Journey to $5M with Multi-Units: FAQ

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Journey to $5M with Multi-Units: FAQ

Nichole Stohler
Rental Property Investor · Scottsdale, AZ · Member since 2017 · 116 posts · 136 votes

Hello BP community! We’ve followed BiggerPockets for years and a few months ago I posted in the success story forum on how my husband and I went from complete real estate failure and debt to coming back and buying a $5M property in 6 years. Some community members asked questions in the post about things like how we got started, when and how we “traded up” properties and why we chose certain exit strategies. Others asked about books we’d recommend and other resources.

In this thread, we are going a step further and answering those questions and more that you might have.   We came up with the most frustrating or challenging aspects of multi-family and will post in this thread each week.   Here's the first post:

Gotta know where you stand.

Your opportunity awaits. What kind of financial base do you have right now to go after your first property?

So you’ve been listening to BiggerPockets podcasts for months… You’ve decided you want to start with multi-units. Where do you actually begin? How do you know where to start? In later forum posts we’ll talk about the business plan but before you can build the plan, you need to know where you stand today. In this post, we’ll look to answer how much money you’ll need to get started. Let’s begin with some very basic property research.

Research

First, we need to determine how much do multi-units cost in your area? At this point, we are NOT doing a full property analysis but simply starting to determine how much you’ll likely need. When it comes to your first multi-unit, there’s a lot of discussion on BiggerPockets about “house-hacking” which means creating rental income that can cover the costs of your monthly mortgage. A common house-hacking scenario described is to buy a duplex, live in one unit and rent out the other.

Very sound strategy… but is this an option for you? House-hacking is not a one-size-fits-every investor. What if you already have a house? What if you have kids in school and there aren’t any multi-unit properties in your district? What if your local area doesn’t have multi-units in safe neighborhoods?

You may be wondering why we are trying to determine this so early in the process. The reason is that as we get into the mortgage options there are some scenarios that will only apply if you will be living in the property. And, the various pros/cons of different types of mortgages include the amount required for down payment.

Ok. So, is house-hacking right for your first multi-unit? Here’s a simple decision tree:

What did you decide? Or, not sure yet? If not, take a drive and see what you think of the properties currently for sale. Maybe list out a pros/cons for your situation.

Now we are ready to look at costs. Let’s use the below example multi-unit costs as a starting point for this analysis with a purchase price range of $100k-$219k. We’ll be using the Phoenix 4-Plex as our case study property throughout this series of posts.

Determining Gap to Down Payment

How much money are you going to need for the down payment? This depends on the type of loan and your credit rating. The great news about properties with 4 units and under is that these properties are still classified as residential. With a residential mortgage you’ll have lower qualifications and the ability to lock in long-term fixed rates.

For our first 4-plex, we worked with Dan Francis, who is a nationwide residential mortgage lender. Because of his experience working with investors, Dan understands the funding details of rental properties as well as tax and income. We caught up earlier this week and he shared the different types of residential loans available and pros/cons of each for investors.

One question you may have is when should an investor start the prequalification process?

Dan’s recommendation is to start as early in the process as possible. He has found that many times potential investors have misconceptions about what is required. Some people might think they don’t have enough of a down payment or that their credit score won’t qualify. A good mortgage broker will help you create a plan for your specific situation.

What types of mortgages are available and could be part of your overall plan? Dan provided me with the following initial guide on mortgages that can be leveraged for 4-units and under:

Looking at our case study property which has a purchase price of $219,000, and using the guide above, we can see that the minimum down payment amounts would be:

  • House-hack + FHA = $7,665
  • House-hack + VA = $0 (!!!)
  • Stay in primary home = $32,850

With a clear direction on the initial funds needed to get started, we can now focus on saving for the down payment. In our next post, we’ll dive into this.

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Randy K.
Investor · Casa Grande, AZ · Member since 2017 · 34 posts · 32 votes
9y

A wealth of knowledge in this thread! And not only limited to multifamily, much of the advice is applicable to SFH investors as well.

