The Pros and Cons of Investing in Multifamily Properties
With residential property prices spiking in California, the opportunity for investors is staying hot, even considering some more recent headwinds. This applies to single-family properties and multi-unit properties, such as duplexes and larger multi-occupancy residences.
More renters mean more income, making the idea of multifamily housing extremely attractive for investors with aggressive goals – as well as those looking for new direction in a market with more single-family properties than during the early parts of the 2022. However, it is always best to approach new opportunities with caution. It may feel compelling to get involved in multifamily property investing, but success is not guaranteed. A lot of factors go into the potential profitability, so carefully assessing the pros and cons can help investors make smart, calculated decisions with risk tolerance in mind – particularly in today’s competitive real estate investment climate.
Pros of Investing in Multifamily Properties
There are lots of benefits to investing in multifamily properties, but it is important to understand the many potential advantages and how they might apply to you and your investment portfolio, as well as your future financial goals. Be sure to evaluate every way in which a property could benefit you, from income potential to tax savings, before moving forward with a particular property; never assume the benefits will be there.
Steady Source of Income
The main purpose of investment properties for all investors is income potential. Multifamily units have at least two units available to rent out, which means more than a sole source of income each month. With more units available, you are effectively able to create several income streams using a single investment holding – a key benefit of this kind of property. If one ends or a tenant has not rent timely, rent from the tenants of the other units can keep the property afloat. Unless all tenants happen to end their leases simultaneously, there is always going to be an income source in play, though, with more units, it means your initial purchase price was also higher.
For those more interested in passive income, it is important to note that multifamily properties do tend to require more maintenance than a single-family dwelling. More tenants mean more points of contact, more maintenance, more details to manage, and more units to advertise in between tenants – overall, more work, to the point that passive income is no longer feasible when working solo. Serving as a property owner in a large building can take considerable time investment, so those who want to stay hands-off may want to consider working with a property manager. A property manager takes the onus off the owner, but it also makes margins tighter.
More Flexible Financing Options
This stability of rental income from multifamily properties versus single-family units benefits lending and financing options as well. While this may seem counterintuitive – banks tend to prefer lower loan amounts, especially where investment property is concerned, and most multifamily properties are significantly more expensive than single-family homes – it is true due to the reduced risk.
Because financial returns are not dependent on finding and maintaining a single renter, our brokers can fine you banks that can provide better financing options and lending terms. We will discuss with you the difference in financing options for a multifamily property versus single-family properties before making an offer on a property.
Possibility for Additional Passive Income Opportunities
With a property manager in place, all rental income is, in a way, passive, but there are other avenues investors can explore to capitalize on multiple renters in ways not possible with single-family units.
Enterprising property owners can drive in extra income by monetizing community amenities, like adding laundry facilities or allowing on-site storage or recreational spaces, such as a pool or gym, for an additional monthly or one-time fee. This kind of strategy does not work well for a single-family home – with one tenant, there is no community aspect on which to capitalize – but when multiple tenants can opt in to benefits for an extra expense, it is easy to earn a little extra income. A one-time cost investment, like adding a storage shed or a laundry room, can result in hundreds or thousands of dollars per year in the future.
This kind of opportunity will not be an option for every property, of course, and should not be a primary driver in choosing one property over another. However, it is something to keep in mind once a property is active and tenants are satisfied. This is particularly true when pools, playgrounds, on-site storage, or laundry facilities are available in comparable properties in your local area.
Taxes play a role in all investment activities and investing in multifamily properties is no exception. In fact, the tax benefits of this kind of investment property are a driving factor for some investors, as there are advantages in this form of investment that can result in substantial savings.
Tax benefits in multifamily properties are not inherently different than single-family properties, but as expenses will be higher, so will the amount you are able to write off – including expenses that may not have been applicable or were seen as an afterthought for smaller real estate holdings. This can include things like maintenance, utilities, insurance premiums, marketing costs, and even wages paid out to someone hired to assist with property management. When expenses are minimal, many investors do not spend a significant amount of time bookkeeping or may choose not to invest in a tax professional to maximize benefits. However, as income streams grow and expenses add up, partnering with a tax professional to make sure every deduction is accounted for can be extremely valuable – especially since it is possible to deduct the money spent on professional tax filings, too!
