When you venture into the world of real estate investment, there’s an entire dictionary of new vocabulary to keep in mind; single-family, return on investment, multi-family, etc. If you’re keen on finding out what a multi-family home is and whether or not it’s a worthy investment, read on.
A multi-family home is a single residential property set up to accommodate two to four-family living separately. Duplex, triplex, fourplex, townhouse, and semi semi-detached house are all examples of multi-family homes.
Multi-family dwellings with more than four housing units are considered commercial properties.
Types and examples of multi-family homes
Here are the various types of multi-family homes:
A duplex comprises two units stacked as a first and second floor or side-by-side. Each unit has a separate entrance, although many share a front and backyard, porch, and parking area.
Related article: What is a Duplex? Rent or Buy? Pros & Cons
A triplex comprises three units configured next to each other or as a three-story design.
Related article: What Is A Triplex Apartment?
This comprises four units arranged side-by-side or two first-floor and two second-floor units.
These units are attached side-by-side, but each has a private entrance.
Related article: What Is The Difference Between A Townhouse And An Apartment?
5. Semi-detached house
This single-family home shares a common wall with another similar unit.
Related article: Questions To Ask When Buying A Duplex
Pros of investing in a multi-family home
There are several perks to owning or investing in multi-family homes, including:
1. Cash flow
One of the reasons investors gravitate towards multi-family property is the cash flow generated monthly. Although the gross rent generated from a house may be higher than the rent from an individual unit in a multi-family home, the cumulative cash flow is much more significant with a multi-family investment.
For example, if a single-family house is rented out at $1,000 and each unit in a multi-family home like a duplex rents for $650 per month, you’ll make 30% more in gross cash flow.
If you plan to live in your multi-family home, the money generated from tenants could help offset the mortgage and your housing costs.
Related article: How Many Rooms Does A Duplex Have?
2. Passive income
Investing in multi-family homes is a reliable way to have an additional income stream without active involvement. You can opt to hire a property manager who will handle the day-to-day responsibilities on your behalf. This is especially appealing to individuals who have little to no experience managing or owning rental property.
Related article: Is A Duplex A House Or An Apartment?
3. Easier to tackle repairs and maintenance
If you live in or close to your multi-family property, you’ll find that it’s easier to tackle repairs and maintenance as it’s less likely that you’ll miss significant issues. Having a faster response time when such problems arise allows you to prevent even more critical issues that will be even more costly.
Related article: What Is The Difference Between A Duplex And An Apartment?
4. Less vacancy risk
Although experts consider real estate a generally wise investment because of its visibility, tangibility, and ability to perform well in an inflationary environment, some property classes are relatively “safer” than others.
A multi-family home gives you more rental units to work with, so you can take on a larger pool of tenants, making it easier to earn back your investment quickly. This makes them more reliable than single-family homes, where if the tenant moves out, your cash flow is negative for as long as it takes you to find a qualified tenant.
Even in an economic downturn where one might assume that returns will inevitably take a sharp dip, people need a place to live. Many people are more open to moving into rental units during a recession. It’s difficult for most people to rebuild their credit after a recession, which creates an increased and prolonged demand for a multi-family property. In comparison, retail, office, or industrial assets, demand almost always falls when the economy is in turmoil.
Related article: Can A Duplex Be A Condo?
5. Valuation potential
Although multi-family homes don’t always appreciate (the 2008-2009 housing market crash made this painfully evident), long-term investors will find that this property class typically appreciates over time and is more resilient to economic downturns. This is especially true if you’re willing to adapt to meet renter demands and changes in the marketplace, which almost always results in increased investor returns.
6. Flexible financing options
In most markets, you have the opportunity to finance a small multi-family home the same way you would buy a house, taking out a conventional FHA or VA loan. Depending on your chosen lender, you may find that interest rates may be a little higher, and the capital reserve accounts demanded by the lender may be more significant.
Related article: Condo Vs. Townhouse: What’s The Difference?
7. Quickly expand your property portfolio
Property investors who opt to go for multi-family homes find that they can quickly build a relatively extensive portfolio of rental units. While single-family investors think of their property in terms of “houses,” multi-family home investors think in terms of “units” or “doors” under ownership. Each unit of a multi-family home brings in its own stream of cash flow.
Since most investors are motivated to build property portfolios for the increased cash flow stream, investing in multi-family homes is a more effective way to expand your property portfolio without finding and investing in one individual house at a time.
Related article: What Is A Townhouse?
8. Tax benefits
Multi-family homes come with numerous tax benefits. Most investors opt to take out a mortgage to finance the property. If you go down this road, you can take a deduction for mortgage interest paid during the fiscal year, typically higher in the first years of ownership as the loan gradually amortizes.
This property class can then be depreciated over 27.5 years, even if it technically appreciates in value. The reduction in value can be used to offset a portion of the rental income that is collected each year, making this a highly appealing property class for investors.
9. Fewer loans
Another benefit of investing in a multi-family property is that you can typically purchase it with one straightforward bank loan, making things more accessible and less time-consuming.
Acquiring a 30 unit apartment building, for example, is a lot easier and much more time-efficient than buying 30 different single-family homes. With the latter, you’ll need to deal with 30 other sellers and move back and forth to conduct inspections on 30 houses, each located at a different address.
Furthermore, in some cases, buying multiple single-family properties to expand your portfolio might require opening multiple separate loans for each property, which can become difficult to track and manage over time. Some property classes often require multiple loan products that mature in independent time zones, which can be challenging to keep up with for a first-time investor. These complications could be avoided by simply buying one property with multiple units.