Regarding market trends and whatnot, I've found that, at least in a general sense, the alert features on the major home search sites can provide a steady flow of relevant information to your personal inbox. Keep in mind, the data may not be up-to-the-minute, and there's a chance the property details aren't 100% accurate, but this method seems to give a nice overview of what's going on in your farm.

Take the time to create accounts on Trulia, Redfin, Zillow, Realtor, and/or your alternate site of choice, and enable email alerts for the type of properties you're interested in, in the areas you're focusing on. Be sure to set up the alerts for both properties for sale, as well as for rent. From there, simply check up on the emails you receive each day, taking note of the neighborhoods, property features, and of course, the prices and rents. Within short order you'll start seeing patterns, as well as shifts in the numbers as time passes by. You could keep it as casual as simply taking mental notes, or go as in-depth as recording the various properties into a spreadsheet, then creating charts and graphs.

Once you start getting a solid feel for the overall market you're interested in, don't be afraid to get more specific with your filters. Perhaps you're only wanting to see 3/2 SFH's, condos, multifamily's, or even raw land. Before you know it, you'll see or hear the name of a community and instantly know the ballpark figures for the various properties held within. And more importantly, when a potential deal does cross your path, you'll recognize it when you see it!

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  • Nichole Stohler
    OP
    Rental Property Investor · Scottsdale, AZ · Member since 2017 · 116 posts · 136 votes
    9y

    @Terrill Clark, you are welcome! Great question... in my opinion, $80 per unit is not very good at all. We've used a conservative $100 per unit per month as a rule of thumb and then set objectives to improve these numbers. If cash flow is your goal, I would look for a way to be at $100 per unit minimum when doing the estimated numbers. We'll get into details on operations and ways to increase this per unit amount. But for now, initial numbers for this property aren't looking that great.... mostly due to the purchase cost + HOA.

    That being said, there could be other reasons for buying this property depending on overall goals and business plan. 

    1Reply
  • Nichole Stohler
    OP
    Rental Property Investor · Scottsdale, AZ · Member since 2017 · 116 posts · 136 votes
    9y

    @Dan Turkel, so glad to hear the information is useful!    Looking to make sure the content is as step-by-step as possible.  Will send you a quick PM -

    0Reply
  • Nichole Stohler
    OP
    Rental Property Investor · Scottsdale, AZ · Member since 2017 · 116 posts · 136 votes
    9y

    Quick follow up on market trends...  most of the local real estate investment clubs provide a regular market update during their meetings.   In Arizona, I've found these are more focused on the residential segment but the information is still incredibly valuable.   Other trends that are covered include employment, new resident numbers and infrastructure projects that impact housing.    Definitely recommend you check these clubs out! 

    Two other areas for getting market data include local universities and commercial brokers.  As an example, Arizona State University publishes research reports under their Real Estate program.   If you pulled down the "commercial brokers forum survey" you'd see that in the multi-family market, brokers are also talking about how hot the market is right now.  https://research.wpcarey.asu.edu/real-estate/

    If the local commercial brokers in your market have an email list for market trends, this is a helpful source of information too.   We're on a couple of weekly updates showing sales data and general trends.  On a national level, Marcus & Millichap provides a nationwide investment forecast report by segment.   The 2017 multi-family provides detail for each major market in the areas of employment growth, vacancy rates, construction of new units and rent trends.   A couple of examples that I randomly pulled directly from this report:

    Minneapolis- St. Paul - "Steady hiring, moderate apartment construction align to restrain vacancy. "  "Robust demand for apartments is boosting rents.  Effective rent will climb an average of 5.0 percent"

    Kansas City - "Positive demand still intact but falling short of development pipeline".   Paraphrasing the Kansas City analysis, the completions of new units will rise in 2017 which are predicted to cause the vacancy rate to go up to a six-year high.  

    As a landlord, where do you want to own property?  As a buyer, where would you want to buy property?

