CHAPTER TWO
Why Multifamily?
As its name states, multifamily property covers different types of residential real estate with the exception of single-family buildings. For the purposes of this book and teaching you to syndicate real estate investments, we will not address single-family units, specifically rental houses. Instead, let's focus our attention on multifamily properties and why they can provide the best bang for your buck. Since terms can sometimes vary by region (although that doesn't apply so much to real estate), let's begin with some basic examples of Multifamily property.
The most common buildings within this subgroup are:
Real Estate
The rental property in real estate can be divided into two main categories: Single Family and Multifamily. The latter is our focus.
Single family properties have a single unit available for rent .
Multifamily properties have more than one rental space. It is also called an apartment complex.
Even among apartments, there are a variety of property types. The chart below will give you a quick look at the varieties.
  1. High-rise : These buildings consist of nine or more floors, and the tenants within a high-rise are served by at least one elevator.
  2. Mid-rise : A mid-rise apartment is typically a multi-story building that is located on the outskirts of an urban area. A mid-rise will typically have only one elevator.
  3. Garden-style : This is an apartment that is built in the form of a garden. Garden-style apartments are usually found in urban or suburban locations and may contain as many as three stories.
  4. Walk-up : A walk-up apartment building will have between four and six stories without any elevator.
  5. Manufactured housing community : Manufactured homes are built on grounds that are leased by the community.
  6. Special-purpose housing : As the name implies, special-purpose housing is multifamily apartments that are built to meet the specific needs of a particular population within the community. For instance, it may be hostel accommodations for students or a home for senior citizens. Special-purpose housing also includes subsidized housing such as low-income housing or special need housing.
Why Multifamily Real Estate?
Countless individuals dabble in real estate with a handful of rental houses and maybe a duplex or two, and some enjoy a comfortable living from their small investment. But since our plan is financial independence, we need to look at a bigger market and a better return. The multifamily market has carved a niche for itself in the commercial real estate sector. No matter the condition of the economy, the multifamily market has a track record of performing better than all other classes of real estate. This sector of real estate has given investors unique high returns and lower risks compared with other sectors. This has made the multi-family investment the most advantageous, stable, and safest market in which to invest within the real estate world.
Going back on memory lane with Vinney
When I started my real estate investing career about 35 years back, I thought buying single-family homes to rent was a great investment and would potentially secure my future wealth. So, I began buying these homes and learning the business that went with it, such as financing, upkeep, and the challenges that went along with owning these rental homes. Since we (my team and I) bought properties in states scattered across the country, we chose to hire property management companies to manage them. The tax benefits of owning and renting them were good, but the cash flows were erratic. However, we just kept on purchasing and holding onto them while looking forward to their payoff in our retirement.
But I must confess that we sold all of them in 2017—with one exception - a duplex that yields a very nice monthly cash-flow even after 8 years after we acquired it.
Single-family and multifamily homes are great for both seasoned investors and up-and-coming investors. As with any real estate deal, please do your due diligence to ensure the deal makes sense financially and fits your personal goals for your investing business .
Scattered Houses vs. Units All on One Site
Obviously, the capital required for unexpected issues tends to eat into your cash flow very quickly. These expenses can include—but are not limited to—the purchase of a new boiler, replacement of or maintenance of an air-conditioning system, garage malfunctions, tree roots getting too close to the structure - and the list goes on.
Some people really do prefer the single-family units for real estate investment. So, in fairness, a comparison of the advantages of both is offered below.
Three Advantages of Single-Family Rental Properties
  1. Single family units are easier to get into and require a single, smaller loan or cash deal.
  2. Appreciation is tied directly to the neighborhood growth.
  3. These units are easier to sell when the times comes to do so.
Three Advantages of Multifamily Rental Properties
  1. Multifamily properties generate higher cash flows , which tends to be more consistent due to less effect of vacancy. For example, if you have twenty units, and two tenants leave, your property is still 90% occupied. Bigger pool of tenants-less risk!
  2. Multifamily property owners have more control over value. The value is based on the net income generated by the multifamily property. By adding value, the rents can be increased over time as the leases expire.
  3. Economies of scale. This is a big one! In the case of a needed roof replacement, consider the fact that, with twenty units, you still only need to replace two or three roofs (one per building). If, however, you are dealing with single-family homes, you may have twenty separate roofs in need of replacement within just a short span of time. Quite simply, maintenance requests can be handled much more efficiently in one location than when your units are scattered across an entire city or region.