10. Insurance simplicity
Compared to other real estate types, insurance is relatively straightforward when buying multi-family property. Insurance policies will become increasingly complicated as the number of units grows, especially if the property contains amenities that could increase an owner’s liability, such as an outdoor pool or a rooftop terrace.
However, most insurance companies are well-versed in multi-family assets and will be able to come up with a suitable policy. As you expand your multi-family portfolio, getting an “umbrella” policy to cover all of your assets under the same company is also easy.
The multi-family property allows investors to scale their portfolios among this asset class. This means that they can easily add to their portfolio two units at a time if they so, please. It’s much more challenging to scale your property portfolio when investing in hotels or strip malls, for example, which typically have higher barriers to entry.
12. Diversity of investment
While a multi-family home is a single type of asset class, it is an expansive sector that allows investors to buy various product types. For example, you can opt to invest in small, neighborhood-oriented triplexes or duplexes. Another option is to choose a value-add apartment building for newly-renovated properties or a more opportunistic investment.
Some investors opt to go for 55+ retirement communities for seniors or private, off-campus student housing. You can also opt to purchase a multi-family property to rent on a year-long lease. Another popular option is investing in a multi-family home and then listing it on Airbnb or similar short-term rental platforms.
13. Multiple investment mechanisms
Another reason investors find multi-family homes appealing is the limitless ways in which they can invest. You can buy a multi-family building as an individual or go in as a group. You can also opt to invest via syndication – this allows you to enjoy the perks without having to take an active role in the partnership. Another investment mechanism involves investing in a multi-family fund with a broad reach to put money into multi-family properties across the country, consequently diversifying the location of your investments. An alternative is to invest via a real estate investment trust (REIT). You can buy and sell REIT shares as easily as stocks, which means this option preserves liquidity.
Cons of investing in a multi-family home
Despite the numerous perks to investing in a multi-family property, there are also some downsides to be aware of:
1. Multi-family homes are expensive
One of the most significant barriers to entry for people looking to invest in this property class is the huge upfront cost. Depending on where you intend to invest, multi-family homes can significantly set you back financially. A two-unit apartment building in metropolitan areas like New York, San Francisco, Boston, or Portland can cost over a million dollars. Most banks expect investors to put down a 20% down payment at the very minimum, which would mean that you have to part with at least $200,000 on a property going for $1 million.
Trying to come up with such a vast amount of cash is challenging for the average investor, especially in a market where many other investors are vying for the same property, consequently driving prices even higher.
2. Multi-family homes are management-intensive
Investing in a multi-family home and renting out the units to tenants essentially throws you into the role of a landlord. Being a landlord is a time-consuming and management-intensive job. If you opt to live in one of the units, be prepared to deal with tenants regularly.
Even if you opt to outsource your property management, you’ll still have to oversee plenty of things. A multi-family property means dealing with multiple individual leases, different tenants who have various repair and maintenance needs, tenants who have different communication styles, and so on.
Compare this to leasing office space to one tenant. You’d only have to deal with a single entity in this scenario. In addition, with commercial leases, most of the routine repair and maintenance responsibilities fall on the tenant, which makes management a bit easier for the investor. When strictly comparing residential-only property types in terms of management intensity, managing a multi-family property can be easier than working a variety of single-family rentals. There are perks to managing a single multi-family home, including hiring a live-in property, depending on how big the property is.
3. Expect to face competition
As previously mentioned, it’s inevitable for multi-family property to draw the attention of more experienced investors. This can result in intense competition for the property, driving up the price and shutting many newbie investors out of the market. Professional investors are often in a better position to pay cash upfront. They are more willing to waive all purchase contingencies, making their offers more appealing even at a reduced price point.
4. You may need a larger capital reserve or emergency fund
As an owner of a multi-family unit, you may need more emergency reserves than someone who invests in a single-family home, as the more units in a property, the higher the risk of having vacancies.
5. It’s difficult to diversify geographically
Since all of the units you own are part of the same property in one place, diversifying geographically is relatively more complex than a single-family property.
6. Limited exit strategy
If you decide to sell your multi-family property, you have a limited exit strategy as your buyer is likely to be another investor.
Tips for investing in multi-family rental homes
Investing in a multi-family property is not as straightforward as buying a single-family house. Each unit comes with different tenants, its own set of appliances and features, and an opportunity for adding value. Here are some valuable tips to keep in mind:
Factors that make a location suitable for multi-family property investment include markets with steady growth, a high housing affordability index, and desirable neighborhoods to appeal to a broader range of potential tenants.
- Unit count
Consider breaking into the multi-family property market by investing in duplex, triplex, and four-plex properties before moving on to large buildings. These smaller multi-family properties are more affordable and can offer the most significant upside potential.
- Income potential
Before purchasing a multi-family property, take the time to conduct a “reality check” – this involves verifying the property’s current rents are” at the market” instead of simply taking the seller’s word for it.
- Understand the seller’s motivation
Any experienced investor knows that sellers aren’t always motivated by price. In some cases, a seller needs a quick close of escrow to avoid having to deal with a pre-foreclosure. Other times, there may be an issue with a tenant that the current owner cannot deal with or deferred maintenance that the seller can’t afford. The more information you have on why the seller is choosing to sell, the greater your potential savings will be.
Multi-family vs. single-family homes investing
There are a few key differences when it comes to investing in a multi-family vs. a single-family property:
A single-family home is cheaper to buy than a multi-family property, so many novice investors opt to get started with the former.
You may be able to take out a regular mortgage for a single-family property, and you’ll likely need a commercial real estate loan to buy a multi-family property.
It’s easier to sell a single-family property, so there’s risk in buying them if you’re not sure about going real estate investment.
If you’re interested in buying real estate, it might be worth looking into a multi-family property. You can start by investing in two or four units, then gradually scale up from there.