How to Invest in Multifamily Properties? The Ultimate Guide

Do you know the hidden barrier that stops most investors from getting to real estate? It’s the fact that it’s a “private” market.

You can’t just contact an advisor or log in to your investment account and pick real estate investment opportunities as you do with stocks, bonds, and exchange-traded funds. Real estate is often perceived as too complicated or too difficult to access unless you know the right people.

But I believe all investors should include some real estate in their portfolios–there are serious benefits of multifamily investing. So to help you do just that, we’ve condensed our experience investing in multifamily properties into this ultimate guide.

In this guide, I’ll cover the biggest mistakes you need to avoid with multifamily deals, how to fully vet a potential sponsor, and the exact steps to follow for a successful and seamless investment experience.

Looking for the right multifamily investment company to invest with? Real estate investment is a proven and tested wealth generation tool. At re-viv, we utilize strategies that drive growth for both investors and the communities at large. Get in touch now

What is a multifamily property?

A multifamily property or multi-dwelling unit is any residential building that contains more than one housing unit.

Multifamily properties can range from a simple duplex or two-unit building which houses two families to a large apartment complex with hundreds of units. The positive outlook for multifamily real estate is attractive for both new and seasoned investors, with occupancies reaching 97% at the national level in the US, up from 95% before the COVID-19 pandemic, and national multifamily rent growing 10.3% year-on-year as of August 2021.

Who should invest in a multifamily property?

Multifamily property deals come with a wide range of benefits from outperforming the stock market and generating passive income to offering the chance to get involved in a real estate project that’s doing social good for a local community.

There are lots of reasons to invest but, generally speaking, multifamily property investment is for people who want to get more out of their investment but are willing to wait patiently to grow their real estate portfolio.

Broadly speaking, investors who choose these types of investments fall into these categories:

Those who want an investment that outperforms traditional stocks and bonds, and provides broad diversification outside the traditional investment portfolio.

Those who want to reap the additional tax benefits that real estate investing provides without having to navigate the complexities on their own.

Investors who are comfortable with the fact that their investment could be tied up for several years and the fact they’ll have minimal control on when they can liquidate or sell.

This can be especially attractive to investors who’ve recently sold a successful business or a piece of real estate and are looking to take advantage of the tax benefits that come with multifamily investing in Opportunity Zones. These types of investments can be structured in a tax-efficient manner to protect and further grow your original capital gain.

Benefits of investing in multifamily properties

As briefly outlined above, investing in multifamily properties brings with it a range of benefits—especially when partnered with the best multifamily investment companies. Here are some of the big multifamily investing benefits:

Outperform the stock market

According to Goldman Sachs, over the past 140 years U.S. stocks have averaged 10-year returns of 9.2%, while bonds tend to give even lower historical returns balanced by decreased risk. Annualized real estate returns typically fall between 12-35%. Cash-on-cash returns, a metric that’s calculated by subtracting net operating costs from rental income, can hit anywhere between 4-12%. As with any investment, the higher the possible returns, the higher the associated risks.

Multiple ways to invest

Apartment buildings might seem like a straightforward investment, but there are multiple strategies and opportunities within the segment. For example, some investors focus on “value add” opportunities, renovating older buildings in up-and-coming areas, whereas others specialize in brand-new, Class A residential buildings with luxury amenities that can attract steady high-income tenants paying premium rental prices.

Both strategies can be profitable for investors but come with their own levels of risk and corresponding returns. Another major difference is those who choose to invest in ground-up development versus purchasing an existing building.

Greater valuation control

Unlike single-family homes, multifamily properties are valued based on the income produced. This means landlords can tailor the rent to match the amenities provided. For example, a landlord could provide a concierge service or include in-unit washer dryers which would increase the total income produced by that investment property based on a fairly predictable amount of invested capital.

The overall valuation of the property would thus increase. Multifamily properties offer more areas where the owner can enhance the perceived value, for example by including a gym, swimming pool, laundry service, or simply completing minor interior upgrades thus increasing the rent and subsequent value accordingly.

Scalability

Investing in a larger scale project has obvious advantages when it comes to cost-efficiency.

In many cases, apartments may be constructed for a third less than the size of a single-family rental.

Less transactional costs

Another big advantage of apartment investing at scale is reduced transactional costs. You can obtain a 10 unit or 100 unit apartment complex with one transaction. Buying that many single-family homes would require 10 separate transactions.