Actually, there are lot more than just three advantages to investing in multifamily real estate. For me, after looking at so many ways to invest in the market, I decided to choose only one path: multifamily investing. I, wholeheartedly, encourage you and other investors to choose this route, also. It made sense 14 years back, and it still holds true today. It just makes all the sense in the world!
Even MORE Advantages of Multifamily Investing
  1. Scalability is much easier in multifamily.  Rather than purchasing individual properties and slowly growing your business one transaction at a time, in multifamily you are purchasing 20 units or 100 units in one transaction.
  1. Forcing appreciation in multifamily properties is easier compared to single-family housing.  When you give your apartment building (or even a four-plex or eight-plex) more curb appeal, you will push up the value of the property exponentially. Think about it – if you fix things in the property that make it more appealing as a living space for tenants by adding a nice media center, a dog park, or a friendlier laundry room space (all of which can be done in larger multifamily complexes, too), you will attract tenants to your building versus another landlord’s building. That’s what you want! And, because your tenants will want to stay, you are simultaneously creating bigger and steadier cash flow.
  1. More income in multifamily assets.  We call these bill-back utilities (RUBS). The residents are billed for a portion of the water, trash, sewer, and pest control services out of the total master bill that the owner receives. Along with paying the monthly rent, residents pay a flat fee or a proportional amount each month for these services. Most of the multifamily properties are individually metered for electricity, and each resident pays that separately.
  1. Great tax breaks come with investing in multifamily properties . When you provide housing it really is a good thing. The government thinks so, too. The city in which the property is located likes the idea, because you are helping the residents of that city by providing clean, safe, affordable housing to people who might not otherwise find it. As a result, you can gain all sorts of tax incentives (also known as tax breaks).
  1. Multifamily properties hold their value.  Once the property is rehabbed and you have made it attractive to tenants, it will also attract other investors who will be interested in buying the property later (if you ever want to sell). You will have put in place everything required to attract and retain tenants. That means steady cash flow, which is mighty appealing to investors.
  1. Investing in multifamily housing allows you to change lives.  We take pride in providing great places for the residents to live. We provide jobs to staff members at the property, as well as the vendors who service your property. Most importantly, though, through syndications we help a lot of investors who are doing well in their profession but don’t have the time for hands-on work with their multifamily properties.
Trends bode well for this strategy !
Are you convinced? Well, if you need any other incentives or assurances that multifamily investments are the avenue to take on your journey to financial independence, consider these trends:
To answer the question, "Why Multifamily real estate even further?" allow me to share the following reasons:
The market is resilient!
In moments of economic recession, the multifamily housing market has proven to be the most resilient, maintaining its high reputation and resisting the effects of an ailing economy. This stability gives the investors the assurance that their money is safe.
It has great demand!
The demand for multifamily properties has skyrocketed over the past few years. This is not unrelated to the values of these properties in comparison with other properties in the sector. Due to many factors, the growth of people renting is growing rapidly.
It carries a lower vacancy risk!
When compared with other real estate properties like offices and rental houses, the vacancy risks of multifamily real estate are significantly lower .
It demonstrates a high growth rate!
Benefiting from the population growth of an area, multifamily housing does not rely much on business cycles for existence. People will always need a place to live!
Property management is more efficient!
It is much easier to manage a multifamily property than it is to manage single properties. For instance, maintaining twelve units within one property will be less challenging and less expensive to maintain that twelve single properties in different locations.
If the properties are scattered all around town or even in different states, you could possibly need three or four different management companies to maintain them.
Consider, though, that one multifamily property single location, even with twelve units, can easily be managed by one part-time property manager. Even if you have a 50-unit apartment, the maintenance job will be handled by one manager or a single management company. The company will oversee the collection of rent, tenant issues, and building maintenance, among other issues.
Forced appreciation is easier!
I will talk in more detail later about this industry term and about how to use the concept of Forced Appreciation to raise the value of a property with the objective of increasing the income generated by that property. This, too, can be much more easily accomplished with a multifamily property than with single-family units. For now, just think about the fact that whatever facelift you do on a single-family property will impact that home only and in doing so will have a very limited effect in comparison to enhancements made on a multifamily property. The financial reward for you in improving a single-family property is greatly diminished in comparison .
