One of the most proven ways to generate wealth is through real estate. If done correctly, real estate can also be a very safe way to invest. But real estate investing is a vast topic and there are many different ways to invest. Some of those strategies are better than others. I have bought and sold single-family rentals, duplexes, and triplexes. I have invested in short-term rentals and long-term rentals. But of all the different types of investing that exist, I believe that multifamily investing deserves serious consideration. Here are the seven reasons why I believe investing in multifamily apartments can be a strong strategy for building wealth.
Reason 1: Rental Property Economies Of Scale Lower Investment Risk
With a single-family rental property I have one stream of revenue coming from one resident. I have one roof, one water heater, and one HVAC system for the house. When I buy my properties, I protect myself by buying positive cash flow properties, but often times the cash flow goes right back into the house for these capital items. When the rental is vacant, I pay for all the expenses until I can get the property rented out again. This is the biggest risk of a single-family rental. I can go from a positive cash flow investment to a negative cash flow investment literally overnight. It can happen quickly. This isn’t the best risk/reward situation. My risk decreases when I buy a duplex. Instead of one revenue stream covering expenses, I now have two. The one roof costs about the same as the single-family house, but I now have more reliable cash flow with two streams of income. This reduces the probability of the entire building being vacant considerably. Scale this up to a 100-unit apartment complex and the numbers get very powerful. All of the costs of the financing, maintenance and management are now spread over 100 units, instead of one.
Reason 2: Professional Property Management For Real Estate Investors
Most real estate investors start out with one or two rental properties. They might have anywhere from $100 to $600 per month of net income on each of their properties. Since the management cost of a typical single-family house can be anywhere from 7-10% of total rental income, most investors choose to manage their properties themselves to save that expense. Now, it’s great that we live in a day and age when there are so many great tools for beginner landlords. It’s great to have websites like BP and YouTube to learn from. But I have to be honest. I’m not a great landlord. Besides, with the precious little time I have, I’d rather focus on being an investor. I prefer the team approach. I like to let the professionals do what they do best. When it concerns larger multifamily properties, the skills and tools required necessitate calling in the pros. Stepping out of the management responsibility allows me the chance to quit hacking away at the landlord gig and focus on making deals happen. That’s where I want to be, not fixing a stove somewhere or leasing up a unit. Management companies in the multifamily space (especially above 100 units) charge a management fee that is about 30% less than the going rate for managing a single-family rental. That’s money in my pocket! Multifamily apartments give me the opportunity to leave landlording behind and focus on being an investor!
Reason 3: Income Property Valuation Based On Cash Flow
When I buy a single-family house in bad shape, I can rehab that house and capture equity up to a reasonable comparable value. This approach to valuation is based on the recent sales of similar properties. No matter how much I rent the house for, the value of the house is ‘tethered’ to this “sales-comp” figure. I recently sold one of my rentals to a tenant. We agreed on a price that we both felt was fair. After the appraisal came back it showed that the price we agreed on was higher than what the appraiser said the house was worth. This impacts the financing of the deal for the buyer in a negative way. So in order to get the deal done, I lowered the price. I didn’t have to do this, but since it would have meant that the buyer would have had to bring more cash to closing, there was more risk to our closing.
There is a ceiling for values in the single-family space. For apartments the valuation is not the “sales-comp” approach, but the income approach. Values are based on the Net Operating Income, or NOI. NOI = Total Rent Revenue – Operating Expenses. It does not include financing. When the NOI increases, so does the value of the apartment community. This means that if I can increase the NOI, then I can increase the valuation of the property. The way we do this in apartments is through upgrading units, added amenities, improved exteriors and the like. In this way we force equity into the property through action, rather than hope the market raises the value of our single-family house or duplex. Instead of hoping for a nice comp to meet our valuation targets, multifamily apartments allow us to take direct action to increase the value of the asset.
