In residential real estate investing, multifamily rentals are the next level above single family rental real estate. Multifamily rentals share the same investment stability of an “essential need” but provide investors with greater returns as the amount of units scale up. The multifamily asset class includes everything from a duplex up to a multi-hundred unit apartment building. Below we take a deep dive into everything you need to know about multifamily rental properties.
Table of contents
- Multifamily Rental Property Definition
- Types of Multifamily Properties
- Pros and Cons of Multifamily Rental Property Investing
- Multifamily Rental Property News
- When is Multifamily Considered Commercial?
- Accessory Dwelling Units (ADU)
- Managing Multifamily Rental Properties
- Financing Multifamily Rental Properties
- Explore Other Types of Rental Real Estate
Multifamily Rental Property Definition
A multifamily property is any residential property that contains more than one housing unit. While they serve for residential dwelling, the general purpose for the property type is for investment (owner-occupied or not).
Types of Multifamily Properties
Multifamily properties generally range in size from small (2 units) up to large (100+ units). Below we explore some of the most common types of multifamily rental properties and their unique characteristics:
A Two-unit residential rental property.
A multi-unit building, often 2 stories or more, that has only residential suites.
A Three-unit residential rental property.
A residential building approximately 5-12 stories tall, containing 30-100 units, and elevator service.
A Four-unit residential rental property.
A professionally managed residential building exceeding 10-12 stories and containing 100+ units.
Pros and Cons of Multifamily Rental Property Investing
There are many factors to consider when determining whether or not to invest in rental real estate, specifically multifamily rental properties. The following is a comprehensive list of the pros and cons you need to know before investing in multifamily rental properties.
Pros of Multifamily Investing
- More Stable Income Stream – Multifamily rentals spread the vacancy risk across many tenants, in comparison to one tenant in a single family rental property. For example, if you have four tenants and one leaves, only 25% of your cash flow is impacted. If you have one tenant and they vacate, 100% of your cash flow is impacted.
- Higher Cashflow Potential – More tenants (often called “doors) in a multifamily property means that there are more opportunities to increase cash flow. Even small but consistent and regular rent increases can significantly boost cashflow, among other revenue opportunities such as paid laundry, paid reserved parking, and paid storage.
- Potential for “House Hacking” – If you don’t mind being neighbors with your tenants, you can occupy one unit and lease out the others. This strategy is called house hacking and is a great way to get started in rental real estate investing by cutting down your living costs while simultaneously building equity in an investment property.
- Resilient Value Appreciation – Multifamily properties appreciate like most real estate does in boom times, but they can be resilient during economic downturns due to their essential need to provide housing. This is in comparison to speculative real estate such as hospitality rental properties that fluctuate with economic conditions.
Cons of Multifamily Investing
- Higher Tenant Turnover – While there are more tenants to generate more cash flow, there is also greater turnover since there is statistically greater probability of one of the many tenants eventually moving out. Having a strong property maintenance system in place helps minimize the business disruption, but still requires unit rehab (also called “Turning”) and re-leasing efforts.
- Greater Management Responsibilities – Owning a large multi-unit property takes a lot of time, which can interfere with your lifestyle (physically, mentally, and financially) whether you outsource rental property management or not. Multifamily properties require dealing with many individuals, bigger and more frequent repairs, and greater financial obligations.
- Greater Initial Expense – The bigger the property, the bigger the price tag. Depending on the market, some multifamily properties start well into the multiple-millions of dollars. Factoring in an approximate twenty percent down payment and sufficient reserves, requires you to have sufficient capital upfront and during your ownership.
- Experienced Investor Competition – Multifamily properties tend to draw interest from experienced investors. Since these experienced investors possess extensive knowledge and are well capitalized, this can create investor competition that is above what a novice investor can compete with.
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Multifamily Rental Property News
When is Multifamily Considered Commercial?
The terms “Multifamily” and “Commercial Real Estate” are sometimes believed to be different and mutually exclusive things. The reality is that Multifamily can be a type of Commercial Real Estate under certain conditions. Residential rental properties that are 2-4 units, are indeed considered as Multifamily (or Residential Multifamily). Once a residential rental property has 5 or more units, it then is considered to be a Commercial Multifamily property.
The biggest impact that this distinction has on investors is during financing. Financing a Triplex (3-Unit) can be done via a Conventional loan that is generally easy to obtain if a borrower has decent personal financials. However, financing a 5-Unit or 20-Unit apartment building falls under the Commercial Loan type that requires greater borrower requirements of the property.
Accessory Dwelling Units (ADU)
Accessory Dwelling Units (commonly referred to just as ADU) are a secondary housing unit on a single-family or multifamily residential lot. ADUs need to follow a permitting process and be approved by the local building jurisdictions, but can be much more cost effective and quicker to build than a traditional structure. The most common type of ADU is a detached ADU, among other types such as Garage Conversion ADUs, and Basement Conversion ADUs. Recent favorable legislative advancements in states like California, have given a boost to the popularity of these unit additions with new companies that solely focus on working with homeowners to add an ADU to their existing property. Futuristic startups such as Boxabl and Abodu have begun offering prefabricated modular ADU style homes for as little as $50,000.
Managing Multifamily Rental Properties
Managing multifamily properties depends a lot on the age, size and market of the property. A newer duplex (2-unit) in a pricy suburban neighborhood might require minimal management efforts beyond normal maintenance and upkeep. Conversely, an older mid-rise apartment complex (100-unit) in an urban infill market will likely require a management team, dedicated maintenance person, and frequent attention to unit turnover and rent collection.
Financing Multifamily Rental Properties
Securing financing to purchase multifamily properties is a much different process than getting a single family home loan for your personal residence. While a conventional home loan will scrutinize the borrower’s creditworthiness and financial ability to repay the loan, multifamily loans are much more dependent on the actual property’s performance and overall merits of the deal. An important distinction when financing multifamily rental properties is the number of units: four-units and under can qualify for conventional financing, but five-units and above is then considered a commercial loan; which has a whole additional set of borrower requirements.