So you’re looking to explore the world of multifamily real estate.
You’re in good company.
Whether you are a seasoned real estate investor or are investing in real estate for the very first time, multifamily real estate could be a great opportunity to diversify your portfolio, hedge against risk, and build passive income.
In this article, we’ll walk you through the ins and outs of investing in multifamily real estate. There are many ways to get into multifamily real estate investing so we hope this guide helps you make the right choice.
What is a multifamily property?
Residential real estate can be broken down into two categories: single-family and multifamily.
Single-family homes are properties that house a single family in them. Fairly self-explanatory. When you picture a typical American suburb, you are probably envisioning single-family homes in a row down a street.
Multifamily properties on the other hand contain more than one unit to house occupants. There is a range though in what is considered a multifamily property. For instance, you could have a triple-decker where the units are stacked on top of each other or an apartment building with dozens of units.
A common way to invest in multifamily real estate is through an apartment building. Apartment buildings offer scalability due to the number of units, which helps to build passive income as well as spread risk across tenants. We’ll get onto that more in the benefits later.
Is multifamily real estate a good investment
Multifamily real estate can make a great investment, but you’ll have to decide how to invest and what you are comfortable with.
Multifamily properties are a great way to build a long-term investment strategy. Rather than seek short-term gains and arbitrage opportunities, multifamily real estate can allow you to build a long-term investment strategy to manage risk and provide a steady stream of passive income. Due to this, there are many benefits to multifamily investing that we’ll explore next.
Benefits of investing in multifamily real estate
There are numerous benefits to investing in real estate, and multifamily real estate in particular. The four benefits we will examine in detail are:
- Cash flow
- Tax benefits
- Passive income
- Many ways to invest
Multifamily properties provide cash flow
One of the primary benefits of investing in multifamily real estate over other forms of real estate is the chance at reliable monthly cash flow via rental income.
Let’s compare a single-family versus a multifamily property. Single-family homes are riskier in that if you cannot find a tenant then you are on the hook for all the property expenses. Multifamily properties spread that risk out across tenants. If one unit is not being rented, the other units are still generating cash flow.
There are many tax benefits to investing in real estate
Numerous tax benefits come with investing in real estate. Depending on how you choose to invest, whether you outright own the building or are a passive investor, the benefits will change.
At Colony Hills Capital, we’re experts in real estate syndications, so let’s use them as an example to highlight some of the key benefits:
- Payment distributions from a real estate syndication qualify as passive income so they are not taxed as earned income. This means that if you can support yourself via your passive income distributions then you do not need to pay self-employment taxes.
- Due to the age and wear and tear of a property, the IRS allows owners to depreciate (expense) a portion of the property’s value each year. Syndication depreciation flows to the investors (you), pro rata.
- Suppose the property is held for over a year. In that case, the difference between the purchase and sale price will be subject to capital gains tax, which is lower than ordinary income tax.
- Properties can be refinanced, bringing in tax implications and benefits, though this can get a bit complex. You can receive some or all of your original investment back, but retain ownership of the property.
- Mortgage interest on the property is deductible, reducing the tax income burden.
- In the event an investment is not profitable, those losses can be carried over and deducted from future taxable income.
Multifamily properties generate passive income
Due to the ability to generate cash flow, multifamily properties provide a better chance of generating passive income for investors.
Investing in multifamily real estate isn’t just about benefiting from the sale of a property. If the building has a high occupancy rate, this will generate a steady stream of passive income and profit; you’ll also build passive income while investing in the property.
There are many ways to invest in multifamily real estate
As you may guess, so far, from this article, there are many ways to invest in multifamily real estate. How you invest depends on your goals, the amount to invest, and the role you would like to take. More active investors may seek out purchasing a property to manage, while REITs and real estate syndications are good fits for passive investors. We’ll examine each of these options in detail later to help you decide how to get into multifamily investing.
So, is multifamily investing right for you?
How to tell if multifamily investing is right for you
If you’re unsure of whether multifamily real estate is the right investment choice for you, here are some helpful signs that it is a good fit.
You want to diversify your portfolio
Real estate is not only a smart investment, it is a great way to hedge your portfolio against uncertainty and risk. Investing in stocks subjects you to volatility, and while the real estate market is not exempt from economic downturns, it can still be a great way to diversify your portfolio against risk.
In 2022 we saw a period where the dollar increased in strength compared to other currencies around the globe. While this led to a great deal of turbulence in the stock market, it also highlighted real estate as a solid investment and a good place to hedge against risk. We break this down further in our guide on how to invest when the dollar is strong.
You want reliable cash flow
Real estate is an excellent investment, but you do need to consider the risk and exposure to a property. If you own a single-family home or even a few single-family homes, your eggs are all in one basket (so to speak).
