The Pros and Cons of Multifamily Investing

 

In my live events and webinars, many people ask me, “Why multifamily?” or “Is multifamily a good investment?”.

While I may be biased, I have personally done the single-family rental game, tried my hand at day trading and even thought of wholesaling early in my real estate career. The main issue with all these things is that they did not align with my goals of building a portfolio of assets that would allow me to reach my financial goals. It wasn’t until I understood what multifamily could do that I realized that these investments could help me reach financial freedom.

You may need to decide whether it makes sense to meet your financial and personal goals. Maybe the thought of being responsible for larger deals give you anxiety and you want to stick with stocks. Or maybe you are concerned about the financing. Whatever your reason, you should weight the pros and cons of moving into the multifamily realm and determine if that business is right for you and your goals. I have outlined a few of them here:

Pro #1: Greater Cashflow
In a single family home, when the tenant leaves, you need to cover the mortgage, fees and the turn – all while that property is generating no money at all. In a multifamily, you have many units kicking up cash every month, generating more cashflow. In a larger deal, if you have other occupied units to continue covering expenses, you are still ok. Your break even should be calculated while you do your due diligence so you know the cashflow your minimum number of units will generate.

Pro #2: There is Cash for Professional Property Management
When you have a multifamily deal, there is cashflow to pay a management company to handle tenant requests. On larger deals, there may even be enough cash to have the management company work full time or live on the premises.Property management can be a hassle for a real estate investor that doesn’t have the experience or time and something so important must not be overlooked. While many investors want to do their own management, they very rarely pay themselves the fee. Additionally, the investor needs to be current of all tenant/landlord laws and handling the bookkeeping.

Pro #3: Economies of Scale
In a multifamily, all the units are in one place. They typically share the same roof, boiler, and water tank. Maintenance goes to one place to work on many units rather than running all around town to work on a bunch of single-family homes. All this means you are able to keep your operating costs down.

Pro #4: Options for Forcing Appreciation
This is probably one of the major benefits when it comes to multifamily. As the name implies, you are able to push the value of the property up by adding amenities to get more income or reduce expenses.

This includes simple things like installing vending or laundry to offering doorside trash pickup. You can make one change and your tenants in the community may end up using it. You cannot do this in single family. In fact, appreciation is based on what other people’s homes are worth. Basically, you have very little control over the value of the asset.

Pro #5: Grow Your Portfolio Quickly
Depending on your goals, you may value time spent getting deals closed. If you have aspirations of getting to 250 units and you are closing single family homes one at a time, it will take years to reach your goal. Rather, if you buy a single 250 unit apartment building, it will be significantly less expensive as you are skipping all the extra lender costs, attorney fees, and other closing costs. And, you can conceivably reach your goal in one or several transactions.

Pro #6: Househack by Living in One of the Units
For those starting out doing a residential play with a four-plex, you may choose to live in one of the units and rent the others for the extra cashflow. Because you are onsite, you can handle the management, control expenses and keep an eye on things. Financing is also fairly simple as it’s considered residential.

Now, let’s look at some possible challenges:

Con #1: Can Be Tough to Finance
When you are diving into deals with 5 or more units, you are now into commercial financing. The cashflow and property value as well as your experience as an asset manager become key. This is very different from residential, where they are looking at your personal earning power as consideration to give you the loan. The interest rates are higher, the terms are different, there are larger down payments required and can get complicated to get out of the loan. For those that have never done such a loan, it may be tough to do without an experienced partner.

Con #2: Operational Experience is Required
A multifamily is not passive; It is a business. Coordinating and running construction crews, CPA’s, attorneys and accountants takes a great deal of experience. Yes, your property management company handles a great deal of the load, but you are still the entrepreneur that needs to make sure the machine is in motion. You need to be ready to dedicate time to building the operations around the portfolio of real estate.

Con #3: More People Problems
When you scale up your units, you will scale up your tenants. While some tenants are nice and will take great care of your property, some will treat the property badly and tear up anything and everything they get their hands on. One day, your appliances are stolen. The next, an evicted tenant will purposely flood a unit causing thousands in damage. The demographics will depend mainly on where you are buying, but all tenants and properties – from A Class to D Class – have their sets of issues.

Con #4: Regulations and Local Government Involvement
As investors and landlords, we already have many regulations about how property can be rented and whom it can be rented to. Multifamily has even stricter regulations. Everything from HUD to ADA to Fair Housing comes into play – and that’s just on the Federal side. Your local government is poised to tax you with things like a “unit registration fee”. You will need to do your research beforehand to find out the laws in your area about their requirement or you could break the law or risk fines.

