Investing in Multifamily Real Estate

There are many reasons to consider investing in multifamily real estate—including reliable passive rental income, value appreciation, and recession-resilient returns. Read on to learn more.

Updated
October 25, 2022
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Commercial real estate was previously considered an "alternative" asset class, especially compared to more traditional stocks, bonds, and equity investments. Yet its strong and consistent performance in recent years has helped commercial real estate investing become more mainstream. 

Today, investors are lining up to invest in commercial property, particularly multifamily real estate which is a key product type in commercial real estate.

In this article:

What is a Multifamily Property?

A multifamily property is considered any property with two or more units. The smallest multifamily property is a duplex with two residential units. However, multifamily real estate also includes large apartment complexes with hundreds of units.

There are multiple subsets of multifamily property, including student and senior housing.

Most people who invest in multifamily property buy buildings with five or more residential units. These multifamily properties are considered "commercial" real estate and qualify for commercial loans instead of residential mortgages.

Five Things that Make Multifamily Investing an Attractive Investment

While broad-based commercial real estate can be a lucrative addition to any portfolio, there are specific reasons to consider investing in multifamily property.

  1. Cash flow: People who invest in multifamily real estate benefit from steady, predictable cash flow that is returned to investors regularly. 
  2. Stability: The stock market is prone to dramatic ebbs and flows. Multifamily real estate is significantly more stable. It has a low correlation with the stock market and continues to perform well despite other economic turmoil. 
  3. Diversification: Investing in multifamily real estate is a great way to diversify one's portfolio away from more traditional stocks, bonds, and equities. Multifamily investors can invest in various asset classes (Class A, B, or C multifamily) and multiple geographies. Passive investors can also invest alongside different sponsors who are in charge of managing and operating the asset, allowing for further diversification. 
  4. Inflation resilience: Multifamily real estate performs exceptionally well in an inflationary environment. This is because most owners utilize fixed-rate debt. Therefore, they can keep costs low while increasing rent annually as inflation rises.
  5. Recession resilience: While no asset is genuinely recession-proof, multifamily property tends to be recession resilient. This is because people always need somewhere to live, regardless of economic conditions. Moreover, in extreme situations, like the aftermath of the 2008-2010 Global Financial Crisis, homeowners may be forced to sell their homes. When that happens, they tend to move into rental housing—often for extended periods.

Watch: Why investors choose multifamily real estate in times of high inflation 🎥  ⤵️

5 Tips for Investing in Multifamily Properties

There are lots of levers for value creation in multifamily and investors who have never invested in multifamily property may find it challenging to navigate the landscape as there are so many factors to consider. 

Here are a few tips for those considering investing in multifamily properties.

  1. Investment goals: Each multifamily property is unique. Two otherwise similar properties will still differ based on the exact location. Deciding how, where, and how much to invest should be based on your specific investment goals. 
  2. Risk tolerance: Those with a low-risk tolerance may want to invest in well-located, already stabilized Class A assets. Those with a higher risk tolerance may want to consider value-add, ground-up development, or other riskier opportunistic deals.
  3. Target returns: Returns are often a function of what's happening in the marketplace. For instance, if the yield on a 10-year treasury bond is 4%, you'll want to earn at least a few hundred basis points more, given the risk you're taking when investing in real estate.
  4. Hold period: Most sponsors have a hold period ranging from three to ten years. In some cases, the owner might plan to hold indefinitely. Be sure the hold period matches your investment horizon. For example, if you have children approaching college age, you might consider a deal with a 5-year hold period vs. a 10+ year hold period. 
  5. Market location:  Some people are familiar with one geography vs. others, which will steer their multifamily investment decisions.

Choose investments that match your goals

Here is a quick snapshot of how various investments perform:

Understand the Current Investment Environment

While multifamily properties tend to perform well regardless of the economic climate, there are specific macroeconomic factors to consider before deciding on a particular investment opportunity.