Passive income

Once an apartment project is complete and ready for its new residents, investors have a steady passive income for years to come. If investing with a sponsor or private equity company, it works just like your stockbroker or wealth manager; you invest your capital and the sponsor takes care of the day-to-day management of the investment.

Personalization

It’s common to have 30 to 40 investors in a single real estate offering. It’s also not uncommon for there to be 3 to 4. Real estate is traditionally very local. There are great sponsors doing cool things literally in your backyard that you can get to know on a professional and personal level. Few of us will ever get to that level with the owners of the companies whose stocks we buy.

More resilient to economic downturns

A greater number of units helps to spread risk and costs if tenants are unable to pay rent, as we saw recently during the height of the COVID-19 pandemic.

Larger pool of tenants

Multifamily properties have multiple tenants which reduces overall risk in case of vacancies or evictions.

Blanket insurance policies

There’s more property to insure overall, but policies may be easier to negotiate and secure due to economies of scale. Usually, everything can be grouped under one policy.

Tax benefits

Investments with a multifamily transaction sponsor are typically structured in a tax-efficient manner. The apartment complex is typically purchased via a limited liability corporation or LLC. All property income and expenses are run through the LLC to reduce individual tax liability. Individual investors can also defer capital gains taxes on a profitable investment using a 1031 exchange.

Those completing major renovations can utilize cost segregation which allows the manager and investors to accelerate depreciation on the capital invested, providing substantial tax benefits to investors.

Types of multifamily properties

Multifamily properties can range from a simple duplex or two-unit building which houses two families to a large apartment complex with hundreds of units. These properties are typically classified as Class A-D depending on factors like their age, location, and condition.

How to invest in multifamily properties?

If you’re considering adding multifamily properties to your real estate portfolio, let’s walk through the steps you’ll need to follow to ensure a successful investment journey.

Step 1: Clarify your financial goals

Start by thinking about why you want to invest in multifamily properties and exactly what you want to get out of this investment opportunity. It can help to ask yourself the following questions:

What investment term am I looking for?
How much liquidity do I need?
How much capital do I want to commit?
What returns can I reasonably expect to achieve?
Are you looking for higher cash-on-cash returns or greater capital growth potential?

Step 2: Am I going to find a sponsor to invest with or am I looking to do this on my own?

Once you’ve clarified your financial goals, you’ll need to think about whether you plan to work with a sponsor or go it alone:

Am I going to invest with a sponsor or am I going to invest on my own?
If I choose to invest on my own, do I have enough time and access to the right expertise to make this investment a success?
Am I comfortable with the enhanced risk associated with investing alone without a sponsor?

As someone who broke into this business while opening another business, I’d be remiss if I didn’t encourage anyone to try it. That said, going at it alone comes with obvious risks. Outside the financial risk, doing it on your own can be a huge time commitment. Bear in mind that tenants can be a lot of work. If you’re running the operation yourself, the last thing you want to deal with is pipes bursting in the middle of the night!

On the other hand, a real estate sponsor is a route to passive, low-stress investing. For those new to the real estate space, this is also a great way to learn from some of the most sophisticated investors in the business. You’ll get an insider’s view on their operations, insights, and strategy. It’s a bit like buying a stock and having a spectator’s seat in the boardroom.

We’ll split these steps now and look at what you need to do next depending on whether or not you decide to work with a sponsor.

If you invest with a sponsor…

Step 3: Vetting your sponsor

If you decide to invest with a sponsor, you’ll need to evaluate their track record and background. Perform a thorough screening which includes the company’s financial health, historic performance, and leadership team.

Here are some key questions to ask your sponsor:

How does a sponsor conduct due diligence? Ask how the sponsor collects and analyzes data and information before conducting a transaction or making an investment decision.

What is the sponsor’s primary goal when taking money from you? A sponsor should be focused on making sure your collective goals align. This extends beyond just financial goals; do their company values align with your own?

What are the standard fees, and how does the sponsor make their money? Any trustworthy sponsor will be open and transparent about their fees.

What are the risks associated with this investment? Your sponsor should give you realistic expectations regarding your investment, and especially any risks involved.

What is the sponsor’s plan at the end of the projected hold period? A sponsor should be fully transparent as to what they typically do or have done.

Hold period and exit strategy. Before any contract is drawn up, a sponsor should outline their expected hold period and their key exit strategies.

How familiar are they with the market and submarkets of the area(s) they are in? Asking about your sponsor’s experience in the markets available in your area to gauge their capabilities and to get realistic expectations of the proposed deal.

