The multifamily housing boom may be slowing, but the demand for apartments isn’t going away any time soon. Multifamily housing offers investors the opportunity for an asset that’s less correlated to the stock market—something that’s certainly appealing this year—as well as generates a steady income stream.
But how do you make a smart multifamily investment, especially if you’re new to the space? Investing in and buying multifamily housing presents a few more complexities than single-family homes. The financing options are broader, you’ll also need more cash to begin, and there are several factors to consider when you are looking for a successful investment.
Fortunately, a little bit of research goes a long way. First, dive into the forecasts for the multifamily market and the trends that have been driving growth. Then, review the components that you’ll need to consider before you make a purchase.
A Multifamily Opportunity?
Developers and investors have been taking advantage of a strong multifamily housing market for the past few years. Several projections show that rent growth may slow—but still grow—in 2020. And while the number of units coming into the market could be less than in 2019, according to CBRE, the continued demand for apartments will keep the overall vacancy rate at about 4.5%—under the long-term average of 5%.
Looking further into the future, demographics suggest that investing in multifamily housing has serious potential. Analysts at Morgan Stanley project that household formation—primarily young people leaving the nest to find housing—will increase by 1.7 times annually through 2023. While some may purchase homes, in many places, affordability issues make apartments a good option.
What’s more, multifamily housing in smaller cities appears to do well, even when developers build-out units to meet the demand. The trend may reflect a shift by Millennials—the largest group forming households—from larger cities to suburbs and smaller places. The CBRE forecast agrees, noting that multifamily housing in suburban areas will likely outperform housing this year.
Understanding the Finances
Before you invest in multifamily housing, it's helpful to perform some due diligence to asses the financial opportunity and potential pitfalls of your investment. The critical aspects to consider include:
- The purchase cost. If you’re a first-time investor, you’ll likely need to finance some of the property purchase. There are many financial tools; which options will work best for you depend on whether you plan to live on the property or use it solely for investment purposes. Some of the most common financing vehicles include cash, hard money loans, conventional mortgages and owner-occupant mortgages. Each has its advantages and considerations. In all cases, however, you’ll likely need at least 20% for a down payment, if not more. Some lenders may require 25% to 30% to qualify for lower interest rates.
- The rental income. Determine how much income the property can provide. If there are current tenants, then the lease rates may stay the same or go up slightly. Of course, ask about the current cash flow and what has impacted it in the past. If you’re purchasing a new property, research the rental market to understand how much rent to charge.
- The expenses. Beyond your mortgage, a multifamily property will cost you money to operate and maintain. As you’re determining the viability of a property, estimate that at least 50% of your rental income will go toward maintenance. You'll also want to account for property management fees.
How to Find the Right Property
Data on property cost and potential income provide essential information. But there are other items to evaluate when you’re considering a multifamily investment. The size of the property, for instance. Many experienced investors advise that those new to multifamily real estate focus on smaller properties such as duplexes, triplexes and fourplexes. That's because smaller properties will cost less to purchase and be easier to manage as a first investment.
The property location is also a dealmaker or breaker. Look for markets and cities that anticipate growth in their multifamily housing needs. As noted above, consider opportunities outside larger cities and in suburbs. Within a geographic area, also consider the property’s proximity to amenities such as schools, public transportation and highways. Lastly, as with any property, be sure to evaluate its current condition and whether it will require significant investment to repair or update.
Done right, multifamily housing can provide an investment opportunity and a steady source of income. Be thoughtful about the type of property you purchase, its location and ancillary expenses, and you'll create a side business that really pays.