Reason 4: Commercial Real Estate Financing Benefits Investment Property Buyers
This is one of the most exciting aspects for the multifamily investor. Properties with more than five rental units are considered commercial properties and therefore must obtain commercial financing. These loans are typically 5-10 year loans with all kinds of different features and benefits that are not offered to a typical single-family house investor. For example, the buyer of an apartment building might arrange for the entire first year to be an interest-only loan with a low fixed rate after 12 months. A loan like this allows the investor to leverage a very low mortgage payment during the first year of ownership in order to plow the savings into renovating units and increasing the NOI. These loans can be tailored to the specific project and business plan. Qualifying for these loans is based mostly on the asset itself and its income and not the debt-to-income ratio of the investor. This is a big advantage. The investor still needs to be approved and credit worthy, but is not tied down by a debt-to-income ratio that is part of the calculus of single-family investing math.
Reason 5: Apartment Investing Performs Well During Economic Downturns
During the Great Recession of 2007-2009 the banks stopped lending on virtually everything in real estate except multifamily apartments. Many people who couldn’t afford to buy homes began downsizing and moving into apartments. Occupancies in many apartments actually increased during the recession in some areas. Furthermore, the research shows that more and more in the United States, we are becoming a renter nation. People need a place to live. In a recession they might give up a house, a car, and a lot of luxuries, but they still need a place to live. This makes multifamily apartments a veritable bulletproof investment option if purchased right, in a good area, and run correctly.
Reason 6: Real Estate Tax Advantages And Depreciation Benefits
Real estate is a cash-producing asset with incredible tax advantages over other types of investments. Income for the owner (or partners) is reduced by taxes and depreciation. This is significant because it often means that even though the investor had a positive cash flow into a bank account, the tax and depreciation expense decreases the net taxable income or eliminates it completely. It’s a nice benefit to experience positive cash flow, but to carry a taxable loss against other types of passive income on your tax statement. This tax savings is as good as an additional cash flow stream because it reduces your tax bill in real terms. (As a disclaimer I do want to say that I am not an accountant, nor do I play one on TV. It’s best to consult with your accountant about how advantageous or neutral a real estate investment might be for your situation. Everyone’s situation is different.) Also, in some cases, and even in the case of some syndications, when the property sells, taxes can be deferred through a 1031 exchange. I won’t go into the details of a 1031 here, but suffice it to say that this is possible in real estate if done correctly, with professional help, and it can save an enormous amount of taxes.
Reason 7: Real Estate Investment Opportunities That Build Communities
This final reason may not be a money-maker but it’s worth mentioning because this type of investing really can make a difference. Today we’re seeing an entire generational shift toward the multifamily lifestyle. In the United States, (I’m not sure about other countries) we are becoming a renter nation. Investors who take control of these assets have an amazing opportunity not only for a great investment, but to shape a neighborhood and build a community. I love this about multifamily investing. Taking over run down buildings and renovating them is an opportunity to breathe fresh life and vision into a neighborhood. I love working with managers and partners who don’t just see the profit involved, but also see the people we get to serve. Many apartment investors these days see themselves as community builders and are adding amenities that foster connection between people and a sense of place. There is a deep joy I feel when I drive by one of our communities and know that we made a better community.
Final Thoughts On Multifamily Investment Strategy
These are just a few reasons I prefer investing in apartments. There are a lot of great books and articles on this subject that go into each of these points in far more detail than I have here. Let me know your thoughts! Are you ready to become a multifamily investor? Keep studying and learning! Cheers and Happy Investing!
By Mike Krieg
About the Author
Mike is co-founder of Leadoutinvest. He earned his degree in Finance from the University of Montana. His real estate career began in the early 2000s as an expatriate in Samara, Russia, where he raised capital to purchase homes and helped other expats do the same. Since then, Mike has co-sponsored projects totaling over 7,000 apartment and self-storage units, been featured on the BiggerPockets Real Estate Podcast, and taught multifamily syndication to university finance students.
Mike is also the Founder of Storyline, an organization providing leadership training for local leaders worldwide. He lives with his wife Kristen and their three children.
Disclaimer: This article is for educational purposes only and does not constitute investment advice. All investments carry risk, including potential loss of principal. Past performance does not guarantee future results. Investors should consult with qualified financial and legal advisors before making investment decisions.
