Before taking any other steps, new real estate investors need to answer one question: what type of real estate? From single-family homes to office buildings to industrial projects, a variety of options exist. Despite these options, we argue that multifamily properties remain one of the most reliable investments. And, in the rest of the article, we’ll explain why investing in multifamily still makes sense in 2022 and beyond.
Specifically, we’ll cover the following topics:
- What Is Multifamily Real Estate?
- Reasons Why Investing in Multifamily Makes Sense
- Obstacles to Multifamily Investing
What Is Multifamily Real Estate?
As the name suggests, multifamily real estate includes all properties that have separate dwelling units for multiple families. On the smaller end, this category includes “plexes:” duplexes, triplexes, and quadplexes with two, three, and four units, respectively.
However, while technically multifamily properties, these two-, three-, and four-unit buildings fall more into the realm of residential than commercial real estate. Generally speaking, lenders classify properties with four or fewer units as residential, meaning they qualify for residential mortgages – similar to the financing used to purchase your primary residence.
On the other hand, buildings with five or more units qualify as commercial properties (e.g. high-rise apartment buildings, garden-style apartments, etc.). This classification means that investors use commercial financing with these projects. This type of financing includes shorter terms and a different, more involved closing process. Whereas residential mortgage approval largely depends on the borrower’s financials and the property itself, commercial lending depends more heavily on the income the property will generate and the implied valuation.
For the purposes of this article, when we discuss multifamily investments, we mean these commercial ones with five or more units (e.g. apartment buildings).
Reasons Why Investing in Multifamily Makes Sense in 2022
Reason 1: Tenant Familiarity
One of the largest challenges to investing in commercial real estate involves tenants and their unique needs. If you haven’t occupied a light industrial building yourself, you likely don’t fully understand the needs of a business that would. This makes tenant relations a challenge in this sort of environment.
Conversely, most of us have lived in an apartment complex. Even if you’ve never invested in one, you likely have an inherent understanding of what these tenants need. This familiarity makes analyzing a property, finding and placing tenants, and managing day-to-day operations far more digestible to new investors.
Reason 2: Economies of Scale
With apartment buildings, investors frequently gain economies of scale that allow expenses that would be cost prohibitive in smaller properties. For instance, say you own a quadplex that generates $6,000/month in rental revenue. With that sort of revenue, you couldn’t afford the salaries of on-site management and maintenance staff. Instead, you’d likely contract a third-party management company to remotely handle the management and maintenance responsibilities.
But, say you invest in a 100-unit apartment building with $150,000/month in revenue. With that much money coming in every month, you could realistically absorb the salary expenses of on-site management and maintenance staff. And, having these individuals on-site decreases vacancy by more quickly responding to the needs of current and potential tenants.
Reason 3: Vacancy Buffers
Multifamily properties also have the inherent advantage of built-in vacancy buffers. With many commercial retail and office spaces, you may have one to several tenants. While these tenants generally pay far higher rents, they also make up a far larger proportion of your rental revenue. Consequently, if a single tenant in one of these spaces leaves, you will – as a percentage of gross potential rent – have a far larger vacancy hit.
With that same 100-unit apartment building discussed above, losing a single tenant has a far smaller effect on your vacancy. Yes, office and retail tenants normally sign far longer leases than residential ones. Regardless, multifamily properties simply absorb vacancy more effectively than other commercial property types due to their greater number of tenants.
Reason 4: Counter-Cyclical Characteristics
It’s an unfortunate reality, but in economic downturns, people tend to downsize. Related, people who otherwise would look to purchase homes may no longer be able to afford to do so. Both of these situations have the effect of increasing demand for multifamily leases. In this respect, the operating performance of many multifamily properties improves when the broader economy slows. This phenomenon leads to multifamily properties creating a counter-cyclical hedge in an investor’s portfolio.
Obstacles to Multifamily Investing
If multifamily investments make so much sense, why doesn’t everyone pursue this strategy?
Capital. That is, these types of properties generally have far higher valuations than single-family homes or plexes. If you want to purchase a $500,000 quadplex with an 80% loan-to-value mortgage, you’ll need $100,000 (ignoring transaction costs). While not chump change, many investors can come up with this sort of sum.
But, let’s say you want to purchase a $5 million apartment building. With the same loan-to-value terms, you’ll need $1 million (once again, ignoring transaction costs, which tend to be higher with commercial real estate acquisitions). Pulling together $1 million is an insurmountable obstacle for many individuals, which is why the capital requirements for multifamily deals tend to turn off potential investors.
Despite this capital-intensive nature, plenty of investment opportunities exist with multifamily properties. And, if you’d like to discuss different real estate investing options for your unique situation, we’d love to chat! Drop us a note, and we’ll set up a meeting to talk about available multifamily opportunities.