  • Rent growth: Many markets have experienced double-digit rent growth in recent years. Whether this is sustainable remains to be seen. However, investing in a multifamily real estate market experiencing widespread rent growth is generally advised compared to a market with declining rent growth.
  • Cap rates: Cap rates are an indication of property value and are generally correlated with returns—the higher the cap rate, the higher the potential returns (and vice versa). In a low-cap rate environment, property values tend to be high. Properties trading at higher cap rates are sometimes more affordable but may be considered "riskier" investments for various reasons. 
  • Construction costs: Construction costs are high across the country. Material and labor shortages have driven construction costs to the point where some ground-up deals no longer pencil out. For this reason, when construction costs are high, many investors will want to consider investing in value-add deals, given their significantly lower replacement costs. 
  • Interest rates: Interest rates are something investors should watch closely. An uptick in interest rates can dramatically impact cash flow. Most sponsors will utilize fixed-rate debt—those who don't are subject to interest rate risk. 
  • Inflation: Investors should also monitor inflation. Multifamily properties tend to perform exceptionally well in an inflationary environment. Most properties are leased on a 1-year term and therefore turn over annually (unlike office, retail, and other property types). This allows owners to increase rent to accommodate rising inflation. 

Choose Your Partners Wisely

When investing in multifamily real estate, typically there is a sponsor or general partner who is in charge of the investment and limited partners who are investing their capital.

As a passive investor, you’ll likely be a limited partner and hence choosing the right general partners (often referred to as GPs, sponsors or operators) is of critical importance.

The sponsor is responsible for running the day-to-day on behalf of LP investors. Two different sponsors may have very different approaches to how they would approach the same deal, so be sure you choose your sponsor carefully.

  • Experience: You'll want to look for a sponsor with the same objectives as you. Moreover, the sponsor needs to have experience with the product type and the geography you're considering. You will also want to look for a sponsor with sufficient expertise across multiple real estate cycles—this helps ensure they know how to navigate surprises like the COVID-19 pandemic. 
  • Investment track record: Past performance is no guarantee of future success, but it can certainly be telling. Look at how the sponsor’s prior deals have performed, including the IRR and cash-on-cash returns they’ve earned on behalf of investors. 
  • Communication: Not every deal goes according to plan. Sponsors who have been at it long enough will inevitably have blemishes on their track record or deals that have underperformed. How a sponsor communicates with their investors is equally important as how the deal ultimately performs. Be sure the owner is transparent and communicates often, clearly, and effectively.

Learn more: How to Evaluate an Online Real Estate Investment

What to Look for When Investing in Multifamily Properties

After you have conducted thorough due diligence on the sponsor, you’ll want to evaluate the specific real estate deal. 

Here are 5 things to look for when considering various multifamily opportunities:

Location

There’s a reason real estate experts preach, “location, location, location!” A property’s location is critically important to its longevity and demand.

Consider the following:

  • Supply / Demand Balance
  • Population Growth
  • Job Growth
  • Affordability
  • Local Amenities

Supply / Demand Balance

Multifamily tends to do especially well in housing-constrained markets. Look to see what sort of supply is coming online and whether there is enough demand to absorb that new supply. 

Population Growth

We generally look for markets with a growing population. This is one of the reasons people are drawn to the Sun Belt states in the United States, where retirees are moving to in record numbers.

When you couple that with high-income earnings migrating, you have a double whammy.

Of the 10 states with the largest influx of high-earning households in 2022, nine are located in the Sun Belt.

This is one of the reasons multifamily has done so well in these states - lots of population growth of high-income earners that can pay higher rents.

Job Growth

Markets with many growing employers who are continuing to hire are generally good markets for multifamily investments. One other thing that's also important to filter for is how diversified the employers are. 

A cautionary story here is the history of Detroit in the US. Detroit boomed in the early 20th century with car manufacturing, making it the fourth-largest city in America at that time. Mass production led to mass employment and mass consumption.