If a single-family home cannot be rented or if anything happens with the tenant, then that poses a challenge to the owner. Multifamily properties spread that risk across all of the units, so you are not relying on income from one tenant.
You want to build passive income
One of the chief benefits of investing in real estate (especially multifamily) is the ability to build passive income. By owning/investing in multifamily units that are rented out, you will benefit from the cash flow created by those rent payments from the tenants.
Cash flow scales the larger the property and the more units it has, making the potential for cash flow from investing in an apartment building very attractive compared to a smaller property or a single-family home.
How much money do you need to invest in multifamily
If you’re sold on multifamily investing, you may be wondering how to get into it and how much it will cost. The answer to that question is, it depends (isn’t it always in finance?).
The reason it depends is that there are several ways you can invest in multifamily real estate. We’ll examine them further as there is a range between them.
You could purchase and manage a property, or you could invest in a fund (and there’s quite a range within funds as well). Buying a property will require enough to cover the down payment, whereas investing with a fund will have different requirements. We’ll examine the different ways to invest in multifamily real estate next.
What are the ways to invest in multifamily real estate?
As we said above, there are many ways to invest in multifamily real estate. The three most common ways are:
- Purchasing a property
- Investing in a REIT
- Investing in a real estate syndication
Purchase a property
Purchasing a property is one of the first things that may come to mind when thinking about investing in real estate. Purchasing a property is straightforward (in theory). Just as you would purchase a single-family home, you can purchase a multifamily property and manage the units yourself or hire a property management company.
There are obvious risks here though. For one, you’ll need to cover the down payment and will be responsible for the mortgage payments on the property. Managing tenants can also be a hassle. You can outsource this of course, but that will eat into your profit on the property.
Invest in a REIT
For those looking to invest in multifamily real estate, but stay at arm’s length, REITs may be a good option. REIT stands for real estate investment trust, and they operate like a mutual fund where you can buy shares that allow you to invest in a large number of homes at a lower price. This allows you to invest in multifamily real estate like you would the stock market, and removes you from much of the hassle of managing the property.
You’ll need much less to invest to get started, which is a major plus for some investors. Being so far removed from the property though comes with a few downsides. You won’t benefit from the sale for one and there are fewer tax benefits.
Invest in a real estate syndication
We think of a real estate syndication as the best of both worlds option. Like purchasing a property, you are a part owner of the property and benefit from the passive income generated by rent payments, as well as the sale. Like a REIT though, you are not directly involved in the property, removing the risk of managing tenants or other risks that come with direct exposure to the property.
One of the downsides of investing in a real estate syndication is the barrier to entry. You typically need to be an accredited investor, which means you have an annual income of at least $200,000, or $300,000 with a spouse, or a net worth of over $1,000,000, excluding a primary residence. There are other ways in which you can be considered to be accredited, which we will discuss in another article.
What are the best markets to invest in for multifamily real estate?
Not only are there numerous options for investing in real estate there are also (nearly) countless markets.
Which part of the country do you want to invest in? What neighborhoods will you invest in? What is available? These questions and more abound as you try to identify the best option to place your funds.
These aren’t easy questions to answer either; the market you invest in is critical. When evaluating options to invest, a handy metric to consider is the cap rate. The cap rate of a property is a helpful way to evaluate a real estate investment and compare options to see which may be the best one for you.
The market will have a direct impact on the cap rate of a property. (See our article on cap rates for more details). Rental growth rates, property values, location, and market size/demand all impact the growth potential of a multifamily property. As you can imagine, there are many factors at play here. At Colony Hills Capital, we take great care with the markets we invest in to do our best to maximize the return for our clients.
Our approach is simple: prioritize cash flow above all else. Rather than debating the cap rates of a property we focus on how to build and maintain cash flow throughout the lifetime of the investment. This allows you to benefit from a steady stream of passive income rather than worry about which market to invest in, or how to compare multiple properties.
Are you ready to invest in real estate?
Think of this as a crash course in multifamily real estate investing.
Between the potential for passive income, the tax benefits, and the security that comes with investing in real estate, it’s easy to see why this would be an attractive option for you.
But how will you invest? Are you looking for a hands-on role? Or do you prefer to be more removed from the property?
If this is your first time investing in real estate, don’t be scared off by the decisions. Even if you are a novice to real estate investing, it can still be a great option for you. It’s important to invest in the right market, and in the right property, however.
At Colony Hills Capital we are experts in the acquisition, ownership, and management of multifamily properties in growing markets around the country. While we cannot guarantee results, we always aim to provide consistent and above-average passive income to our investors. Past performance is no guarantee of future results. Interested in investing? Contact us today to learn more.