    3Reply
  • Randy K.
    Investor · Casa Grande, AZ · Member since 2017 · 34 posts · 32 votes
    9y

    A wealth of knowledge in this thread! And not only limited to multifamily, much of the advice is applicable to SFH investors as well.

    Regarding market trends and whatnot, I've found that, at least in a general sense, the alert features on the major home search sites can provide a steady flow of relevant information to your personal inbox. Keep in mind, the data may not be up-to-the-minute, and there's a chance the property details aren't 100% accurate, but this method seems to give a nice overview of what's going on in your farm.

    Take the time to create accounts on Trulia, Redfin, Zillow, Realtor, and/or your alternate site of choice, and enable email alerts for the type of properties you're interested in, in the areas you're focusing on. Be sure to set up the alerts for both properties for sale, as well as for rent. From there, simply check up on the emails you receive each day, taking note of the neighborhoods, property features, and of course, the prices and rents. Within short order you'll start seeing patterns, as well as shifts in the numbers as time passes by. You could keep it as casual as simply taking mental notes, or go as in-depth as recording the various properties into a spreadsheet, then creating charts and graphs.

    Once you start getting a solid feel for the overall market you're interested in, don't be afraid to get more specific with your filters. Perhaps you're only wanting to see 3/2 SFH's, condos, multifamily's, or even raw land. Before you know it, you'll see or hear the name of a community and instantly know the ballpark figures for the various properties held within. And more importantly, when a potential deal does cross your path, you'll recognize it when you see it!

    2Reply
  • Vina Real
    Alexandria, VA · Member since 2016 · 111 posts · 164 votes
    9y
    Thanks for starting this thread!
    0Reply
  • Nichole Stohler
    OP
    Rental Property Investor · Scottsdale, AZ · Member since 2017 · 116 posts · 136 votes
    9y

    @Randy K., thank you for sharing your system for how you automate market research!   

    0Reply
  • Nichole Stohler
    OP
    Rental Property Investor · Scottsdale, AZ · Member since 2017 · 116 posts · 136 votes
    9y

    Pro Forma Dreams vs. Actual Reality

    For our case study property we don’t have the actuals to get into real numbers but after looking at the information available right now, I would not recommend going further with this property. The key reason is that you make money when you buy and there are not many opportunities to increase profitability in the case study example due to:

    • HOA costs are a huge expense that cannot be improved
    • Rents are very close to market rates already
    • There are no other ways to generate income

    I mentioned in the property analysis video that there are spreadsheets you can use for the analysis in addition to the tools on BiggerPockets. The one we use is from the CCIM Institute (http://www.ccim.com/) which is an organization for Commercial Real Estate. Agents that have the Certified Commercial Investment Member (CCIM) designation have taken several classes in areas such as financial, investment and market analysis, created a portfolio documenting their experience and passed a final exam. You can find similar tools online, in some of the BiggerPockets forums.

    Since we won’t be spending any more time on the case study property, let's use another property to show an example of how the pro-forma numbers looked good but the actuals tell a different story. This is a commercial property that we were looking to purchase and while it’s not multi-family, it’s a good example of why real numbers are a critical part of your due diligence. 

    Here’s what the numbers looked like with pro forma:

    Here are the actual numbers for 2016:

    Immediate red flags:

    1. Revenue. Projected in the pro forma at $356,520 but in 2016 total revenue was only $196,006.44. Why does the pro forma have an increase of $164,000? Was their a 40% vacancy rate in 2016? Is there that much opportunity to increase rents? After doing due diligence on current rents and the market, the answer is “no”.
    1. Expenses. The pro forma only showed fixed expenses and the management fee. This particular property has a lease from the city which was listed at $115,632 on the pro forma. Actual for 2016 was $155,668.32. In this particular situation, you can think of the fee like an HOA -- it's not going to go down and more than likely would go up. Why would the pro forma assume otherwise?