But then a downward spiral of American manufacturers from overseas competition hollowed out a lot of the middle-class population of the city. 

Affordability 

It's good to understand the area median income (AMI). Be sure that renters can afford the rent at the property you're considering buying.

In the US the AMI is $70,000, meaning the average renter can afford to pay $21,000 per year in rent (or $1,750 per month). 

This varies widely across the country, but the general takeaway is that multifamily apartments for rent below $1,750 would be more affordable in the market versus apartments over $1,750.

Local Amenities

Renters are increasingly drawn to areas with robust amenities. These include restaurants, retail, proximity to highways, public transit, good schools, parks, and more.

Age

Newer buildings are typically found in core/core-plus markets. They tend to be more expensive to buy but less costly to maintain. Older buildings are better candidates for value-add investors. Opportunistic deals, like ground-up development or property conversions, really vary. Older properties might be repositioned for a new use, whereas other buildings might be tear-downs where the site is slated for new construction. 

Physical Quality and Attributes

During your due diligence process, compare the prospective investment with others in the area. 

How does it compare in terms of its physical characteristics (e.g., unit mix and layout) vs. the competition? What sort of amenities does the property offer? Are these standard in the marketplace? 

If there are no amenities, consider whether they would need to be added to remain competitive. Finally, assess the extent to which the property has deferred maintenance and what it would cost to improve. 

Recent Performance

Sponsors should provide information about projected revenue, but it’s equally important to take a historical look at the property. Look at in-place rents vs. proposed rents post-stabilization. 

When rents are significantly under market value, this presents an opportunity. Look at occupancy levels and compare this to the market average. 

Finally, consider how the units will perform whether or not they’re renovated (there can always be surprises that put value-add improvements on hold). 

Price 

There are two important metrics to look at when analyzing the price of multifamily homes. First, look at the different cap rates - and there are three key ones you should worry about:

  1. The going-in cap rate: This is the cap rate that you’re paying, based on historic performance
  2. The project's cap rate one-year out: This is based on projected Net Operating Income (NOI)
  3. The exit cap rate: This is important when investing in a sponsor's business plan, based on their expectations about a refinance or sale

Second, look at the price per unit vs. others in the marketplace. 

For example, you might be investing at a cost per unit of $250,000 versus a price per unit paid on other acquisitions of $300,000 and new building cost estimates of $350,000 per unit.

The bigger the gap between the price per unit you're investing in versus other transactions or building from scratch - the better.

Single Family vs. Multifamily Investing

There are two primary ways to invest in residential rental property. The first is to purchase single-family homes that are then used as rentals. The other is to invest in multifamily properties.

Single Family Investing Benefits

The low barrier to entry is the primary draw to investing in a single family home. In some markets, homes sell for less than $200,000. This is generally affordable for real estate investors who want to own a property outright. It also allows investors to "test the waters" before investing in something more substantial.

Multifamily Investing Benefits

While there's a higher barrier to entry to investing in multifamily property, the benefits are tremendous. 

When you buy multifamily, multiple streams of cash flow come in. This provides insulation if one tenant stops paying their rent. Also, it's easier to scale an investment portfolio of multifamily rental properties. 

For example, if you buy one 20-unit investment property, you're only going through the underwriting, due diligence, and financing process once. You'd have to go through this process 20 times to acquire as many units when investing in single-family rentals. 

Take a deeper dive: Multifamily vs Single-Family Real Estate Investing

What is a Good ROI on Multifamily Property?

Determining a "good" ROI on a multifamily property depends on each investor's objectives. It also depends on their risk tolerance. 

In general, investors should seek to target returns based on the respective investment strategy of the investment:

  • Core: 7-9%
  • Core-Plus: 10-12%
  • Value-add: 13-16%
  • Opportunistic: 20%+

Is Investing in Multifamily Property Safe?

In general, investing in multifamily property is considered safe. ✅

This is partly because the nation continues to face a widespread housing shortage. The wide gap between supply and demand is expected to exist for at least the foreseeable future. 