Does their business plan include ways to force appreciation, or are they banking on continued growth in the area? Ask your sponsor to cite similar projects in your area, how these sponsorship projects proceeded, and what happened to the value of these properties.

Do the sponsors invest in other MSAs (metropolitan statistical areas) across the US or just this one? Sponsors with a wide range of experience are more likely to be able to deliver a satisfactory investing experience and attractive returns.

Are they investing in B-C class assets in A-B neighborhoods? This shows that the sponsor is capable of turning fixer-upper properties into high-earning real estate opportunities.

What is the sponsor’s exit cap rate? This determines how fast you will get a return on your investments. A higher cap rate means there is higher risk and higher potential returns, while lower cap rates indicate lower risks and lower returns. Interest rates have been at historical lows for close to a decade; creating a lot of tailwinds for real estate investment. Rising interest rates comprise risks that sponsors should be speaking to.

Does the sponsor invest in their deals alongside passive investors? A fully-committed sponsor will consider their investor’s needs first before they invest in their own deals.

How is the deal structured? A reliable sponsor will take the time to fully explain the structure, terms, and other essential points of the deal.

How is the deal structured in terms of profit-sharing? Always ask what you are entitled to when it comes to sharing future profits.

Step 4: The sponsor forms either a limited partnership or an LLC

An LLC considers limited liability protection to all partners and better tax flexibility compared to a partnership. When managing multifamily properties, a limited partnership will allow one or more partners to control daily operations.

Working with a sponsor, you won’t have to worry about as many steps as you would if you were going alone. For instance, they’ll handle choosing locations, negotiating with sellers, inspecting properties, and any renovation work that’s needed.

Looking for the right multifamily investment company to invest with? re-viv helps investors drive growth with scalable multifamily investment strategies. Get in touch now

If you decide to go it alone…

Step 3: Pick a loan program and loan provider

Now that you have your financial goals settled, discuss your loan needs with a provider. Study their loan programs and select lenders that will work best for your investment needs.

Step 4: Choose your location wisely

Consider local demographic data to decide if it’s worth investing in multifamily properties in the area. Factors you’ll need to weigh up include:

Vacancy rate: Vacancy rates vary depending on the area of a city. A reasonable vacancy rate in a metropolitan area is from 4-6% Most lenders have standardized underwriting for vacancy so be sure to check with your lender.

Accessibility: The property should be easy to access, must be near amenities and transportation hubs.

Security. The property must be well secured with fencing, security equipment, and lighting.

Feedback on the building’s condition. Consider the building’s age, structure, and overall condition. Take time to make a full visual inspection AND hire an experienced inspector. Having a pre-vetted general contractor walk the property with you (don’t be afraid to pay them for their time) will only decrease your risks if completing substantial value-add improvements.

Potential problems. Cite all potential problems that may arise among tenants or issues that you as the owner may encounter while managing the property.

Supply-demand imbalance. Is there a high demand for rental properties in the area? Call other vacant properties in the area. Get a feel for the market.

School districts and schools’ quality. Are elementary schools, middle schools, and high schools nearby? A property near top-performing schools and universities will be appealing to families with school-aged kids.

How are the crime rates? Areas with high crime rates are less likely to attract renters.

Is there positive population growth? Your rental property is assured of constant renters in an area with positive population growth.

Is it relatively affordable relative to the other areas? Or is it the most expensive neighborhood? Match the multifamily property type to the neighborhood the property is in to command a better rental rate.

Look for positive population trends and demographic trends. Was there an increase in college-educated people? Favorable demographic trends attract higher value renters. These indicate that the area is a peaceful, established, and quiet place to live.

If you’re investing with a sponsor, they should be able to provide you with full information on the criteria above.

Step 5: Know the seller and why they’re selling

Once you’ve decided on the property you wish to buy, check the property’s ownership history and the reputation of its owners over the years. Ask for legal documents early on to guarantee seamless processing and transfer of titles.

If you’re investing with a sponsor, they should take care of these details and perform due diligence checks on the vendor.

Step 6: Verify the property’s current rental prices and income

Checking the current rental income can give you leverage to negotiate a better price as well as avoid any nasty surprises. If investing with a sponsor, these details should be shared with you in the proposal documents.

Step 7: Devise a working management plan

If you’re handling the investment by yourself rather than working with a sponsor, you’ll need to have a solid plan in place to manage the property. For example, a maintenance team will be required to fix any repair issues and you’ll need good insurance coverage to protect you from any unexpected expenses.