    We used the information to explain back to the seller what the price would need to be for us to move forward.  The seller chose not to accept the new amount so we are passing on this property for now.

    4Reply
  • Nichole Stohler
    OP
    Rental Property Investor · Scottsdale, AZ · Member since 2017 · 116 posts · 136 votes
    9y

    Wait…. Back up. How do you decide which markets?

    Recently a BiggerPockets member asked me about broader market research in order to narrow down areas of the country that would be good areas to invest. This person said “I understand the local research but how do you decide where to focus before you get to this point?”

    This is a great question.  Let’s dig into criteria to think about and some ideas to explore.

    Management from a distance?

    With your first couple of multifamily properties will you be self-managing, using a property manager or implementing some type of hybrid approach?

    For this analysis, we’ll say that you have decided to use a property manager. Logistics to think about include how often do you plan to visit in order to build your local network and relationships? Once you own property, what time commitment will you be making to check on things in-person? How will travel (in whatever frequency) impact your schedule? Will you have to take time off work? Can you visit by day trips or overnight stays? What are the costs involved between airfare, hotel and meals? Ultimately, how does the location impact your profitability and ability to support the property?

    I have a friend who just bought his first property out of state after spending close to a year trying to find something that fit his budget and situation. Frustrated with options where he lives in Arizona, he started looking at Missouri and Florida. Why those two? By considering the questions above, his thought process was:

    • Where do I already travel as part of my job that I could take an extra day to establish local relationships and check in on a property? Missouri
    • Where do I like to travel for fun that I would want to take time off for? Florida
    • Where have I’ve lived before and still know some people? Florida
    • Where can I purchase a property in my budget and return criteria? Both states

    Because he and his family really liked traveling to Florida and he knew (non-real estate) people he could ask for help he felt comfortable buying his first property in this state.

    Where is it easier to be a landlord?

    If you are able to choose any market from the beginning, make it easier on yourself and add landlord friendly states to the top of the list. Why does that matter? Well... have you heard the stories of evictions that took months? Tenants that violated their leases but still stayed in the property?

    Choose the right state, and your rights as a landlord will enable you to quickly remove bad tenants, recoup damages and reduce loss of income.

    If you do a simple Google search on “landlord friendly states” and you’ll find many articles on BiggerPockets and a variety of other sites.

    Economics

    At this point, you can gather various sources of economic data to understand the trends in various markets. Some data to look for includes job growth, resident growth and new multi-unit construction trends which can saturate the market, increase vacancy rates and take time to absorb.

    Some example resources include:

    • Commercial real estate brokerage reports (such as Marcus & Milichap’s MFH outlook)
    • United States conference of Mayors economic trends
    • Joint Economic Committee’s State-By-State reports
    • Compare50 website
    • FreddieMac’s multifamily outlook which includes this recent table:

    Something to think about...since you make your money when you buy, do you want to purchase property in a market that is hot right now? Or, would it be better to find an area that has some kind of temporary decline?

    Types of questions to consider could include:

    • What is this area’s future opportunity for growth?  Are there cyclical industries that can rise and fall (oil, tourism, transportation, etc.)
    • What resources does the area have that are always in demand?  Desirable weather? Beaches? Mountains for skiing?
    • Am I interested in cash flow or appreciation? Or both? All markets can have strong cash flow if you buy right. Conversely, markets with more desirable features or significant job growth will have higher appreciation.

    Getting Local

    Once you’ve narrowed down potential areas, you can now start establishing relationships and work to understand more of the market details. How? Here’s some ideas:

    • Use the BiggerPockets search to find potential local team members including wholesalers, agents and mortgage professionals. Connect, start to develop relationships and schedule in-person meetings.
    • Schedule your trip so you can also attend local real estate club meetings. You are looking to hear about market updates, trends and then also meet fellow investors.
    • Spend time driving the areas you are looking at so you can get a feel for neighborhoods and the places you are more interested in investing.
    • Keep a regular activity schedule of fostering the relationships you’ve established, looking at properties remotely and in-person and making offers.

