For new investors, the idea of developing a property may seem like an insurmountable challenge. Fortunately, options exist to invest in development deals despite having limited experience. In particular, multifamily properties offer tremendous opportunities for new investors. As such, we’ll use this article to explain why developing multifamily is a great strategy.  


Specifically, we’ll discuss the following topics: 


  • What is Real Estate Development?
  • Reasons Developing Multifamily Real Estate Makes Sense
  • Additional Considerations 
  • Final Thoughts


What is Real Estate Development?




Before discussing multifamily development, we need to briefly explain real estate development, in general. While much confusion exists around the term, at its core, real estate development has a straightforward definition. Namely, real estate development is the business process that creates value by improving land and existing real property. Whereas construction entails the act of building, development involves planning and figuring out how to pay for that construction. In this respect, real estate development and construction are intimately related – but distinct – processes. 


For example, a real estate developer could solicit investors and lenders for a project to improve vacant land, connect utilities, and build an office building. Alternatively, a developer could take that same capital and use it to renovate an abandoned warehouse into loft apartments. In both situations, the developers took a vision for a property, raised funds, improved that property, and added value in the process. 


Multifamily Development


Commercial real estate includes a multitude of different property types (e.g. office, light industrial, medical, hospitality, retail, etc.). Due to the differences between these types, many developers focus on a single one. 


As the name suggests, multifamily development involves deals with multifamily properties – generally any property with five or more residential units. These properties could include high-rise apartment buildings, garden-style apartments, or townhouse communities, among others. 


For instance, a multifamily developer may want to convert a vacant school into apartments. In this situation, the multifamily development process would include everything from raising funds for the deal through property renovation and lease stabilization. 


As we’ll outline in the next section, this multifamily development process has some major benefits. 


Reasons Developing Multifamily Real Estate Makes Sense


Reason 1: Higher Returns


In a properly underwritten and executed deal, a real estate developer will typically command higher returns than someone who simply buys a stabilized property. First, developers generally charge a fee for their services in planning and overseeing the execution of a deal. Second, when you develop a property, you have greater control over project costs, design, and future income, allowing you to maximize returns. 


Reason 2: Ability to Control the Design Process


When investors purchase stabilized properties, they have no control over the design process. That is, the property already exists and generates income. But, if you develop a property – either ground up or renovation – you work hand-in-hand with architects and general contractors to design that property. In this fashion, a new development can be compared to a blank canvas, albeit one constrained by cost, zoning, and engineering restrictions. 


Reason 3: Multifamily Properties Have a Vacancy Hedge


If you develop a bulk storage warehouse, you likely have a single tenant. While this can provide stability with a long-term lease, it also creates major vacancy risk. That is, if the single tenant leaves, you have zero rental income. Conversely, multifamily properties have an inherent vacancy hedge. If one tenant leaves, the other tenants help offset that vacancy loss until a new tenant can be found. 


Reason 4: Money Flows to Deals


In the current environment of historically low interest rates, investors and asset managers constantly seek higher yields. Multifamily properties consistently provide high and relatively stable returns, part of the reason so much capital flows into these deals. If you establish a proven track record of developing multifamily properties, money for deals will flow to you. There just aren’t enough alternative investments offering comparable returns and reliability. 


Reason 5: Tax Advantages of the Real Estate Professional Designation


Real estate developers generally qualify for the IRS real estate professional tax designation. While the full details of this designation are beyond the scope of this article, gaining this status allows you to offset ordinary income with passive losses from rental properties. 


When developers charge a development fee, that qualifies as ordinary income, meaning you must pay self-employment tax and marginal income tax. Normally, depreciation leads to rental properties operating at taxable losses while being cash-flow positive. If you do not qualify for real estate professional status, you cannot use these rental property losses to offset ordinary income. But, as a real estate developer, you’ll likely qualify, meaning that the taxable losses on a multifamily property you developed can offset the development fee income you earned in executing that deal. 


Additional Considerations 


While real estate development may have a straightforward definition and plenty of advantages, the process itself is anything but simple. Rather, successful real estate development entails significant amounts of experience, capital, and risk-taking.


Risks of Real Estate Development


Developers may command higher returns, but they also take on far greater risks than your average real estate investor. During the entire development process, a variety of factors could derail a project. From legal to zoning to financing to structural issues, even the most thoroughly analyzed deals can hit unexpected obstacles – some of which could prove fatal to a deal. 


Furthermore, developers must pay a number of costs before they know whether or not a deal will happen. During the feasibility period of a project, developers pay for environmental studies, architectural renderings, and other soft costs that, if the deal doesn’t continue, the developer still must pay. This reality means that, depending on the size of the potential project, a developer could be out tens to hundreds of thousands of dollars (or more) in feasibility period expenses.  




All of these risks means that new real estate investors should not jump directly into the development game. In other words, if you’re just getting your feet wet as an investor, you shouldn’t attempt to develop your own multifamily project. The process just requires far too much experience, leading most new investors to partner with veteran developers on their first few deals. Over time, investors can then potentially gain enough experience as a limited partner to begin developing their own properties. 


Final Thoughts 


While real estate development certainly has challenges, strategies exist for new investors to reap the benefits of multifamily development. In particular, many experienced developers seek investors for future deals, allowing you to purchase an equity stake in a multifamily project without assuming responsibility for day-to-day operations. 


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 development opportunities.