Real estate investors sometimes go their whole career without venturing into the realm of multifamily homes for sale. The reason is that many believe real estate investing in multifamily homes for sale is way too complicated compared to investing in a single family home. While the two types of real estate investing do in fact differ, it is not difficult to learn how to invest in multifamily real estate.
Residential Real Estate or Commercial Real Estate?
Before learning how to invest in multifamily homes for sale, it’s important to know that there are two different classifications for multifamily real estate. This difference in classification affects everything from financing through return on investment to the value of the income property. Even the steps of how to invest in multifamily real estate differ for each type.
Small Multifamily Homes for Sale
Any investment property with 2-4 housing units falls under this class of multifamily homes for sale. This type of investment property is considered a residential real estate property. Because of this, investing in small multifamily homes for sale is very similar to investing in a single family home. Of course, there is more cash flow from rental income as well as a difference in rental property management methods, but it is still grouped as a residential real estate investment.
Large Multifamily Homes for Sale
This type of investment property has 5 or more housing units. Multifamily homes for sale in this class are considered commercial real estate by mortgage lenders. This type of multifamily real estate will be the focus of this post, as it differs in many ways from a single family home.
If you’re familiar with residential real estate investing, you might choose small multifamily homes for sale. However, if you’re looking to make more money from rental income, commercial multifamily homes for sale are the way to go.
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How to Invest in Multifamily Real Estate
Choosing a Location for Multifamily Homes for Sale
For residential real estate and commercial real estate property, there are common factors that make up a good location for real estate investing:
- Strong economy with potential for job growth
- Population growth
- Low crime rates
- Good school district
- Walkability/public transportation
- Close to major job districts and commercial centers
- Low chance for supply increase
Related: Location Location Location: What Makes for The Best Place to Invest in Real Estate?
When it comes to large multifamily homes, there is another aspect of location that real estate investors have to take into consideration: property class.
There are 4 different classes for commercial real estate property:
- A new investment property with no deferred maintenance and modern amenities
- Rent is the highest for these rental properties
- Highest occupancy rate
- Lowest cap rate
- Highest price per unit in these multifamily homes for sale
- An older income property (no older than 10-15 years old) with some deferred maintenance and some modern amenities
- Rent is high for these rental properties
- More room to force appreciation than Class A
- A much older investment property than those in Class A and B with more deferred maintenance
- Higher cash flow due to a larger pool of tenants who can afford the rent prices
- Higher cap rate
- Not much room for appreciation
- A very old investment property that requires serious renovations and maintenance
- Usually not in great neighborhoods for real estate investing (in general)
- Recommended for experienced real estate investors only
To determine the class of an income property, perform investment property analysis. Investment property analysis will help you find cash flow, cap rate, repairs, etc.
Related: How to Do Investment Property Analysis
Once the class of multifamily homes for sale is found, it’s now time to choose a location based on the property class. Real estate investors should choose multifamily homes for sale that are in a location of equal or higher class. Classification of the locations for real estate investing is similar to that of an investment property:
Class A: a newer neighborhood with high potential for growth
Class B: an older neighborhood that is stable and reliable for real estate investing
Class C: an even older neighborhood that can be in decline or even sometimes unstable
Class D: very old neighborhood that is in serious decline
Determining the class of the neighborhood is technically part of investment property analysis, as you need to find out if the neighborhood is a good choice for an income property. With this knowledge, real estate investors should be able to choose a good location to invest in multifamily real estate.
For example, a Class A property in a Class C neighborhood will not be a great real estate investment compared to one in a Class A neighborhood. A Class B property in a Class A neighborhood would make for a successful real estate investment, and so on.
Determining the Value of Multifamily Homes for Sale
For a single family home or a small multifamily homes for sale, determining the value of the income property is done through comparative market analysis. A comparative market analysis consists of finding the prices of real estate comps that are similar to the income property and deciding how your investment property compares.
However, this only gives the accurate value of residential real estate property and not commercial real estate property. The value of large multifamily homes for sale comes from its potential to generate rental income and a return on investment. Most metrics for return on investment should be calculated from the investment property analysis: cap rate, cash on cash return, cash flow, etc.
To get to the real estate market value of the income property, the following equation must be used:
Real Estate Market Value= Net Operating Income (NOI)/Capitalization Rate (Cap Rate)
Net operating income is found by taking the total rental income minus any operating expenses for the income property.
Cap rate can be found in two ways for multifamily homes for sale. Usually, real estate investors list the cap rate for the income property. However, these numbers can sometimes be off in order to make a sale. Perform comparative market analysis to find out the average cap rate of similar rental properties in the area.
From there, plug the numbers into the equation above and get the real estate market value. This helps real estate investors avoid overpaying for rental properties. Want to find multifamily homes below real estate market value? Then this equation is your friend.
Related: How to Generate Passive Income from Multifamily Real Estate Investing
What About Financing Multifamily Homes for Sale?
Well, real estate investors generally don’t have to worry about financing multifamily homes for sale. It’s actually easier than financing a single family home. How is that possible when multifamily homes for sale are more expensive? It’s because mortgage lenders see less of a risk in this kind of real estate investment. Multifamily real estate has greater cash flow and very rarely will a real estate investor experience 100% vacancy and no rental income to pay off a mortgage. Nor are these rental properties likely to end up in foreclosure.
Consider Alternative Options for Investing in Multifamily Homes for Sale
Don’t forget that while directly owning residential real estate property has many benefits, there are alternative options for investing in multifamily homes for sale. Real estate investors can go for REIT investing or real estate syndication (limited partnerships, limited liability companies, or real estate crowdfunding). These options are considered passive investing, which some real estate investors might prefer when investing in multifamily homes for sale.
Should You Invest in Multifamily Homes for Sale?
Now that you have a basic idea of how to invest in multifamily real estate, make sure you are up for it. No doubt, there are many benefits to investing in multifamily homes for sale:
- Greater cash flow from rental income
- Professional property management financially viable
- Tax benefits
- Easier financing
- Option to be an owner-occupier
- More control over appreciation
But is it right for you? In general, it’s advised that real estate investors start with a single family home and work their way up to multifamily homes for sale. However, depending on your real estate investment goals, you may go straight for multifamily real estate. Make this easier by opting for professional property management.
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As long as you learn how to invest in multifamily real estate, the low risk that comes with this type of real estate investment makes it right for almost anyone.
Related: What You Need to Know Before Buying Multi Family Homes for Investment
Don’t hesitate to invest in multifamily homes for sale; it isn’t difficult to do. Real estate investing of any kind takes some time to learn, and learning how to invest in multifamily real estate will be the best thing you can do as a real estate investor!
To learn all you need to know about real estate investing, keep reading Mashvisor’s blog.