    For those that have invested outside of your primary residence, would love to hear your thoughts. What criteria did you use to decide where to invest?  

    2Reply
  • Michael Richardson
    New Lenox, IL · Member since 2017 · 9 posts · 2 votes
    9y
    Nichole Stohler This is a great perspective to have when considering where to invest. It seems so simple to tie potential areas to things you already have in place whether traveling for work or vacation, but something someone new like myself may not have considered. Another option that occurred to me could be looking in an area where you might potentially like to retire. With the long term outlook of the typical rental property this may be a viable option for some as well. Thanks again for all the information you have shared! I look forward to additional topics and feedback as the thread progresses. Thanks, Mike
    0Reply
  • Nichole Stohler
    OP
    Rental Property Investor · Scottsdale, AZ · Member since 2017 · 116 posts · 136 votes
    9y

    Building your team

    You’ve assembled money in order to purchase your first multifamily. You know where you want to buy and you’ve pre-qualified for whichever mortgage type you’ll be using.

    Now what?

    It’s time to build your team.

    Real Estate Agent

    What should you look for in an agent? How should you approach him or her?

    When we started investing again in 2011, we knew that even though we had to start small our end goal was to own large apartment complexes. Our plan always involved trading up in order to purchase large 100+ units. With this objective, we narrowed our search for a realtor to those specializing in commercial real estate. And then, within commercial real estate, we looked for agents that focused on multifamily. Searching in this niche narrowed down the potential list of agents significantly. From there, we looked at the types of listings the agent had, the events he/she participated in or was hosting and any reviews that were available.

    Once you have a couple of agents you’d like to talk with, how should you prepare to meet with them? First, understand that agents get approached on a frequent basis by potential new investors that have unrealistic expectations or don’t follow through. Just like you are interviewing potential agents, a good agent will be interviewing you too. They are looking to understand if you are serious before spending any time helping you find properties. Knowing this, here’s a few ideas for the meeting.

    -Share why you chose to meet with him or her.

    - Ask about how he or she likes to work with investors? This is a broad question and could mean anything… which is why it’s great!

    - Explain what your goals are and steps you’ve already taken. Pre-approval, research on areas, etc. Most commercial agents will require you to be pre-approved for funds prior to submitting offers.

    - Ask about how the agent works specifically with new investors like yourself.

    - Provide details on the kinds of property you are looking for and why. Things like size of property, purchase price, type of neighborhood (A, B, C or D) and location.

    During the meeting, be open to the agent’s ideas around property types and location that might be different from your initial thoughts. Ask “why” around any recommendations. Ideally, you are looking for an agent that can help guide you -- not just sell you property.

    Going back to the first agent we met with after researching our market. Why did we choose to meet with her? Some of the key items were that she focused on multifamily, was an industry veteran, hosted regular investor education events and personally invested in real estate as well.

    Lawyer

    For your first property, you don't need a mountain of legal paperwork. You just need a LLC and a lawyer to set this up correctly. Key benefits of a LLC are that it provides some liability protection but allows the tax burdens or losses flow to you personally. Any losses help offset your regular income and reduce your overall taxes. There are many articles on BiggerPockets about legal entity structure as well as tax benefits so I won't go into those here. What you need to know at this point is that you'll need a LLC set-up prior to closing on your first property.

    How do you find a real estate attorney? The easiest way is to ask the experienced commercial agent that you are working with for a referral.

    CPA

    Speaking of tax benefits….When it comes time to file your taxes after purchasing your first property, I recommend working with a CPA that has experience working with real estate investors. Your agent can give you recommendations for CPAs in his or her network.

