Before You Buy That First Multifamily Building: Part I

Purchasing a multifamily building or apartment isn’t as simple as buying a neat little home and renting it to a single person or family.

It can, however, be extremely more profitable when it’s done right.

Even if you’ve purchased single family structures in the past, this time your tenants are going to be living right alongside other people’s children, property, and animals — and that can create a whole new kind of mess to deal with if you’re not careful.

Not to mention, a mistake when dealing with a $100,000 home can be quite a painful lesson…but a mistake with a $1 million apartment can destroy you.

On the other hand, if you are careful, the benefits can be amazing — so let’s talk about how to maximize them and minimize the fuss.

Finding a Needle in a Haystack

If you’ve bought single-family investment properties before, the first difference to understand about buying a multi-family building is that it’s much harder to find deals. There are obviously significantly fewer multi-family buildings than single-family homes, which means there are fewer sellers and even fewer motivated sellers.

Secondly, there are a decent number of real estate agents that will work with an investor to find a single-family investment, but far fewer qualified agents willing to help find a multi-family investment.

Qualified is key, as most single-family agents will be like fish out of water when it comes to the multi-family market. Most of the qualified commercial real estate agents actually work for sellers, so getting them to find a buyer a deal is not likely to happen.

So, that usually leaves you the investor with a tougher challenge to find a multi-family deal compared to a single-family deal.

How can you address this challenge?

By networking with as many real estate agents that list the size of apartment buildings in the locations you want to target.

It’s also probably a good idea to do your own research on buildings in your target area that aren’t listed for sale and “beat” the agents to the seller. Start a mailing campaign to all the apartment owners in your target area to see if any are interested. Keep in mind that usually the smaller number of unit apartment buildings are probably owned by a single person or two, as opposed to a REIT or syndicate, making them statistically more likely to be a “motivated seller”.

The biggest opportunity maker for you is finding an apartment building where rents are below the market. There’s no easier way to find a deal than one that’s under-rented! The catch is to be sure you know all the reasons the rents are below market: absentee owner, “lazy” owner, poor management, too much deferred maintenance, wrong tenant population, units never redecorated, ineffective marketing, etc.

Before You Buy, Crunch ALL the Numbers

Before you consider making an offer, get a pen and paper out and work out whether or not this specific multifamily building is something of value to you. To do that you need to analyze the deal and make sure you cover everything.

The basic categories consist of these:

Property taxes – be sure you understand what changes to them may occur upon a sale to you
Insurance – quotes can be complicated, so find an experienced insurance agent that can estimate them accurately for you.
Management – always factor this in, even if you plan to do it yourself!
Maintenance – often underestimated, so be careful, especially with older buildings.
Deferred maintenance – we’ll cover this in our next installment of this series, but it’s very important.
Current rent versus target rent – this is tricky as the target rent isn’t a proven number, so be conservative.

NOTE: Be careful with numbers given by the seller or an agent. It’s in their best interests to underestimate expenses and overestimate income. Agents will often prepare a “proforma” analysis for marketing purposes that shouldn’t be trusted. Verify all numbers yourself.

Once you have all of the core numbers, it’s a matter of wrangling them until they tell you what you want to know (we’re not going to get into Net Operating Income (NOI) and Capitalization formulas here, as there are plenty of other articles out there explaining these). When crunching your numbers, don’t forget about deferred maintenance and capital improvement costs.

Analyze the deferred maintenance & capital improvement issues and determine the replacement timeline of each. For instance, if you have to replace a roof, you may pick a timeline of 20 to 30 years before it has to be replaced again. Use these to figure out your monthly deferred maintenance & capital improvement costs.

Some costs to keep in mind: roofs, parking lots, sidewalks, pools, furnaces, hot water heaters, ac units, etc. How soon you’ll have to address each of these issues will definitely affect your cashflow and could easily cause financial havoc or ruin.

As it’s highly unlikely an apartment building will be consistently 100% occupied, don’t forget to include a vacancy factor in your calculations. The number will depend on the marketplace, but don’t underestimate this number. Keep in mind to either include lost rent from evictions in your vacancy factor or make it a separate category.

Another useful analysis is figuring out how many of units have to be rented in order to meet your monthly costs. If you’re in the 70% range, you’re doing well — if you’re approaching 100%, you’re looking at a pretty risky investment.

Come back for Parts II and III, and we’ll delve into additional details that make multi-family rental buildings significantly more complex and delicate than single-family rentals.

Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.