Key Considerations in Multifamily Real Estate Investment

    Multifamily property investment is a great way for first-time real estate investors to dip their toes into the rental property market.

    Key Considerations in Multifamily Real Estate Investment

    Table of Contents

    1. What is a Multifamily Property?
    2. Historial Performance
    3. Why Invest in Multifamily Property?
          a. Strong Rental Demand from Millennials
          b. Urban Renaissance Become a Positive Driver for Multifamily Demand
          c. Preferential Mortgage Market
          d. Tax Incentives
          e. Short-Term Lease Allows for Immediate Adaptation to Market Condition
    4. Some Drawbacks of Multifamily Property Require Intensive Management
          a. Costly to Invest
          b. Fierce Competition in the Market
    5. In Conclusion

    Multifamily property is a popular form of investment for real estate investors. Investors continually pursue deals for multifamily assets, which have seen strong rental and occupancy rates, over other sectors, despite the impact of the pandemic on other markets. This is especially notable in mature and well-established multifamily such as the US and Japan, where the demand in the multifamily market has increased and is expected to continue growing. It is an asset class that many people are familiar with, especially those who have previously rented out an accommodation or purchased a home. Similar to any residential property, a multifamily unit also comes with a functional kitchen, bathrooms and a mixture of living spaces and bedrooms.

    Multifamily real estate is considered by many experienced investors as the most basic type of commercial real estate. It is much less complicated and less tedious compared to investing in other commercial property, such as office buildings and hotels. Multifamily property investment is a great way for first-time real estate investors to dip their toes into the rental property market.

    What is a Multifamily Property?

    A Multifamily property is commonly known as a multi-dwelling unit or MDU. It is a residential building with multiple separate housing units or several buildings in one complex. Multifamily real estate accommodates multiple tenants; each having their own housing unit. Rental leases for this type of property typically run on a monthly or an annual basis.

    There are several different forms of multifamily property in the market; each having its own set of unique features and amenities. Here, we will discuss the different types of multifamily real estate:

    • Duplex: A duplex is a two-floor building with two separate housing units. The building will have one front door and foyer in which both units will have to share. However, each unit will still have its own entrance in the building.  
    • Triplex and Fourplex: Similar to a duplex, a triplex and fourplex are buildings with three or four separate housing units.
    • Townhouse: Townhouses are quite common in the outskirts of the city. This type of houses shares one or two walls with other units while having their own private entrance. Typically, they are connected to one another in a row and are usually two or three stories high.
    • Semi-detached house: Semi-detached houses are like townhouses though they share a common wall with the next house side by side.
    • Condominium and Apartment: Condominiums and apartments are commonly found in the city area where land prices are high. These types of housing have at least five separate units and have amenities such as swimming pool, gardens, playground, and parking spaces. A condominium is a building or complex of buildings containing several individually owned units, whereas an apartment is wholly owned by one owner.
    Condominium and Apartment

    Historical Performance

    According to CBRE, a prominent real estate services firm, multifamily real estate was the first sector to recover from the 2008 recession and has outperformed many other real estate asset classes since. A research study conducted by them has found that the demand for the U.S. multifamily property sector has grown exponentially from approximately 15 billion dollars in 2009 to an astonishing 170 billion dollars in 2018.

    Historical Performance for U.S. Multifamily Investment

    Evidently, multifamily investment has also proven to deliver stable and solid returns for its investors. CBRE has pointed out that over the past 25 years, multifamily investment has had the highest average returns compared to other commercial real estate asset classes. Furthermore, it also had the lowest level of standard deviation (volatility) in return performance, indicating lowest level of risk among other asset classes.

    Multifamily real estate is well-known for its low-risk characteristic and is considered by many investors as a ‘defensive investment’. This is due to the fact that multifamily real estate investments address a relatively inelastic housing demand. During economic downturns, there could be loss of jobs, economic duress and strain where people may be forced to sell their homes and occupy rental properties instead.

    Average Annual Return and Standard Deviation by Property Type

    Further there is always a need for a residential property for families to stay in and multifamily real estate makes a good renters choice. It is common for real estate investors who wish to add resiliency and diversification to their portfolio to include multifamily real estate investment. Multifamily property tends to be more resilient against economic cycles since everyone needs a place to live, even when a declining economy might empty other types of commercial space. The higher average total return on investment of 9.75% and a comparatively lower standard deviation of 7.75% for multifamily real estate, as indicated above, supports multifamily properties as a more attractive risk-adjusted return option.

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    Why Invest in Multifamily Property?

    Why Invest in Multifamily Property?

    Strong Rental Demand from Millennials

    Median home prices have increased gradually since the financial crisis of 2008. As a result, homeownership has become out of reach for many young adults. According to the US Census Bureau, the national rate of homeownership for the population overall was 64% in 2019, which decrease from 2012 and 2013 when the rate hovered around 65%. Meanwhile, only 11% of younger millennials and 29% of older millennials in 2019 owned their own home; most prefer to rent or live with friends or family.