    Personally, we made a huge mistake here. We already had a CPA prior to purchasing our first property and we kept working with him for several years while we were continuing to buy property. One day, I came across an article on BiggerPockets about tax benefits and realized that we had been missing opportunities to reduce our tax burden. I read the BiggerPockets book on real estate taxes and immediately sought out a CPA that could provide recommendations and advice specific to our situation. The good news is you can amend filings for up to three years from the current date but the bad news is the years prior to that are lost opportunities. Don’t make this mistake. Work with the right CPA from the beginning.

    Another piece of advice in working with a CPA is to consult with him or her before you purchase any property. He or she can guide you towards the right tax-advantaged approach towards funding, entity structure and any other considerations.

    Property Management

    How will you manage the property? If you are planning to use a property manager instead of self-managing, this is going to be one of the most critical team members to impact your profitability and success. What are some things to look for when hiring a property manager?

    Responsibilities

    What will the management company handle for you? Common responsibilities include tenant communication, finding tenants, collecting rents, handling maintenance calls, facilitating evictions, coordinating regular maintenance such as landscaping and ad-hoc maintenance such as getting units ready to rent or emergency service like plumbing and HVAC. The management company should provide reporting on all of these activities. Some first time landlords may also ask the management company to handle bookkeeping activities such as paying maintenance invoices or utility bills.

    Performance metrics

    This is the most critical step! Please be aware! Most property management groups and owners have different goals for the property. What’s best for the Owner is worst for the PM group and the best case scenario for the PM Group is the worst case for the owner. The owner wants long-term stabilized tenant that pays on time. The Property Management Group wants a non-stabilized property that has many turnovers, a lot of call-outs, short-term leases, anything that would create a charge to the owner. I highly recommend you research how the companies get paid.

    Many organizations are structured in a way that pays for tenant turnover. Commissions based on signing new leases and fees for getting units ready to rent. So look at the contract metrics carefully to align interests as much as possible.

    Cost transparency

    What are all the possible fees that a property manager will charge? How about maintenance? Is there incremental margin the property manager adds on top of the normal maintenance service? On the other hand, has the property management organization negotiated discounted maintenance pricing with various provides for its clients? If a company can charge you for miscellaneous fees, they will. If a tenant calls them, you could get charged. If they visit your property, you could get charged. I’ve seen $50 charges for replacing a door knob! Remember, they don’t care if you make money as long as they do.

    Are there fees to terminate the contract with the property manager? Or, minimum dollar amounts the property manager enforces? Look for a percentage of gross revenue only. If a unit is vacant the property management company should not get paid on that unit!

    Property Management companies can make or break your property. In our experience, we didn’t start making the profits we wanted until we decided to self-manage and put our own managers on-site.

    References

    Your agent can provide recommendations for property management companies but it is a good idea to ask for and speak with current client references. Some of the questions you might ask are:

    -How long have you worked with xyz property management?

    - Why did you choose them?

    - If you worked with a different company prior, why did you switch?

    - What has been the best aspect of working with xyz?

    - If you could change anything, what would it be?

    - What do you wish you knew prior to signing with xyz?

    It’s unlikely you’ll find the perfect scenario but you can be informed about the pros and cons so that you have the right expectations. You can also leverage this information to negotiate contract concessions and understand the financial impact to your business of working with xyz.

    Are there any other team members that you've considered adding when buying your first property?

    3Reply
  • Chris H.
    Rental Property Investor · Cottontown, TN · Member since 2017 · 20 posts · 2 votes
    9y

    Nicole,

    Enjoyed reading the post.  This team topic is something I have personally thought about for a while.  I tend to agree with you regarding the CPA or Tax Specialist.  When looking for the deal most probably look at how can I afford it, but beyond rent and maintenance the Tax man is going to get his. I suspect if someone is considering the tax implications while fleshing out a deal, you are probably in better shape than most.

    0Reply
  • Nichole Stohler
    OP
    Rental Property Investor · Scottsdale, AZ · Member since 2017 · 116 posts · 136 votes
    9y

    @Chris H.,  absolutely!  Pretty sure we missed opportunities since we'd just meet with our CPA once a year -- after decisions had already been made and some things were too late to change.

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