You want to invest in real estate. You understand it can increase diversification without taking on more risk. In fact, a 2021 Gallop poll revealed that 63% of Americans owned real estate while only 52% had stock investments. Among the wealthy, it remains popular.
But Where Do You Start?
Single-family homes often come to mind when you begin to explore real estate investing. It is familiar because you purchased your current home and have likely been through the buying and selling process multiple times.
Nevertheless, it is may not be the most efficient way to start or expand your current portfolio. Before you adopt a strategy for single-family home acquisition, explore all your options, which could include multifamily housing units.
What Are Multifamily Properties
Multifamily properties are residential buildings containing more than one housing unit. Each one must have its own kitchen and bath to be considered multifamily and can include property ranging from a duplex to an apartment building with hundreds of units.
Residential investing includes properties with one to four units. Single-family homes, condominiums, townhouses, duplexes, triplexes, and quadruplexes make up the residential real estate market.
Commercial investments in the multifamily space include all properties containing five or more units.
Valuations for Multifamily Investments
The frequent sale of residential homes allows appraisers to use the comparable sales method when calculating the value of a home. The appraiser gathers data on the house considering the total square footage, number of bedrooms and bathrooms, the lot size, and the existence of features like a garage. Using this information, they compare it with recent sales of similar properties in the surrounding area.
Commercial property does not use the comparable sales method. Instead, an income-based appraisal provides a more accurate formula to represent the property value based on revenues received.
Multifamily appraisals typically establish the property value based on the NOI or net operating income. NOI starts with gross rental income, plus any additional revenue generated by the property. Then subtracts out expenses and divides the result by the market capitalization rate or cap rate. NOI includes all expenses required to operate the property but excludes the cost of debt, capital expenditures, and depreciation expenses.
The market cap rate uses the average cap rate for similar properties within a geographic region. The cap rate for an individual property is the NOI divided by the purchase price. Using an average cap rate for the real estate type within the region provides a reasonable estimate of the property’s yield without considering debt. It helps establish the un-leveraged rate of return.
Using an income-based appraisal for commercial properties allows you to evaluate the risk versus return on the property.
Investing in Multi-Family Properties
Real estate investing provides steady returns, an asset that appreciates, cash flow, and tax benefits. You can leverage the investment through financing, allowing you to scale your portfolio faster and add depth to your diversification strategy.
In many ways, real estate investing is easier to understand because you are familiar with the home buying process. However, buying residential investments can require a great deal of time and money as you deal with tenants, repairs, and day-to-day operations. Hiring a property management company can reduce the time commitment but directly impacts the rate of return.
If you are drawn to real estate but looking for more passive opportunities, commercial multifamily investments often provide higher returns at lower risks without the time commitment.
If you are ready to learn more about multifamily investing, click here to schedule your free call with me.
This article does not offer legal or accounting advice, and is only meant for informational purposes. For specific tax questions seek the advice of an industry professional.