How to get started in multi-family properties

Question

Looking for a bit of guidance on how to get started in multi-family rentals. I'm targeting a 10-20 unit apartment building within the next year or two. I think $1mm-$2.5mm range would be a realistic purchase price.

I intend to have 1-2 partners to put up the capital for the down payment, operating costs, etc.,

1. Should we create an LLC or trust to purchase the property under? Pros and Cons of each?

2. What are some of the hurdles when obtaining funding for a deal like this? Assuming we can put up the capital for the down payment (80% LTV is the standard ceiling I believe) and our personal finances are good (credit score/ DTI, etc.), is there anything else that would instantly kill our chances of getting a loan?

3. I'll be searching for properties that are already rented and will find a local property management company to handle the day-to-day operations. What other considerations should be made in terms of tenants, cap rate, renovations, etc.?

Michael Dang · Answer

As Kyle said, lenders look for the borrowers experience and underwrite the deal themselves to ensure it's sound.  Form relationships with banks that have an appetite and invest in multifamily.  Some banks will say yes but when it really comes to crunch time they may leave you in a bind.

Understand your submarket and demographics.  Get your team together: Property Mgmt, Lenders, GC, attorneys, brokers, title company, CPA, insurance, cost seg guys, and more.  Never just get 1 of each.

Always over raise for CapEx, reserves, and initial working capital.  Always assume there will be some re-positioning\evicting of bad tenants.

Sam Bates · Answer

@Kyle Houlahan I would second an LLC and also have an operating agreement the states what the job responsibilities are of each partner and what percentage of the deal each partner has. Depending which market you purchase the property will depend if they will lend up to 80% LTV. Also, with the economy softening the LTV percent could be lower if you are not buying the property for a year or two.

Posts from the previous guys are correct. When you are looking at multifamily assets, the lender is more concerned with the asset than your personal credit history. Your net worth or combined net worth if you bring in guarantors will need to equal the loan amount and they typically require roughly 10% liquidity of the loan amount from all guarantors.It can be a smart move for your first multifamily property to be a yield play so it is cash flowing from day one and you don't have as many headaches with a value-add deal. With this being said, I would suggest that you buy an asset where there are some ways to add value to the deal to increase NOI and force appreciation. This can be done in many ways by increasing income or reducing expenses. I do not focus on to much on cap rates because they can be subjective. I base it more on what the return to investors are.

Yonah Weiss · Answer

I agree with Kyle, especially with regards to the banks looking at your finances and experience. If you don't have enough net worth to cover the loan, you may need to find a co-guarantor. This is common practice for first time investors.

What do you mean about the 10% for CRE? are you referring to PM fees? If so, they are usually less on MF properties, depending on size. Usually between 6-8%

Kyle Houlahan · Answer

@Yonah Weiss - Correct. In my experience, most property managers monthly fee is around 10% of monthly rental income for SFR properties.

Glad to hear CRE is a bit less.

Kyle Lewis · Answer

@Kyle Houlahan - I've always been advised by CPAs to create a multi-member LLC for these types of partnerships. This way each member's income/loss will pass through to their personal taxes. I'm not an expert and would definitely recommend speaking with a CPA or tax attorney to ensure this is the best fit for your situation.

In my experience, commercial lenders will be looking at your personal finances, but more importantly, they'll be evaluating the deal itself (DSCR, historical vacancy, appraisal, etc.) and investor experience. Check out the below link. This could be a good loan product for what it sounds like you're looking for:

https://www.fanniemae.com/content/fact_sheet/smallloans.pdf

Not sure how to answer you last question. There are a number of other factors that may need to be considered depending on the deal. Finding a good property management company is an important piece of the puzzle.

Hope this helps. Best of luck in your search!

Sam Bates · Answer

@Kyle Houlahan the net worth only has to equal loan amount so if you buy a property that's $2.5M your net worth will need to be 75-80% of that depending on LTV. If it's a good deal you can probably bring in a guarantor pretty easily especially if it's a non-recourse loan. From your initial post I wasn't sure what you wanted to do with it, but increase value and hold for 2-4 years is a great strategy. We all hope prices drop in the next few years, but I don't rely on it to make buying decisions. In 2014, at least around Dallas, people were saying the market was nearing its end so if you stayed on the sidelines you missed out on 5 years of growth. I say you should always be in the game or you could miss out on some opportunities, but now that we are nearing end of this cycle you need to make sure your very prudent on your underwriting, become more conservative, and potentially take on less leverage than before. IE - higher reversion cap rate than purchase cap rate, lower rental growth estimates, etc. Also, stress test the deals more than you might have a few years ago with different scenarios to see if the deal is still a deal.

Kyle Houlahan · Answer

@Sam Bates - Great points, Sam!

I think my biggest issue will be checking the net worth box. One of my partners is a PI lawyer and the other is a real estate agent and CEO of a nightlife event marketing company. Both do very well. However, the three of us combined still dont have a net worth of $2mm.

I'll have to talk with a few lenders and see how important our net worth is for funding. If its vital to the deal then we may have to aim a bit lower for our first property.

I agree that a yield play is my best bet, but I would plan to strategically update the property in order to force appreciation and increase value. I think this would be a good strategy for a 2-4 year holding period, at the end of which I would sell the property, completely updated, for a premium.

Another thing that I'm considering is the market right now. Property prices are insane in most metro areas. Hopefully in a year or two things have settled down a bit.

Kyle Houlahan · Answer

@Kyle Lewis - Thanks, Kyle!

That Fannie Mae loan seems to be right along the lines of what I'm looking for. I'll just have to talk to some local lenders. I've been told the smaller banks are much better to work with for CRE loans.

Called my contact at Chase and she said they have zero appetite for commercial loans at this time.

Regarding an LLC, my best bet may be to form a parent LLC and then for each property I acquire, create a subsidiary LLC to take ownership. This will help reduce liability from one property to the next, as well as give me the option to have different members for each property and avoid comingling of funds.

I agree that finding a good property management company is key. When that time comes, I'll be sure to do plenty of research. Is the standard rate typically 10% for CRE as well?

How to get started in multi-family properties

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