Here’s what new investors need to know about investing in multifamily commercial real estate, apartment buildings and apartment complexes.
When most new real estate investors think about buying an investment property, they automatically assume they should buy a single-family home. However, there’s another option: You could invest in multifamily commercial real estate, or apartment buildings and apartment complexes.
If you’re interested in learning more about the multifamily approach, read on. You’ll learn more about what multifamily commercial real estate is, the benefits and risks of this type of investing, and how to get started. Armed with this knowledge, you should have a better idea if investing in multifamily real estate is right for you.
What is multifamily commercial real estate (MFCR)?
At its core, multifamily commercial real estate (MFCR) is a term used to describe residential properties with more than five units. Most often, this term refers to an apartment building or apartment complex. However, there are quite a few different subtypes within the multifamily commercial real estate genre, such as:
- Garden apartments: Typically found in the suburbs, garden apartments are usually walk-ups and two to four stories high.
- Mid-rise apartments: Mid-rise apartments have five to nine stories.
- High-rise apartments: High-rise apartments have over 10 stories.
In addition to that distinction, multifamily commercial property is also divided up into separate asset classes. As an investor, you’ll have the following asset classes to choose from:
- Class A: Class A properties are essentially luxury buildings. They offer high-end amenities like pools and state-of-the-art fitness centers. As you might expect, these properties garner the highest rents, but they also require the biggest investment.
- Class B: Meanwhile, Class B properties still offer a good amount of value in terms of quality, location, and function, but they may not have as many amenities.
- Class C: Class C properties are still functional but generally outdated. These properties offer the most affordable rents.
What are the benefits and drawbacks of investing in MFCR?
Now that you know a bit more about what multifamily commercial real estate is and how it’s classified, the next step is to learn about the benefits and drawbacks of investing in this type of property. Like any real estate investment, there are pros and cons you’ll need to weigh before jumping into the multifamily market. We’ve laid them out below.
The benefits of investing in multifamily property
One of the biggest benefits of investing in multifamily housing is that it might be easier to finance than a single-family home you intend to make into a rental property. While that may seem strange, it’s because a multifamily home often represents less of a risk to the lender. Since there are multiple tenants in the building, there will be less of an impact on your bottom line if someone defaults on their payments than if you were only dealing with a single tenant.
Since multifamily housing offers short-term leases, often only lasting a year or two, there are lots of opportunities for the investor to adjust leases to inflation or current market demand. Unlike other types of commercial leases, which can last many years, investing in this type of commercial space allows you to make adjustments to your bottom line as needed.
The drawbacks of investing in multifamily property
The main drawback of this type of real estate investing is that it comes with a bigger upfront cost. While there certainly are multifamily financing options available, your closing costs and down payment still will be substantially higher than with a single-family home. Unfortunately, the price point for this type of investment property can sometimes put it out of reach for newer investors.
Additionally, maintaining this type of commercial building is often more labor-intensive than a single-family residential home. While it’s certainly an option to hire a property management company to deal with the day-to-day complexities of managing your property, that means your regular overhead costs will be greater.
How to get started investing in multifamily housing
If you’ve considered the benefits and drawbacks of investing in an apartment building or apartment complex and decided this type of real estate investing might be right for you, the last step is to learn how to get started. We’ve laid out a set of guidelines below. Use these steps to learn how you can start adding multifamily properties to your portfolio.
Know your financing options
in general, there are three different ways to finance a multifamily commercial real estate property:
- Government-backed multifamily mortgage loans: Fannie Mae (OTCM: FNMA), Freddie Mac (OTCM: FMCC), and the Federal Housing Administration (FHA) offer multifamily mortgage loan options. They’re typically the best fit for investors who intend to live in one unit and rent out the others, or house hack. Government-backed multifamily mortgage loans are typically easier to qualify for than conventional financing, due to lower credit requirements. However, you’ll still face strict requirements regarding income documentation and cash reserves.
- Portfolio loan: if you don’t qualify for a federally backed loan program, you may be a good candidate for a portfolio loan. Financial institutions set the qualifying requirements and interest rates for a portfolio loan on a case-by-case basis, and these loans are kept on the books, rather than being sold on the secondary market.
- Short-term multifamily financing: Short-term multifamily financing usually comes in the form of a hard money loan or bridge loan. As the name suggests, these loans are short-term and typically a good fit for investors who want to rehab the property or season their experience as an investor before qualifying for more traditional financing.
Review your options
After you have an idea of what type of financing may work best for you, get a sense of what options are available in your area. To do this, you’ll work with a real estate agent. First, narrow the field by letting your agent know what subtype of multifamily property and asset class you’re most interested in focusing on for this purchase. Then, go see any available listings to zero in on the buildings you like best.
Do your due diligence
Before you can decide whether to make an offer on a property, it’s important to do your due diligence. You’ll want to gather any relevant financial documents — including a pro forma — from the seller to ensure the property meets your bottom line. It’s also a good idea to have a licensed contractor perform a property condition assessment for you, which will give you an idea of any necessary repairs or renovations.
You’ll also want to do a market survey. This document will compare your apartment building to competitors in the area to help you determine market rents.
Make an offer
After you’ve ensured a property suits your needs, it’s time to make an offer. You’ll use the figures you’ve worked up while doing your financial due diligence and work with a real estate agent to negotiate the best terms possible. From there, the transaction will continue much like any other.
Hire a property management team
Once the property is in your portfolio, the first thing you should do is hire a reputable property management team. Unless you’re planning to make a career out of property management, there likely will be too much work on a day-to-day basis for you to handle on your own. After you get above two or three units, hiring a property management team can be a worthwhile expense.
The bottom line
Since multifamily buildings allow you to manage more than one tenant at a time, investing in multifamily commercial real estate can be a great way for investors to diversify their portfolios and increase their cash flow. However, before getting into this business, it’s important to understand the pluses and minuses that come with buying this type of building or complex. To that end, use this guide to help you decide whether buying multifamily real estate is for you.
By Tara Mastroeni
Tara Mastroeni is a real estate and personal finance writer. Her work has been published on sites like Forbes, Business … Learn More