A good time to buy multi-family?

Question

I've been buying SFHs for a few years now and as the market rises am looking at other alternatives. I've been buying my rentals close to the 2% rule. In most cases, I have $50k in for $1,000 rent or $60k for $1,200. All are in good neighborhoods in the Minneapolis metro. As prices have gone up, I've had a tougher time finding new properties to purchase. I've been looking at multi-family, but the economics don't make sense to me, so I hope someone can help explain.

There is an 11 unit (1 beds units) apartment building in a decent area of North Minneapolis for sale for $560k ($51k/unit). Rents in that area for 1 bedroom is $725/mo. So, I'm looking at $51k/unit for rent of $725/mo. This isn't really close to meeting the 2% rule, it's at 1.4%.

So, my question is, what is the motivation for buying multifamily, when SFHs are so cheap? SFHs are more liquid, tend to appreciate better, have more financing options, command higher rents, and can be sold to the retail market. Is now just a historically bad time to be buying multifamily due to low vacancies and increasing rents?

I'd appreciate any insights people have to offer. I seem to get asked frequently why I'm not in multi-family and I just haven't figured out the economics of it.

-Jaden

Chris Winterhalter · Answer

@Jaden G.

I would connect with the top players involved with your property qualifications. So if you are seeking out 5-20 unit properties you are not going to connect with the broker that has the top volume transaction in the 100 unit+ mark. They may be the best rated CBRE broker in your market however they probably won't spend the time it takes finding you the right deal (or more than likely will refer you to someone from the beginning). I would also connect with property managers who handle these types of properties in the areas you are targeting. They will have the pulse on the market and it's a conversation you need to have either way. Let them know your investment goals and make sure to connect with them on a regular basis. Just like direct mail marketing - network marketing needs just as many follow ups (if not more) to properly work (I really need to take my own advice more often!). Beyond that you can also set up a direct mail campaign. There have been a few threads about it in the multi-family section.

Good luck!

Chris

Chris Winterhalter · Answer

Jaden - Congrats on the success you have had so far. Regarding your question...

It really depends what your goals are personally and professionally. Scalability is greatly important to me for many reasons. I'm not sure what your business model is however it appears to be rehabbing and renting single families for the long term (up to this point). In my experience setting up a single family redevelopment vs. a 20 unit apartment building redevelopment is essentially the same from a standpoint of time input. That all depends on what type of team you have set up and your goals and strategies involved however the time input from the investor/developer is about the same. The numbers do become larger however there comes a point when funding the deal becomes the least difficult part (I just knocked on wood).

It sounds like you are building a portfolio of cash flowing, professionally managed, and properly rehabbed projects. So my small take away is that you either want to scale your operation larger or spend your time doing other things (or both). Multi-family is perfect for both of those points. The 2% rule is just a rule of thumb. I think it's more important to assess your goals and come up with investment guidelines that fit into those goals. And then see if the market can provide that. From there you should always compare your investment to the rest of the market (and possibly other property types like you are doing now). We all have different investment philosophies however at the end of the day cash flowing real estate is about arbitrage. A Class-A California 100 unit multi-family building that trades at a 5.5 cap works for the risk adverse investor that can borrow long term debt a 3.25%. Likewise a 10 unit C-class building that sells at a 12 cap (with private debt of 8%) and is purchased by an experienced investor who understands low income tenants can be a great deal as well...barring that it's inline with their investor philosophy. Time is a very scarce resource...your overall ROI percentage might be higher with SFR's right now however the total dollar amount of income can be much larger with apartments. It will take you a lot more time and energy to get to 100 SFR rentals than it will take you to purchase (5) - 20 unit buildings. Just my two cents...

Shaun Reilly · Answer

Jaden Ghylin

Do you know what a typical market Cap for the area is?

Taking away thoughts of the 2% rule for a minute it just seems like it might be overpriced anyway. Given those rents expenses would have to be around 40% with a Cap of 10%.

If market Cap is more like 8-8.5% then the expenses could be higher and still justify the price.

However I would think that in an area where it isn't that hard to buy 2% properties the Cap would likely be 10% or higher.