Additionally, multifamily property is historically recession resilient. This makes multifamily a strong contender for anyone looking to protect their downside in the wake of a market correction.

Managing Multifamily Properties

Most investors find that utilizing a dedicated property management company is the best way to manage multifamily properties.

A property manager can be someone in-house (who works with the sponsor) or someone from a third-party company specializing in multifamily management. 

Experienced property management will enforce leases, communicate clearly with tenants, turn over units quickly and effectively to minimize downtime, and respond to repair and maintenance requests promptly.

4 Reasons Why Multifamily Real Estate Investing May be Right for You

  1. You want to expand your portfolio
  2. You want to generate additional income
  3. The timing is right
  4. You want to reduce your living costs

Let's quickly jump into each reason below👇

1. You want to expand your portfolio

Investing in multifamily is a great way to grow your retirement portfolio. It's an intelligent way to diversify away from more traditional stocks and bonds. Those who have invested in single-family homes will find that multifamily investments help grow their real estate portfolio faster. 

2. You want to generate additional income

One of the primary benefits of investing in multifamily property is that it generates significant passive rental income. Those looking to supplement their regular earnings will appreciate the monthly, quarterly, and annual cash flow dividends multifamily provides.

3. The timing is right

Timing is everything, they say. Those sitting on the sidelines waiting to invest may find that now is the perfect time to start. If you have some extra cash that you'd like to put to work on your behalf, consider multifamily property.

4. You want to reduce your living costs

An often overlooked reason to invest in multifamily is that it can reduce your living costs. Many people will live in one unit while they rent the others. The rental income from the other units helps offset the owner's mortgage cost, reducing their personal living expenses. 

4 Ways to Invest in Multifamily Real Estate

  1. Buy and Own Rental Properties Directly
  2. REITs
  3. Tokenized real estate
  4. Crowdfunding

Buy and Own Rental Properties Directly

There’s an important distinction to be made between active and passive real estate investing.

Active real estate investing is when you buy and own rental properties directly. This is a great option for those who have the capital, time, and expertise to manage a rental portfolio. It allows for total control over business plan execution. Direct ownership is a major commitment, though, and involves a substantial amount of risk.

Those who are looking for less responsibility will want to consider passive real estate investing strategies, like those outlined below.

REITs

REITs, or real estate investment trusts, are publicly-traded companies that invest in commercial real estate (including but not limited to multifamily investment property). REIT shares are purchased as easily as stocks in any other company.

It’s important to know that when someone invests in a REIT, they are not directly investing in real estate. Instead, they are buying a share of the company that owns that real estate. The largest multifamily REITs include Essex Property Trust, AvalonBay Communities, and UDR.

Tokenized real estate

Institutional-quality real estate is generally out of reach for individual investors.

An alternative way to invest in these high-quality assets is by purchasing a fractional share of that property—otherwise known as tokenized real estate. Tokenized real estate leverages Blockchain technology and "smart contracts" for administering and tracking investments through "tokenization."

Learn more: The Ultimate Guide to Investing in Tokenized Real Estate

Crowdfunding

The 2012 JOBS Act ushered in a new commercial real estate investing era. Regulation changes now allow sponsors to solicit investment from those with no pre-existing relationship. This sparked the launch of platforms that allow sponsors to advertise their deals. Then individuals (accredited and non-accredited investors—depending on the platform or deal) can use the platform to invest directly in those deals.

Getting Started in Multifamily Real Estate Investing

As you can see, there are many things to consider when investing in multifamily property. 

Invest some time researching investment opportunities, both generally and then, more specifically, in your target areas of interest.

Those who are just getting started will want to do some homework first.

If you are looking to get started but want the benefit of investing alongside experts, you can learn more about HoneyBricks here.

About the Author

HoneyBricks Team

HoneyBricks is a technology platform that connects investors with high-quality commercial real estate opportunities through asset-backed security tokens.

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