    With unaffordable home prices, millennials are now opting to rent rather than making real estate purchases. Furthermore, millennials also tend to appreciate the flexibility to change residence anytime and the geographic mobility over the benefits of owning property.

    Urban Renaissance Become a Positive Driver for Multifamily Demand

    Over the years, many cities in the US have developed into bustling and picturesque metropolises. The lively urban atmosphere and convenient lifestyle have not only enticed young adults, but also the older generation, especially baby boomers (aged 52 to 70).

    Research conducted by Inman, one of the industry’s leaders in real estate information, has shown that the number of renter households aged 60 and above rose 43% in the past decade, with the prevailing housing choice for urban living in most US cities being multifamily rental. The availability of for-sale multifamily units is rather limited. Because downsizing is from a larger house to a multifamily rental is an increasingly popular option for this older demographic, the demand for these properties is expected to continue rising over the next decade.

    Preferential Mortgage Market

    Multifamily investments do enjoy a preferential mortgage market and a cheaper acquisition cost. In fact, mortgage loans for commercial multifamily property typically reap a lower interest rate and better loan terms when compared to other types of commercial real estate investments. According to a study from Real Capital Analytics, the typical mortgage rate for multifamily property is 4.25% while the overall commercial real estate sector is at 4.5%. In addition, multifamily investors also received higher loan-to-value ratios (67% on average) than other commercial real estate investors (which averaged at 59%). Reflective of the sector’s relatively lower risk profile, lenders and banks are willing to extend loans to the sector on more favorable terms.

    Tax Incentives

    Multifamily investments also enjoy favorable tax treatment at entity level. When a multifamily property is acquired, the owner can begin to depreciate his capital expenses to offset the tax duty. A multifamily asset can be depreciated over a 27.5 years period, as opposed to 39 years for other commercial real estate property types. This means that investors are able to receive beneficial tax treatment directly from multifamily projects. Not to forget that the interest rate for commercial mortgage loans is also tax deductible.

    Short-Term Lease Allows for Immediate Adaptation to Market Condition

    As noted above, the majority of multifamily properties use monthly or annual rental leases whereas other types of real estate such as office and retail run on leases of 5 years or more. This gives multifamily assets a huge advantage because it permits its owner to adjust rent based on market condition. Short term leases offer investors the flexibility to quickly increase rent during rising market demand in an effort to capture higher rental returns. However, this has its downsides in tough economic times, with shorter lease tenures also resulting in faster rental price falls.

    Some Drawbacks of Multifamily Property Require Intensive Management

    At the end of the day, multifamily properties are large real estate assets that house multiple groups of tenants. This means that owners will be dealing with many individual leases and tenants simultaneously.

    Clearly, every unit in the property is going to induce more management responsibilities to the landlord. Every single tenant will have different repair and maintenance needs, different ways to pay their bills, request different set of furniture and hardware, and so on.

    Costly to Invest

    One of the negative sides of investing in a multifamily property is that it requires a considerable large amount of capital to start. In fact, this is one of the largest barriers to entry for most investors. Banks often require a down payment of at least 20% on such investments, which can become costly given that the price of multifamily properties in more expensive cities may exceed a million dollars.

    Beside the heavy initial investment, there are also fees related to renovation, property insurance, legal taxes, repair, maintenance, and so on. Therefore, investors must take note of all the upfront fees associated with acquiring a multifamily asset as it can amount to a considerable sum of money.

    Fierce Competition in the Market

    Given the benefits of this real estate option, multifamily property deals are highly competitive. This fierce competition in the multifamily property sector means that, like most other sectors, first-time buyers who wish to invest in a multifamily property will find themselves having a hard time locating the ‘ideal’ deals. On the other hand, experienced investors are often able to pay cash and are experts in negotiating terms that are more attractive to sellers.

    In Conclusion

    To sum up, any type of real estate investment will carry its own set of benefits and risks. Multifamily properties are great investments. They can be immensely profitable and can offer investors consistent streams of passive income. The financial securities and tax advantages that come along with investing in multifamily homes are irresistible. However, they require a high amount of initial capital and are hard to manage.

    Nonetheless, a smart investor must know how to mitigate his own investment risks. RealVantage is a co-investment platform that allows investors to co-invest alongside other investors. This can effectively lower the initial investment for all kinds of real estate deals, hence, reduces capital risk.

    Additionally, RealVantage is run by experienced industry experts who have access to multiple potential multifamily property deals in the US. Investors are able to leverage on their in-depth knowledge of the industry and make sound investments. Finally, they also offer hassle-free direct asset management services for real estate investments.

    Find out more about real estate co-investment opportunities at RealVantage. Visit our team, check out our story and investment strategies.

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    Disclaimer: The information and/or documents contained in this article does not constitute financial advice and is meant for educational purposes. Please consult your financial advisor, accountant, and/or attorney before proceeding with any financial/real estate investments.