So, as far as an investment, multifamily comes with many pros and cons. I personally believe that investing in multifamily real estate is the best way to generate cashflow and build personal wealth, but that’s me. Again, it depends on what your personal and financial goals are. It also depends on your experience in dealing with tenants and running a business. If you are not sure, perhaps you can start with a duplex or a fourplex to see if it’s right for you. Smaller properties are easier to buy, sell and manage.

Anyway, are you on the fence about getting into multifamily? What is holding you back? Let me know in the comments. I’d love to hear from you.

If you liked this content, go ahead and give it a thumbs up and share it. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.

Be great.

FOUR TYPES of Prepayment Penalties & How to Negotiate Them

 

When you are working with a lender or broker on a commercial loan, one item you will want to pay close attention to are prepayment penalties. Overlooking this would be an expensive mistake if you want to shorten your refinance period or make a significant reduction to your loan balance.

For those that aren’t familiar, prepayment penalties aren’t seen in residential mortgages. These prepayment penalties are regularly seen in the loans that many of you out there are making: commercial loans – loans for properties with 5 or more units.

Before we go into some of the fee and penalties, let’s go into the “why”. The primary reason lenders charge a penalty is to recoup the cost of the loan if there is a change to the payoff of the term. You will notice that banks won’t charge you a higher interest rate or points as a hard money lender would. The penalty is in place so they can get that money back if you terminate the loan earlier than expected, whether through a refinance or just paying it off for the outstanding principal amount.

A lender wants to keep a performing loan on their books. When the loan is paid off early, it introduces uncertainty to their forecasts. They put these fees in place to keep that loan in place.

There are four common prepayment penalty structures for commercial real estate loans:

1) Yield Maintenance
In this penalty structure the lender will charge you the interest as if you had made the payments for the entire period to maturity. They will calculate the net present value of the interest and hit you up for that amount at closing. This one is fairly common.

2) Defeasance
This is primarily used by insurance companies; Basically, instead of paying cash to the lender, this option allows you to exchange the note with another cash-flowing asset. If you are doing this, the new collateral is usually much less risky than the original commercial real estate asset. There is a much longer explanation, but doing all this is not easy or cheap. This is primarily seen if the loan has been bundled with other loans and sold as debt security as a Commercial Mortgage-Backed Security (CMBS). Chances are that you will not see this on your loan docs.

3) Step-down
This one is quite common and simple; In this case, the lender will put a prepayment fee schedule in place that will decline over time. For example, in a 3-2-1 scenario, you would pay 3% of the loan amount prepaid in Year 1, 2% in Year 2 and 1% in Year 3. If you are doing a refinance with the lender that has this provision, they will sometimes waive the penalty if you keep the loan with them. Be sure to ask this upfront.

4) Lockout
This one is rare to see; It doesn’t allow for any prepayment at all during a specified period. Let’s say you have a 10-Year loan without contractual ability to prepay, or a lockout, in the first 6 years of the loan. There will be no option to refinance or even sell the property during that time. As you can imagine, this will not work for us in the world of commercial real estate. Avoid the lockout provision.

There are many lenders with good rates and no prepayment penalties. You will see this with lenders that offer a floating rate loan. Depending on where we are in the economic cycle, you may be comfortable with this. Personally, I like to fix my rate so I know what to expect out of the monthly payment and know what my net operating income will be.

There is sometimes room for negotiating the penalty. When you are presented with a term sheet, review it closely. Have your partners take a look as well and look for any prepayment penalties. If you need flexibility because of the deal you are working on – for example, a 3-Year refi and distribution to your investors – then a 5-Year step-down won’t work for you unless you are prepared to pay. Telling the lender what your plan is important. You can push for the prepayment you can commit to by swapping it for another penalty type. Perhaps you would be fine with a 3-Year Yield Maintenance and sell at the beginning of Year 4. Or, they may even eliminate the entire prepayment altogether by bumping the rate up a little. This may actually be a better choice for you depending on your plan with the property. Lenders like to mitigate risk whenever they can. By offering a prepayment mechanism that suits your needs, they are more likely to accept and help you get this deal closed.

Anyway, have you ever been hit with prepayment fees? Have you heard of the ones I spoke about today? Let me know in the comments. I’d love to hear from you.

If you liked this content, go ahead and give it a thumbs up and share it. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.

Be great.

FIVE REASONS Your First Deal Needs to be 12+ Units

 

If you’ve been listening for a while, you know that we are always talking about cashflow deals. From the first time you underwrite a property, we are looking for deals that not only cashflow, but also deliver returns for you and your investors. This is especially critical for people doing their first deal.