Taxes
As mentioned above, owning apartments is a tremendous tax benefit. As in any business, we are able to deduct all the expenses incurred in administering the management of the apartment, and the benefit of deducting the depreciation often results in losses at the bottom line. This happens even when there is a large net income generated during the years of performance. This is a huge benefit that is not realized in other means of investing. We use the LLC owning the assets as pass through entity for Taxes. This way the whole effect of depreciation, profit or losses are passed through to the Class A investor members and to us the Class B members.
Tax breaks are available
Providing housing for people is considered a good gesture by many people. The government shares that sentiment! You are rendering a good service to people by helping them to have access to safe, clean, and affordable housing that, otherwise, might not be available. As such, you may benefit from a variety of different tax incentives or tax breaks from the government, possibly even providing you with grants to offset all the upfront costs on the property. In some situations, you may end up not paying any property taxes at all.
Depreciation
Depreciation is one great benefit of owning real estate. Simply put, depreciation can allow you to reduce the amount of taxes you pay due to accounting standards. It is treated as a paper loss. Even though the asset is producing cash flow due to collection of rents, minus expenses and mortgage, we are able to depreciate the structures (usually 70%-80% of the value of the apartment buildings) over 27.5 years, straight line. There are other avenues where we can deduct larger depreciation amounts through “cost segregation” also called “accelerated depreciation ” in the first 5 to 15 years, thus yielding more tax benefits .
They hold their value!
The first thing to do after purchasing a multifamily property is to renovate it according to the latest property trends. Even some minimal renovation to the property will increase its value and make it appealing to other investors should you ever decide to sell the property. You have also increased the property's value to its current tenants, those who may not yet be ready to leave the property, and that guarantees continued cash flow, which is an added bonus for you, the new owner.
Unless you are planning on being a slumlord (in which case you should put down this book now), proper maintenance of the property should be of utmost importance to you. The floor, the roof, and the environment around the units must be put in good shape, and those occasional repairs should be carried out swiftly and happily.
You are changing lives!
Providing housing is a great investment in humankind! When you invest in multifamily properties you are having a positive influence on many people:
  1. Residents in your community
  2. Teams of people managing them
  3. Vendors servicing your communities
  4. Investors receiving cash flows and equity gains
  5. Neighborhood businesses and facilities
Multifamily Properties are easier to finance!
While many people believe that it will be easier to get a loan for a single-family home than a multi-family home, those people are mistaken. In fact, that notion is far from the truth. In reality, it is easier to get a loan for a multifamily property than for a single dwelling. Although it takes more money to finance a multifamily property, lenders are willing to take the risk because multifamily properties guarantee steady cash flow, something that single-family units cannot do so easily .
For instance, if the tenant of a single-family property leaves, the home becomes 100% vacant which is bad for business. However, if a tenant of a 10-unit, multifamily property leaves the property, the vacancy is 10%, leaving 90% of the property as a source of income until the vacant apartment is rented again. This ensures a steady cash flow for the property owner and reduces the probability of a foreclosure, a valid reason for lenders to be willing to give the borrower a loan. It really is a less-risky investment for the bank and for you in comparison to ownership of a single-family rental property.
Debt leverage
It is only in real estate that the banks, financial institutions, insurance companies, Fannie Mae, and Freddie Mac are willing to partner with you in such an advantageous way, providing loans from 65% to as high as 80% of the value of the real estate you are purchasing. You have to only put down 35% to as low as 20% to control the investment.
Consider stocks, bonds, precious metals, and even cryptocurrency — Lenders typically do not provide loans to purchase any of these. Real estate, then, is an excellent vehicle of wealth building due to “debt leverage.” It’s important to understand that this leverage can go the other way as well, and that’s why we talk about having a safety net through your Debt-Coverage ratio later on in the book.
Building a portfolio is easy!
If an investor wants to quickly build a portfolio of rental units, the best way to go about it is to invest in multifamily properties. This is a much more enticing prospect than the idea of buying twenty different units, which will require the appraisal and inspection of twenty different properties in just as many locations. On top of that, there is the potential of having to hire twenty different managers, and you might even have to take out twenty different loans. Whew! That's a headache!! It is much easier and less time-consuming to buy one twenty-unit multifamily property and avoid the extra time, hassle, and stress .
Debt pay-down
As rental and other incomes are collected monthly in apartments, the mortgage (interest on loan and the principal) is paid out monthly. Consequently, the loan balance amount, which is your principal, is decreased monthly. If we keep the asset over 30 years, and pay down the debt for that long, we will own the apartment complex free and clear. Mind you, it all got paid for by the rents collected with no money out of pocket.