Step 8: Inspect the property

As with any property purchase, you’ll want to contract professional surveyors to perform a full inspection of the property in case of any hidden issues. Make sure you do a thorough check of any plumbing and water damage, fire safety measures, uneven floors, septic system, ventilation, wiring, and other electrical components, as well as signs of pest infestation.

Sponsors should perform these types of checks on behalf of the investors and should be able to provide you with the results of these inspections.

Step 9: Get ready to make a formal offer

The next step is to make a formal offer that’s appropriate to the condition, age, and rental income potential of the property. This is either done by the individual investor if you’re going it alone or by the sponsor on behalf of all the investors.

Step 10: Renovate and repair the property to make it more appealing to renters

For Class B, C, or D multifamily properties you’ll want to consider renovating the property to increase its attractiveness to tenants and thus increase the rental potential. For example, consider how to maximize the property’s space and any extras you can offer like a concierge service in return for increased rent.

Mistakes to avoid when investing in multifamily properties

To protect your investment and make an informed choice, it’s essential that you understand the most common mistakes investors make when investing in multifamily properties—whether that’s with a sponsor or going it alone:

When investing with a sponsor

Not aligning with your investment goals: Make sure that you and your sponsor have the same investment goals and risk appetite.

Underestimating the importance of debt and equity relationships: A higher leverage ratio (often referred to as Loan to Value/LTV or Loan to Costs/LTC) indicates that a real estate investment has a higher risk. Everyone has a different way of looking at debt, and investors should approach any deal with their own risk appetite in mind. Generally speaking, an investment opportunity with a higher return profile due to interest-only debt, short-term exit strategies, or higher leverage (i.e. more debt) will obviously have a much higher risk profile. Understanding the debt-equity ratio will help you make better investment decisions.

Not taking the time to ask the “dumb” questions: Whether you’re just starting out or a seasoned pro, the best questions are the simplest. What if the project isn’t completed on time? What happens if we struggle to retain good tenants? Good sponsors should talk not just about the positives of a project, but also be transparent about any potential threats that may be outside their control. We always include a SWOT analysis in our investor decks. It’s an opportunity for us to be upfront about any potential risks and help you make a considered and informed decision before proceeding with your investment. Take time to research your sponsor’s credibility, investment history, and past projects before you decide.

Spreading yourself across too many investment types or asset classes: Looking at Class C retail shopping centers in addition to developing hotels in major metros will not only be overwhelming, but it increases your risks by not being able to compare apples to apples. Identifying a product type (industrial, retail), a certain asset class, and the size of the project you are familiar with or can specialize in will give you an advantage in the long run.

Not reading the private placement memorandum: The PPM sets out the full details of the real estate investment opportunity. It can be lengthy but make sure you or your attorney read it in full so you don’t get caught out or run into unexpected problems.

Not understanding your rights as a limited partner (LP): Familiarise yourself with your rights in a partnership, especially regarding investment management, responsibilities, and sponsorship agreements. As a limited partner, liability for the firm’s debts cannot exceed the amount that person invested in the company.

Not understanding the syndication’s equity structure: Real estate syndication deals are typically covered by an 80/20–split, with the investors receiving 80% of the investment returns and the partners only 20% for syndicating the property.

Not understanding interest rate or “CAP rate” risks: To put it simply, we’re experiencing unprecedented times in the monetary policy world. At no other time in history have we had low interest rates for this long. It is one of the largest threats to our industry. CAP rates are calculated by dividing a building’s annual net operating income (NOI) by purchase price. Higher interest rates increase the borrowing costs for the next owner, thus hurting values over time.

When investing on your own

Neglecting due diligence: Failing to fully inform yourself about the property and the wider market can be costly. For example, not performing a full property inspection can lead to big problems later down the line, such as roof leaks or pest infestations.

Buying the wrong properties and not sticking to your criteria: Only invest in properties that meet your original criteria. An attractive long-term investment opportunity that promises excellent capital growth in return for extensive renovations probably isn’t a good match for an investor looking for steady passive cash-on-cash returns.

Not paying attention to economic vacancy: Economic vacancy is the difference between actual rent and potential gross rent. This gives you a measure of how much income you’re losing out on due to vacancies. An increasing economic vacancy metric can indicate there’s an underlying issue that needs addressing to improve occupancy rates, such as problems with building maintenance.

Ignoring diversification: Where possible diversify your portfolio across different markets, sectors, and investment strategies to reduce overall risk. To help you with this, we’ve compiled a list of the best markets for multifamily investing.