I am not a big fan of buying and renting single family homes or putting big amounts of money into properties that do not throw off cash. Really, I often coach people to get into 12+ units for their first deal. While it may seem a little scary for a first deal, but there are many reasons why. Here are just 5 reasons:

1) Lower Cost per Door
As you get into larger multifamily properties in a given asset class and market, the cost per door decreases as compared to the cost of a regular single family home. For example, if there is a B-Class 12 unit apartment building in a B-Class area, the cost per door in a typical midwest city like Cleveland Heights, Ohio might be $55,000. A home in the same area STARTS at $75,000 and goes up from there. Depending on the amenities, you could offer a community center, gym and upgraded security. All these things drive the income of the asset and hits your NOI.

2) Install Professional Property Management
If you are looking to scale your portfolio of real estate, implementing professional property management is an absolute must – not only for their ability to manage the tenants but also so you can rely on their track record of experience. If you are going the single family route, you know that having 12 different homes in 12 different area, with 12 roofs and various demographics, it’s difficult to manage. It becomes even more difficult as you more to the mix. If you have homes in various parts of the city, you would need to become familiar with all the local landlord-tenant laws and deal with eviction court. Instead, having a professional management company that interacts with your tenants, handles collections, and maintain the property is easier when done by a professional.

3) Greater Cashflow
Cashflow in the multifamily space is driven by units. The more units you have the more cashflow you get. The great thing about many units is that if the property is being managed well, and you put a little increase across all the units, it can impact the overall gross income substantially. For example, if you have that same 12 unit apartment building and you increase the rent by $25/unit/month, you will gross another $3,600 annually. This grows exponentially if you have many more units. But it does not end there; Because you have so many units, you can install coin operated laundry to drive additional income. On larger deals (greater than 40 units), you can put in other amenities like vending machines and reserved parking spaces.

4) Income Stability
If your single tenant decides to leave the single family rental you have provided for them, you are now at 100% vacancy. The income of that property is at zero income as it takes you a 3 to 4 weeks, at best, to turn the unit, run the advertising, interview tenants and get it filled.

In a multifamily, if you lose a tenant, you will still be cash flowing. If you lose 1 tenant in a 12 unit, you are at 8.3% vacancy. You can still pay the note, cover your expenses and even have money left over. In a multifamily deal, you are not nearly as exposed financially as a single family. deal.

5) Friendly Financing
When you are getting into larger deals, they are actually easier to finance than a four-plex or even a single family. This is because in the smaller deals, the bank is looking at income. Since these types of deals are considered “residential”, they look at YOUR ability to make the payments. The bank is looking at your borrowing power, your income and credit report. As you move up to 5 units and beyond, financing deals becomes easier. If the deal is good and strong under $1.0MM, your local community bank would probably love to see it. If you get into a deal over $1.0MM, you leverage a larger lender or even the small-balance loan programs from Freddie Mac and Fannie Mae depending on your track record and that of a partner if you have one. There are long-term fixed rate HUD financing for larger deals available from national banks, private lenders, hedge funds and others that need to put large sums of money to work. Some lenders will even do interest-only for a to allow you time to stabilize the property, allowing you to cashflow even more. In this case, they are not looking so much at your personal income as much as they are looking at your team to make the deal a success.

Anyway, are you looking to get into your first deal? Are you looking to do something small or go into something larger than 12 units? Let me know in the comments. I’d love to hear from you.

If you liked this content, go ahead and give it a thumbs up and share it. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.

Be great.

THREE MUST DO Multifamily Renovations

 

As landlords and syndicators, our job is to preserve the investments we have made in our multifamily deals. Typically, A & B Class properties have many amenities and are newer and are in better overall condition. If you own an older, C-Class property, a little luxury can go a long way. As buyers of this asset class, we are looking for good neighborhoods in desirable area – preferably a B-Class area – that may just need need simple renovations or upgrades. By doing these three renovations, you can attract tenants that will pay at the very top of your market:

1. Get Stainless or Black Stainless Appliances
Stainless steel and black stainless kitchen appliances are durable, look great and shows as fresh and modern and high-end style. Installing a new appliance package – a refrigerator, stove and microwave – you will be able to pull in more rent because people love their kitchens. This simple update could pull in $75-$150 more per month per unit, getting you a very healthy return. Many will justify paying the extra rent because the newer appliances are energy efficient. You could save some money buying 5 or more appliance packages from an wholesale or distributor appliance store.

2. Install New Flooring and Kitchen Decor Accents
Installing laminate vinyl plank flooring is one way to make an instant positive impression when they walk into the unit. The modern feel of an ash wood on a grey wall with white trim feel modern and fresh. What’s more, that flooring will me much more durable than carpet. You can also install modern backsplashes and upgraded lighting in the kitchen. It brightens up the room and looks amazing.

3. Improve Overall Curb Appeal, Exterior and Entryways
Aside from keeping the exterior clean from debris, painting the windows, putting up exterior louvered shutters on certain buildings, and trimmed up landscaping will give your property excellent curb appeal and a great first impression when the tenant shows up to the property. You can take it a step further and improve the vestibules at the property. When a tenant walks in, they make an emotional decision on whether they like what they see. It must be clean, secure and make the tenant proud to call home.