Appreciating rental rates in the future
Many real estate investors go into multifamily due to the many benefits mentioned above. If you are interested in making a living from real estate investment and want steady cash flow, investing in multifamily property really is one of the best options for you. You will contribute immensely to society, add value to people’s lives, and be assured of passive income for as long as you are in business.
Property Classification
As I attempt to sell you on this idea of multifamily real estate, perhaps some classification of the various property types would prove useful. Property classification: What does that even mean? This is another common question I receive from new investors. We classified real estate properties in to 3 categories: Class A, Class B and Class C. Let's break each category down and, in doing so, see why these classifications matter.
What and Why?
Property classification is a simple way of differentiating one type of property from another. It is developed and used by lenders, investors, and brokers to discuss the rating and quality of a piece of real estate. This classification method makes it easier to communicate quickly and efficiently amongst the various stakeholders in the deal about the quality and rating of a property. For investors, property class is an important factor to consider because each class represents a different level of risk and return. The following criteria are used in this classification method.
Criteria of property classification
The combination of these factors will determine which letter grade will be assigned to a property. Here are the various classifications:
Class A
As its name implies, this category represents the premium quality properties in the area. A common trend among them is their age; they are usually built within the last 15 years, which makes them relatively new in comparison to the buildings in other classes.
This category is generally marked by...
The location of these properties is another criterion that distinguishes them as Class A. They are usually in prime locations in the market. This makes the demand high and increases the potential rental income they will generate. This is not a problem considering the type of tenants that opt for Class A buildings. These properties typically have few maintenance issues, as they are (almost) always professionally managed.
Class B
The quality and the price of the properties in this subcategory is little bit lower. These properties are usually older than the properties in Class A and are occupied by lower income tenants. While the location may not be on par with that of Class A, the location is still very good and has more value than the buildings in the next, lower Class C. The rental income per unit is less than that of Class A largely due to the location. Owners can expect to have a few more maintenance issues because the buildings are older than Class A properties.
Most of the buildings in this group are well-maintained and are still popular with investors because, with just a little tweaking here and ther e, they may be upgraded to Class B+ or Class A. This makes the Class B buildings a good investment for some investors who might not have the financial power to invest in Class A property. Class B can also be resilient during economic downturns, as Class A tenants may transition to Class B apartments if their financial situation forces them to do so.
Class C
The properties in this subcategory are the oldest in our market. They are typically more than 20 years old, and they are sometimes located in less-than-desirable locations. Class C properties usually need renovation. Because of this, Class C buildings tend to have the lowest rental rates in a market.
Each subcategory carries its own set of pros and cons. Why are Class A properties the preferred first choice of investors? Because those investors feel more confident investing their money in properties that do not require much additional cost to improve. The fact that these buildings are new and require no renovation removes the burden of extra expenditure upfront. Despite their favorable attributes, though, running a Class A property can be challenging during an economic crisis when high-income earners may be faced with lower income or temporary unemployment as a result of a loss of job or layoff. Class A properties will typically have lower returns when you first acquire them because of this risk-reward tradeoff.
The other two classes usually have higher CAP (Capitalization) rate when they are sold or bought than properties in Class A. This is because those who decide to invest in these properties are compensated for investing in a property located in a neighborhood with lower income or lower income tenants.
If you need a property with capital preservation, go for Class A properties. Classes B and C properties are ideal for you if you are looking at capital appreciation .
Before we move on from why multifamily properties are the way to go, let me provide you with a few more reasons why I recommend this type of investment. The following seven steps to building wealth through apartment investing are sure to entice you further.
I sincerely hope that you are seeing the major advantages in apartment investing, often called multifamily investing. With Millennials liking portability and the downsizing of the Baby Boomers population, the demand for apartment rentals is predicted to be strong and increasingly sustained well into the future.
As you can see, I really am very bullish on investing in multifamily real estate, as opposed to single-family or other commercial sectors. I sincerely hope that this chapter will cause you to investigate diversifying and beginning your investment in multifamily real estate. Syndication is the best game - pooling money together in accordance with the SEC (U.S. Securities and Exchange Commission) rules and regulations to leverage the greatest turn-around on your investment as we discussed in the previous chapter. Now let share with you the five plates I have been talking about in great details in next few chapters.