Generally people will get into multifamilies for the economy of scales that allow for better cash flow. Given how well you can buy SFHs around there it doesn't seem to be a great fit. Maybe some of the ones Aaron pointed out will be better fits but at first glance I agree with your initial thoughts on this place given what you said about getting into single families.

Aaron Montague · Answer

Jaden Ghylin

Yeah, it violates the 2% rule. For the most part that rule seems to hold up and this place may simply be an exception. I tend to look at anything that gets 1% or higher of the asking price in gross rents. In my opinion rules of thumb are designed for scanning large sheets of data.

My property management contract is 5% of gross rents plus $100 incentive to fill the apartments. I know it is quite low. My back of the napkin calculations still indicate he makes about $42/hour for time spent on my places :)

The guy also has a contract to cut my lawns.

My "general" fund is the amount I set aside to cover renovations, lawn care, snow plowing and the like. It is a moving average of my costs since I bought the place.

The ROI number I mention above would be about 20% if it weren't for a renovation I had to do because of one of my tenants. I added 20k to my down payment to adjust the ROI calculation.

Each market has its own strengths and weaknesses. Take a look at:

10114 JADEMONT LN in Houston TX for a great cash flow SFH. I calculate 15% ROI at a purchase price of 95k with another 1k for paint and flowers.

Aaron Montague · Answer

Jaden Ghylin

4 Unit MFH

Rents: 625/625/750/500 = 2500 total rent

Mortgage: 636/month

Insurance 1454/year or 122/month

Purchase 149000

25% down

Taxes: 5182/year

Trash: 75/month

Utilities: 30/month (manager's electric)

Property Management: 125/month

Sewer and Water: 135/month

General (lawn/light bulbs/general repairs): 186/month saved to another account

Cash Flow is ~750/month

Major Repairs (renovating an apartment and new furnace) 20000

ROI is about 15% overall

MFH can be pretty awesome in some places. This one is in VT. Others can be pretty bad, Boston MA is a good example.

In Minneapolis I'd look at:

804 Oliver Ave N

5120 Vincent Ave N

2503 Irving Ave N

I pulled those from Realtor.com. I don't know much about the Minneapolis market, but those are all worthy of running number against in my book.

Jaden Ghylin · Answer

@Jeff Greenberg

Thanks for the link. Very helpful.

-Jaden

Jaden Ghylin · Answer

@Chris Winterhalter

I think you nailed it on the head. Thanks for your very insightful post. You are correct that I've been getting good returns on SFH, but am now trying to figure out how to scale. I have been doing a mix of flipping and buy-hold. It is very time consuming to manage SFH projects and I'm at the limit of what I can do.

I've gotten very good at finding and evaluating deals on SFH, but really don't know how to start on multifamily since the information doesn't seem to be as readily available. It seems that I need to find a good broker that can help me find deals. I've rarely had luck using brokers to find SFH deals, so hopefully it's different in the commercial world. Any tips on finding a good commercial broker would be appreciated.

-Jaden

Jeff Greenberg · Answer

There are many threads on the MF vs SFH debate. Here is one http://www.biggerpockets.com/forums/52/topics/72944-sfh-vs-multifamily-rentals--pros-and-cons

Jean Bolger · Answer

If you have realtor level access to the MLS you may find more listings. Some public mls sites (Trulia, Realtor.com, etc) seem to give more mulitunit listings than others- no idea why- and it seems to vary by area. If you are seriously shopping, by all means find a broker. To start looking, you might look for a realtor who has a site that will let you set up your search parameter (keep them wide at first and analyse a ton of listings) You can also look at Loopnet and Cityfeet websites.

I would highly recommend you buy @Frank Gallinelli 's books if you are thinking of making the jump into commercial property.

Jaden Ghylin · Answer

Thanks Jean, that makes sense. I guess I don't really know how to look for multi-family. The MLS has listings for 1-4 unit and almost all seem to be overpriced. Beyond 4 units, do I just need to get a broker to track down deals?

-Jaden

A good time to buy multi-family?

A good time to buy multi-family?

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