Getting a boost in rent from the bottom of the market to the top of the market through these renovations will give you a higher NOI, driving the overall valuation of the property higher because of the higher cap rate. Many landlords have been able to bump rents 10% to 30%.

Not all of these 3 things makes sense for every multifamily deal. Before you commit to a renovation, think about what makes sense for the tenant profile, the history of how the previous tenants have treated the property and how much should be invested. For instance, if tenants are notoriously hard on the carpets and they only stick around for 12 months at a time, consider a better laminate flooring. It is much more money upfront, but you shouldn’t need to touch it for years, especially if the installer offers an extended warranty. Again, make smart changes that will appeal to the tenant profile and always look to preserve the value of your investment.

If you liked this content, go ahead and give it a thumbs up and share it. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.

Be great.

Five Reasons Your Home is an AWFUL Investment

 

Today, I will explore a touchy subject and explain why buying a home is a terrible investment. Before we go into why, let’s define how the dictionary defines an “investment”. According to the Merriam-Webster dictionary, it is “the outlay of money usually for income or profit”. To paraphrase, an investment is anything you put money into and expect to get more in return than what you put in.

At this point you may be thinking that a house that appreciates overtime matches the definition of investment, but is it a good one? I will give you 5 reasons why your home is a terrible investment:

1) You Have Dead Equity
Let’s say you have $75,000 or $100,000 saved up for a down payment on a $350,000 or $400,000 house. You hand it over to the bank for the opportunity to move into a house – a non-performing asset that does not give you a return every month. That money is trapped and you can’t do anything with it. You could use that same money and put it into an apartment and get cashflow every month.

2) You Are Sinking Money Month over Month
After you tie up all this money you saved up, you are then obligated to send the lender a mortgage. Then, you need to pay taxes, insurance, and maintenance costs, which always go up. All this is aside from the fact you need to also spend hours mowing the lawn, trimming trees or shoveling snow. In a rental, the landlord handles all that so you don’t have to.

3) It Is A Depreciating Asset in Need of Updating
As the property ages, your home requires updating as your tastes change. I’m sure many of you don’t like to see those kitchen cabinets and shag carpets from the ’60s in any house, let alone in yours! For example, generally speaking, people today like open floor plan with solid color formica or granite countertops and either stainless steel or black appliances. When tastes change, those will be out of style and the home will need to be renovated again. In a rental property, a good landlord will often update the units with modern colors, flooring and kitchens.

4) No Control of the Value
The value of your home is directly tied to the surrounding homes. If the properties go up in value because Amazon just happens to open a fulfillment center 10 minutes away, that’s great! But, if a hospital nearby shuts down, and the neighborhood takes a hit, your home’s value will get crushed. Because the housing market fluctuates unpredictably, you can never count on your home appreciating. This means that you could be upside-down on the mortgage when you go to sell it. Perhaps you lose your job and you want to pull out some equity only to find out that you have none because the market value has gone down. You just don’t know. Think about it: If a home were such a great investment, why did so many people walk away from their houses in 2008?

5) You Are Stuck in One Place
The days when you would go work for a company for 20 years and turn that job into a lifetime career are gone. If you lose your job or you want to take an opportunity in another state, you can’t just move. You need to unload the house and possibly take a loss if you are paying the mortgage while paying for the place you are going to. With a rental property you are much more flexible, not only because there are management companies that can do the job for you, but because your emotions are not so attached to your place.

I know that both owning a home and renting an apartment has money coming out of your pocket. Both give you one thing in return: A place to live. I think of it as an expense just as you do with food, clothing, and fuel for my car, but definitely not as an investment. Making a profit on home ownership is so rare that I wouldn’t even call it an investment. It may turn out well, but for the most part, only the banks win.

I’m not saying owning a home is bad. I’m just saying there is more to owning than what the “American Dream” used to be. Many people find happiness and enjoyment in doing home improvements, gardening or even mowing their lawns. They are happy to stake their claim on their own corner of Earth. If you don’t care about investing in your future – outside of your IRA, trust or savings account – then you should buy a home. But if you are looking to build financial freedom, take all your cash and invest in properties that get you cashflow.

Anyway, do you think homeownership is a generational phenomenon, due to life experience or the age gap? Do you agree? Let me know in the comments. I’d love to hear from you.

If you liked this content, go ahead and give it a thumbs up and share it. Also, check out the Bulletproof Cashflow podcast on iTunes or Stitcher, and subscribe to our YouTube channel. We are working on getting new content out all the time to help you build your success in the world of multifamily.

Be great.