NOI is $500,000 per year, and the normal cap rate in an area is 5%, then:
$500,000 / .05 = $10,000,000
Does that mean you should only pay $10,000,000 for this property? Not necessarily. Maybe the property needs to be improved. Maybe you can get it cheaper. Maybe you can increase rents immediately, so overpaying might make sense in the grand picture. Remember, regardless of these cap rates and NOI formulas, the property is worth what makes it a good deal for you. So, work backward, stick to the math, and buy a great small multifamily deal.
There are plenty of loan types that you can get to finance your multifamily property. Here’s a quick list of the most common ones.
In addition, there are many creative strategies that can allow you to invest in real estate with significantly less money, even no money. Perhaps the most common no/low money down strategy is that of utilizing partnerships, where one partner brings most (or all) of the down payment. The other partner handles the rest (such as finding the deal, negotiations, offers, due diligence, closing, and managing), and profits can be split however the two parties choose—often 50/50.
Now that you’ve figured out your financing route (it’s usually a good idea to do this before making offers so that you’re not wasting anyone’s time), and you know exactly how much you can pay for the property to make it worth buying, it’s time to make an offer and negotiate a deal.
If you’re using a broker, they can draw up all the legal documents and make sure all your i’s are dotted and t’s are crossed. If not, consider using an attorney to help make your offer.
The document you’ll use to make your offer is known as a purchase and sale agreement, or simply “the P&S.” However, when dealing with complex multifamily property transactions, it’s customary first to submit a document known as a letter of intent, or LOI. The LOI is a much simpler document—usually just one page—that spells out the important stuff, such as who you are, the amount you are offering, the date you’ll close, and how you’ll finance the deal. The LOI, although not legally binding, allows both parties to negotiate before spending thousands of dollars and weeks of time on the thousands of small items found in the P&S.
After making your offer, you may get a yes, a no, or a negotiation.
If competition is intense (which it often is), you should do whatever you can to entice the seller to pick you.
One way to do this (beyond price) is to give a shorter closing time. Instead of the standard 30-45 days, offer to have the deal done in two weeks. This may put a lot of pressure on you as a buyer since you’ll have to run through inspections and more during the due diligence period, but sometimes letting a seller know that their payday is in two weeks is enough to make them bend a little. But note that quick turnarounds on closing might eliminate financing options like conventional mortgages. Be aware of the risks.
You can also offer more earnest money. This is a percentage of the property’s price given as a deposit to show your seriousness about the purchase. More money can indicate more commitment. Typically, earnest money is between 1% and 3% of the purchase price and is generally refundable if you back out for reasons outlined in your offer up to a certain time period defined by the offer.
The due diligence period is a set amount of time before closing, where the buyer can pick apart the property with inspections and tests to ensure that they want to make the purchase. It also gives time to finalize financing and ensure everything closes smoothly.
One of the most important things you can do during this time is get an inspection. This will help determine whether you’re making the right investment.
You’ll also use this time to dig into the financials of the investment, double- and triple-checking that your estimates for income and expenses are accurate. Insurance can be ordered during this time, management can be hired, financing is finalized, and lawyers or the title company will handle the legal paperwork and title searches.
Whatever else you decide to do during this period, ensure you’re getting it done before it ends so that you don’t find something that ruins the deal later when it’s too late to back out.
When your due diligence period is up, there’s only one thing left to do: Close on your new multifamily property!
When it comes to managing your multifamily, you have several options. With a smaller multifamily, you may choose to manage it yourself. Managing tenants is not an overly complicated process, but there are some vital legal and functional rules and processes you should follow.
But landlording is not for the faint of heart or weak of will. You will need to be professional, firm, and systemized. You must learn how to advertise vacant units, screen tenants, sign leases, and handle problems when they arise (and they will).
If you choose not to manage the units yourself, you must engage a professional property management company. Typically, these companies charge between 5% and 10% of the rent collected as their payment, plus other leasing fees. However, this can give you a significant amount of your time back, allowing you more time to find other deals (or to lie on a beach). Remember that even if you hire a manager, you’ll still need to watch over the manager and ensure they are doing a good job—or you’ll need to replace them.
Become homeowners. AFC Mortgage Group will help you navigate the loan process, secure financing, and purchase your dream home.
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