A multifamily real estate investment can provide cash flow and contribute to a strong, diversified portfolio. But how do you go about identifying a good investment opportunity? What makes one property a better investment than another?
Research, research, research
To choose the right multifamily investment opportunity, begin by conducting thorough market research, which might include consulting online forums, connecting with colleagues, or maintaining membership in professional real estate organizations.
Local appraisers can also offer insights into the current market and what factors increase or decrease the value of a property. The research process should help you decide if current prices and interest rates in your local area are aligned with your budget.
Location and neighborhood
Next, narrow the search by consider the location of each prospective investment, considering your goals to ensure an ideal fit. What are the average rental rates, price per rental unit, and vacancy rates in the neighborhood you’re interested in? What amenities and employers are nearby? For example, residential units near a university or corporate campus often see high demand. Properties with good access to public transportation are also considered desirable.
Further, evaluate the general appeal of the neighborhood, conducting research into crime rates, planned developments nearby, shopping, and public amenities like parks and libraries. A highly rated school district can be a draw for renters with children. In up-and-coming neighborhoods, consider the current price and condition of surrounding homes to gain a clear picture of the investment’s earning potential.
Specific property information
Beyond general research, conduct due diligence on specific properties that catch your attention. Working with a trusted real estate professional, request information such as unit inspections, property surveys, the deed, mortgage records, and liens. In the U.S., the county assessor, clerk-recorder, and/or registry of deeds can provide access to public real estate records.
A property’s rent history can also yield valuable information. A property that has changed owners numerous times, for example, might not be a red flag, but it could indicate poor performance. At least, it should prompt further research. The property history will also give insights about performance, measured by factors like current vacancy rates and rents compared to market averages.
Additionally, consider when the property was built and when critical building components like the roof, windows, and HVAC system were installed. Whenever possible, visit the building yourself to see if there is visible damage or any other issue that might cause problems. If you can, speak directly with the owner to ask questions about any information not revealed in your research, and to find out why they are selling. This can give you a clearer picture of the property’s challenges. Of course, as with any real estate transaction, consult professionals like tax experts, lawyers, and brokers for specific guidance.
Understand your budget
Budget is perhaps the most important criteria in choosing the right multifamily investment. Multifamily property mortgage loans usually require a 20 percent down payment, and the units can carry hefty property management and maintenance costs. You will want a clear picture of your finances before making an offer.
If you have identified a multifamily property in an optimal location, negotiate a fair purchase price. Overpaying will make it harder to achieve a good return on investment (ROI). The earning potential of a multifamily unit, however, depends on much more than the purchase price. Most units will need repairs or renovations.
Repairs and other expenses
Necessary repairs might be as simple as fresh paint, or as complicated (and expensive) as a new central HVAC system or multiple kitchen and bath renovations. Especially on low-priced properties, consider exactly how much money you will spend on repairs. Extensive renovations and repairs not only cost more, but they often require the building to remain empty for a longer time. You’ll need to budget for running costs during renovation periods when rent money is not coming in.
Most experts recommend overestimating expenses, as multifamily units nearly always need unexpected repairs. Overestimating potential costs will leave you with an extra cash reserve, while inflating your repair budget when calculating ROI puts you in a better position to handle surprise needs that arise.
Taxes
Taxes are a major consideration for calculating potential ROI. You’ll pay more in property taxes for a multifamily property than you would for a single-family home. Depending on your location and your situation, you may also have to pay real estate income tax, business income tax, net investment income tax (NIIT), and capital gains taxes when you sell. Always consult with a tax professional to understand the tax burden (and benefits) of any real estate investment you’re considering.
Management, maintenance, and other ongoing costs
If you’re not interested in actively managing the property yourself, expect to pay a property manager up to 15% of the monthly rental value of the property. You’ll also need to budget for landlords’ insurance, ongoing repairs, and maintenance.
Fannie Mae advises budgeting around 2% of the multifamily property’s total value for annual maintenance expenses. This means the owner of a $500,000 multifamily property should plan to spent around $10,000 each year on maintenance needs.
Assess the potential ROI
There are a few ways to estimate the ROI of a multifamily property. First, calculate the property’s net operating income (NOI). Add up all the income you
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