Cons of Investing in Multifamily Properties
There is a lot to love about multifamily real estate investment endeavors, but there can be some disadvantages as well. Investors need to take a careful look at all elements involved in a property purchase. This is especially true for those who are new to the competitive world of multifamily property investing, or who are still new to serving as a property owner or property manager.
The benefits of a multifamily property are not a secret, so other savvy investors know the upsides as well. This means that competition in the real estate market, particularly in a high-demand state like California, can be fierce. When a market is saturated and moves quickly, both breaking in and staying in can be particularly challenging.
Speed is an important aspect of competing for a good property, but stiff competition in real estate does not necessarily mean that being the first in the door guarantees a sale. While being an early bidder is a good thing, in a competitive market, sellers may be looking for additional rewards, like sales in cash or offers over the asking price. Be prepared to be aggressive and make your best offer to stand out.
If being competitive is not possible for you now, you may need to pivot strategy to stand out to sellers. This could mean adjusting goals, like downsizing expectations from a larger building to a duplex or increasing the amount you are willing to invest. In addition, you could investigate properties that have been on the market for a while due to some sort of flaw that makes them less than ideal; this could mean more in initial costs but can be an effective way in the door. Alternatively, you may choose to delay plans while saving more money to better appeal to sellers in the future, or to partner with another investor who brings in additional capital.
Higher Initial Expenses
Many investors know to expect a higher initial price to purchase a multifamily home versus a single-family residence, but the other expenses can come as a shock.
Most investment properties require at least a little work, like updating appliances and remodeling outdated kitchens and bathrooms, and most investors realize that more units result in more expense. However, there are other costs that may not be fully factored in. For example, utilities on a larger building are higher, costs for things like whole-building plumbing repairs are higher, roofing repair or replacement will be higher, and even trivial things, like re-painting an exterior, will add up over time. Investors who are only looking at unit-specific costs should also keep in mind how much more a larger building will cost to maintain in general, as these costs can come as a shock. When in doubt, always stay conservative with cost estimates, and consider how much a worst-case scenario, like flooding or a collapsed roof, could add toward expense estimates prior to purchase.
Higher expenses may taper off once necessary repairs are made, but this is not guaranteed, either. Some buildings may require more upkeep than expected, which means the big maintenance bills keep on coming. Investors new to this space are encouraged to factor in the potential for higher ongoing expenses and ensure a financially prudent purchase that does not come with unsustainable risk levels.
More Management Requirements
For those used to managing single-family homes, the switch to a multifamily property can come with a steep learning curve, especially for buildings with four or more active units. A single-family residence can truly be a source of passive income if upkeep is straightforward and tenants are not problematic, but the workload significantly grows the more units there are to juggle.
If you are used to doing everything solo, like handling repairs, organizing maintenance, doing lawn work, or collecting rent checks, you may need to make other arrangements once a multifamily building is in use. This is especially true if you want to keep tenants happy. If pipes burst, for example, and you are at your day job, leaving multiple families in the lurch until you get home is not going to result in satisfied tenants willing to commit to your property for years on end. If you have never worked with a management company or an independent superintendent, now may be the time to consider your options. These professionals can do the leg work so that you do not have to, like advertising vacancies, arranging maintenance, caring for properties, collecting rent, and managing complaints.
Savvy investors know, if you want real estate to continue to be a passive income source, you are going to have to give up control. How you choose to approach that is a personal decision, but as the number of units in your portfolio grows, so will the list of things you need to attend to keep your tenants happy. And providing a comfortable, safe place for tenants to live is always an imperative part of succeeding in operating rental properties.
The Bottom Line
With so many pros and cons to consider when evaluating an investment opportunity, it is important to understand what is to be gained – as well as what can be lost. Multifamily investment properties can be an excellent choice for many investors, but they will not be the right fit for everyone. California investors should keep the pros and cons, from tax benefits to steep initial investment costs, in mind when weighing investment decisions, regardless of the property in question.
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