How to make multifamily profitable in a more expensive area

Question

Hi BP community! So in my learning phase of real estate, i've come across a few questions. After finishing up Josh and Brandon's book on How to Invest In Real Estate, I was drawn towards multifamily units and commercial real estate. I want to start my journey with a house hack that is very close to my day job (so I can drastically reduce time and money on commuting) and from there get into multifamily homes. I feel like it is a great way to scale my portfolio which will then lead to commercial RE. My problem is investing in a somewhat more expensive area. I'll be investing in Northern Philly Suburbs where duplex's can run well above of 300k. But the thing is that rents mostly don't pass even the 1% rule.

My question is, are multifamily homes in more expensive areas a bad investment, or is it a thing of finding the right deal? I hear of so many examples of Midwest investors putting 100k into a multifamily unit that pulls $1500 or more rent, but that isn't the case around here (as far as I know).

Any input to help me would be great. A lot of what I want is to know that this IS possible and how people are able to take this concept and really scale. Trying to learn all I can!!

Rick Pozos · Answer

Everyone wants to get rich quick. They want to 'scale' into 20 or 30 homes in the next year or two. STOP thinking that way unless you are willing to put 70 to 80 hours every week into real estate. Knocking on doors, sending out 1000s of postcards every week, 3 or 4 virtual assistants, CRM system in place for your 4 or 5 in person employees. If you are not willing to do all of that along with an ulcer or two, you WILL NOT have 30 homes in 2 years. Not only that, you have to have the knowledge to manage all of these people AND know how to handle all kinds of real estate issues like probate leads, divorce, burned houses, construction knowledge to handle full gut rehabs, two or three construction crews and so much knowledge about managing these people.

Realistically, if you want a nicer area, the numbers will not be quite as good. Thats ok. Less than 1% is fine because we have such low interest rates right now. Like you said, get a room mate. Rent out the other units. Maybe rent out the other units by the bedroom, like your unit. Over time, you will build some equity OR better yet, live below your means and SAVE some more money to buy another one. As @Greg Scott said, it is exponential. After you have a couple, over 4 or 5 years you have equity and can borrow against it to be able to pounce on a great deal when you find it.

Nick Scullin · Answer

@Rick Pozos Those are great points. I'm not trying to come off as "get rich quick" as that's not really my plan. I am learning all I can and starting off slow with a house hack just to get an understanding of all the basics. When knowledge and experience grows, the portfolio will follow. I just am ambitious because I don't want to do the slow approach of duplex one year, then maybe one more the next, then a couple years later a SFH. Trying to take the advice of Brandon Turner and start working that expansional growth.

And i love your point in the second paragraph. The goal would, in theory, to get a modest portfolio (10 doors) and have all my CRM together, a team in place, and methods for being efficient. Then use the equity through selling or refinancing to "scale up" into commercial.

Also, I am a very frugal person and live well below my means already. Spending $2000 or less a month for ALL my expenses and investing everything else into index funds. Emergency fund is stuffed up as well. So my money is real, not tied up in labilities (no debt fortunately).

Thank you for the advice, it helps!

Chris Herrera · Answer

@Nick Scullin I wouldn’t say they’re a bad investment, obviously we can’t predict the future but if it’s in a good area then we should be able to reasonably predict that the value will increase over time and rents will likely increase as well. You just won’t be able to scale as fast as you may think you want to, but it could be a ‘blue chip’ property in your portfolio.

There’s properties a few years ago that didn’t make sense at the time but would be a steal now. As long as it cash flows enough right now for it to be worth it to you then you shouldn’t automatically be turned off from it, but like I mentioned you’ll take longer to scale unless you find a run down place that you can add a ton of value and cash out to reinvest the money

Greg Scott · Answer

Real estate investing growth is exponential.  At first it feels linear and seems to plod along but a few years down the road it starts to take off.  Just getting the ball rolling, you can do very well in the long run, but  you are unlikely to get to 20+ units in 3 years simply doing buy & hold off the MLS.  You would need to incorporate some other strategies such as buying with OPM or finding under market deals.

Noah Chappell · Answer

@Nick Scullin you don't want to put the horse before the carriage. Scaling a real estate portfolio is talked about a lot, but involves a high degree of complexity. I think your idea of starting with a house hack is great, it will allow you to get your head around the basic process of buying a multi family. You could buy one that's moderately priced and needing some cosmetic updates, so there's some value add component. After this I'd head towards the more blue collar areas to start your core investing. Maybe start with a duplex in need of more extensive cosmetic turnover. Value add is the name of the game here, and the way you'll scale. When you're confident in BRRRRing smaller multi's, then go into commercial multi family, mixed use, commercial, etc. Thats how you build your portfolio.

Greg Scott · Answer

The 1% rule is just a simple and fast way to guestimate if a property will cash flow.  If a $100K property rents for $1000/mo it probably has good cash flow.  You are actually better off if you do the math and ANALYZE the cash flow.

Ideally you want a deal that cash flows and I'll bet you can find them in the Philly area.  If you are assuming you are going to house hack, in my opinion you should look at it two ways.  First, what does the deal look like if it I'm not living in it.  No sense in buying something that has negative carry.  Second, if has negative cash flow with you living in one unit, what is your opportunity cost?   For example, if you are living in one unit of a triplex which causes the property to have a negative carry of $500 but it would cost you $1,200 per month to rent a similar place, you are still much better off.

Nick Scullin · Answer

@Chris Herrera Good point about cash flow. I have been analyzing deals (just to really get this skill down) and I do find some that will cash flow. I guess you make the great point that, it can still be a great deal when it cash flows, it will just be hard to scale quicker. And i'm always hesitant to assume appreciation, say 2%. I want the numbers to work in my favor even if for some reason that doesn't happen to the extent I want long term.

I think this where learning to use OPM is very advantageous. I am currently reading the Bigger Pockets book How to invest with no (and low) money down. I've also been learning about it through some BP podcasts and other blogs. While easier said than done, it can be a great opportunity to ramp things up in a more expensive area.

My biggest question with using OPM is how to make each person benefit? I guess i'll figure that out more from reading the book!

Steve Morris · Answer

It's tougher since you'll be competing with less knowledgeable buyers that want a place for curb appeal and not so much return.

You can make money, but you need to get in at a good price and figure out your upside plan.  I'd just look at it with some hard actual numbers and returns.

Brandon DeVega · Answer

You should connect with me. I definitely can give you some pretty good ideas on this particular topic. @Nick Scullin

Nick Scullin · Answer

@Noah Chappell Thanks for the input. It's true i'm getting ahead of myself and need to start first. BRRRRing seems like the way to go. I'm just concerned about taking on a MASSIVE rehab projects in say Class C properties. The goal is to get a couple multifamily units under the belt over the next couple years and put methods in place so that when scaling becomes possible, I'm ready. Hopefully I can then use the equity from my multifamilies and dive into Commercial RE maybe with the help of private lenders made through connections by that point!