5 Things To Consider Before Purchasing A Multifamily Property
Posted by JD Esajian // September 13, 2016
There are pros and cons to almost everything in real estate. One segment of investors will tell you that multifamily rental properties are the only way to go. Another camp will tell you that they are more trouble than they are worth and you should be focusing on single family properties. The reality lies somewhere in the middle. Multifamily properties are a great way to accumulate long term wealth but only in the right situation. Before you get involved you need to know exactly what you are jumping into. One bad rental property can weigh your portfolio down and become a burden on the rest of your business. Here are five things you need to consider before purchasing a multifamily rental property.
- Increased Price Of Entry. Over the past five years the multifamily market has grown in leaps and bounds. Once devastated by the mortgage collapse multifamily homes have seen an increase in home prices for the better part of the last decade. While this may be great as an owner it can cause some problems if you are looking to buy. Multifamily home prices are at a five year high point and in most markets considerably more expensive than the average single family rental. Rising home prices require additional capital for down the down payment, closing costs and property tax escrows. It also means that the rent generated needs to be higher to offset the rising monthly costs. There is a definite trickle-down effect to every aspect of the property solely due to the increased price of entry. Multifamily investing has its benefits but can make ownership a difficult hill to climb.
- Higher Mortgage Standards. There is a tremendous difference in the loan items required for a multifamily property as opposed to a single family. With a single family property you can get away with around 10-15% down payment with credit scores considered good but not great. With a multifamily property you need to have excellent credit scores, 20% down payment and have low debt to income. Being strong in two of these areas is not enough. A two or three family property has stricter loan guidelines across the board. With home prices rising coming up with the 20% down payment is a difficult initial hurdle. This money needs to be in an existing account of yours for at least 60 days. Gift funds of any kind are not allowed. Credit scores must be at least 700 and in some cases as high as 720. You also need to look at how you generate income. Most lenders only use 75% of any rental income received and will calculate income based on the adjusted gross income. Before you do anything else you need to reach out to your lender or mortgage broker and find out exactly what you need to do to qualify.
- Tenants. Having an additional number of tenants can be considered a blessing and a curse. On one hand more tenants increases your cash flow options. Instead of having just one tenant to rely on you can have two, three, four or more checks coming in. On the other hand more tenants usually mean more potential issues. A three family property has three sets of tenants each with their own set of problems and drama. If you decide to manage the property yourself you can expect a phone call from one of your tenants at least every week. This is one of the reasons it is so important to find quality tenants you can trust. If they don’t respect the property or each other you can have a continuous cycle of problems. There is certainly an upside in collecting more checks but you need to be weary of everything that comes with it.
- Increased Maintenance. Yet another example of differing points of view with multifamily rentals is with the cost of maintenance. Investors that favor multifamily rentals will point to the economy of scale associated. Under this scenario you can cover multiple expenses at once. If the roof needs to be repaired there is only one roof on the property, not three. If the lawn needs to be cut or the driveway plowed there is only one item of each regardless of the number of units. The other side to that coin is that the cost of repairs is generally much higher. Additionally you also need to stay on top of multiple units. This means repairing or replacing multiple sets of dishwashers, dryers, stoves, toilets and more. With increased tenants and units the odds are that something will need to be fixed during every lease.
- Limited Buyer Pool. Owning a multifamily property works in reverse when you are trying to sell. Even though home prices have jumped higher it still can be difficult finding the right buyer. Not every interested buyer will be able to satisfy the required mortgage guidelines. If, and when, you do find a buyer it will take some time to close. Single family homes are closing in roughly 40 days and multifamily homes take between 50-60. This increased closing timeframe makes it almost impossible to sell in a pinch if you needed to. It also stresses the importance of accepting the right buyer as opposed to the highest offer.
There is nothing wrong with pursuing a multifamily property but you need to know what you are getting into. There are pros and cons associated and it is important that you always form your own opinion.