Overestimating tax deductions and underestimating your expenses: It’s always a good idea to hire a respected tax advisor to ensure you’re not exposing yourself or leaving money on the table.

Not keeping sufficient cash reserves: Having insufficient cash reserves may result in reliance on credit, and ultimately even bankruptcy.

Not choosing the right professionals to help: Real estate and investment professionals can give you expert guidance and introduce you to excellent multifamily opportunities that you may not have discovered or been able to access alone.

Stopping renovations and lowering rents: Renovations on your multifamily property investment will help you command a better rental price. Stopping improvements will negatively affect the value of your property and may lead to expensive repairs in the long run.

Having unrealistic expectations on returns: Analyze multifamily investment opportunities carefully to identify any risks and create realistic expectations. All types of investments have risks; it’s just a matter of preventing these through careful property management.

Single-family vs Multifamily investing: Which is better?

Multifamily properties are appealing because they offer economies of scale and risk can be spread across multiple units. Here are some things to consider when looking at single-family vs multifamily investing:

Potential returns: single-family investments typically deliver much lower cash-on-cash returns than multifamily properties. Investors may have to look at riskier secondary or tertiary markets to achieve comparable returns.

Risk: With multifamily investments, the total capital at stake is likely to be significantly higher, but the risk is spread across multiple units. With single-family properties, you’re putting all your eggs in one basket, and vacancies can be much more damaging if you’ve only got one or two units.

Economy of scale: It’s usually more cost-effective to manage many units, for example for maintenance or insurance purposes.

Investment threshold: Large multifamily investment projects require significantly more capital. This is one compelling reason to use a sponsor since it reduces the individual capital requirement.

Exit strategy: Multifamily investments can be harder to exit unless you have a sponsor or the property is in a high-demand area.

Tax benefits: Real estate sponsors are often better equipped to handle 1031-exchanges, a provision that enables real estate investors to defer paying capital gains taxes. Individual investors often avoid this attractive tax benefit since it can be very complex. That’s where it can be advantageous to invest in a multifamily property deal via a sponsor who can handle the tight deadlines required.

Start investing in multifamily properties today

It can be hard to know where to start with real estate investment but real estate isn’t for an exclusive club: it should be part of every investor’s portfolio.

It’s possible to go it alone but risky and time-consuming and comes with its own risks. For most investors, it’s a good idea to work with a multifamily property investment company that knows this complex market inside out.

As well as managing your investment, the right sponsor will help you get the best possible returns and connect you with housing market deals you wouldn’t otherwise be able to access.

Looking for the right multifamily investment company to invest with? re-viv helps investors drive growth with scalable multifamily investment strategies. Get in touch now.

Frequently asked questions about multifamily investing

What is multifamily property investment?

A multifamily property is any residential building that contains more than one housing unit. Multifamily properties can range from a simple duplex or two-unit building which houses two families to a large apartment complex with hundreds of units.

Are multifamily properties a good investment?

Multifamily real estate investing is attractive to investors since it typically offers higher cash-on-cash returns when compared with single-family properties. Since they consist of multiple units in one building, investors benefit from economies of scale on maintenance and insurance costs. Multifamily properties can also have tax advantages, especially if you invest via a sponsor who can structure the deal in a tax-efficient manner.

Do multifamily homes appreciate?

Multifamily properties appreciate in line with the residential real estate market. Factors such as increased desirability of a particular neighborhood can push up both rental income and the overall property value. Investors also have the option to add value to the property by doing renovations or adding amenities like a swimming pool or gym. Since multifamily properties are valued based on their rental income, adding extras like a concierge service in return for increased rent can be a convenient way to boost the property valuation and ensure capital growth.

How do you know if a multifamily investment opportunity is a good deal?

As with any property investment, it pays to do your homework before committing any capital. Possible indicators of a high potential multifamily property deal include an up-and-coming location, limited supply of comparable rental properties in the area, a property that only needs minimal renovations to add value, and an experienced third-party sponsor that’s brokering the deal.

Is now a good time to buy a multifamily property?

Now is a great time to buy a multifamily property since rising home prices indicate the US is on track to become a nation of renters. Strong demand for rentals and growing interest in more affordable co-living solutions amongst younger generations make multifamily properties an excellent addition to a diversified investment portfolio.

DISCLOSURE: The above references an opinion and is for information purposes only. It is not intended to be investment advice. Seek a duly licensed professional for investment advice.

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