Investing in Multifamily Houses

What exactly is a multifamily house? For the purposes of the real estate industry, a multifamily house is a freestanding building composed of from two to four separate living units, with each unit having its own bedroom, kitchen, and bathroom facilities. Some are structured with all of the units on a single ground level, while others may have one or more units on multiple floors. Still other types of multiplexes, as they're sometimes called, are made up of multi-floor units built side-by-side under one roof. These are commonly known as townhouses.

Many real estate investors, especially those new to the marketplace, prefer multifamily properties as their investments of choice. Let's examine some of the more common reasons for this popularity.

Multifamily houses provide a relatively easy entry into the real estate marketplace. If you don't yet own any real estate, you don't have very much cash at your disposal, or you want to combine your first home-buying experience with your first investment property, a multifamily house may well be the solution to your needs.

While not only providing physical shelter as your home, this type of investment can also be supported by the rental income you receive from it. Additionally, there are numerous federal, state, and community financing programs in existence that can help you purchase an owner-occupied multi-family house with little or no down payment. Qualification guidelines for these mortgages are generally less stringent than for any other type of investment real estate, and the rent from the unit or units that you don't occupy can be considered as part of your qualifying income.

Multifamily houses provide an opportunity for the investor to employ "sweat equity" to build real estate wealth. The maintenance demands of a multifamily property are not very different from those of a single-family house, and both owners and owner-occupants often find that they can save substantial amounts of money and build up sweat equity (increasing their property's value with direct labor) by doing much of the maintenance and renovation work themselves. Furthermore, the work can be done over time as cash becomes available and units become vacant and in need of renovation. This can be very appealing to investors looking for long-term capital gains. On the other hand, for those investors in search of a quick turnover more like that of the single-family fix-up property, the cash received from a multiplex's rented units can ease (or perhaps even eliminate) the financial burden of carrying the property while renovations to units, the exterior, or the property grounds are in progress.

Multiplexes can very often provide a substantial positive cash flow. A well-chosen multifamily property can be a long-term positive cash-flow investment. Because these properties are often managed by their owners, operating costs can be significantly reduced. Vacancy of a unit, however, can cut into the property's cash flow. In an owner-occupied two-unit house, for example, all property income ceases when the rental unit is vacant. In an owner-occupied four-unit home with one vacant unit, the income is reduced by one-third. So, if you're in the market for a multiplex and you know that you'll be depending upon rents to meet the property's debt servicing and operating costs, be very careful to choose a property in an area where rental demand is high and the vacancy rates are low - even if you have to pay a bit more for the property. The added income security will likely be well worth the additional expense. What's more, because the property is in a high-demand area it can generally be expected to appreciate more than similar properties in marginal locations.

It must be kept in mind, however, that ownership of multifamily real estate is typically management-intensive. It's a "hands-on" investment that often calls for the performance of routine maintenance, such as mowing grass, unplugging sinks and toilets, and replacement of the odd refrigerator. Especially at the outset, owner-occupants will usually always do their own managing because during that time the cost of a professional management firm would likely be too large for the owner's operating budget. Later, once several multifamily houses are in the investor's portfolio, a management company will typically be hired.

A multifamily property can be used as an effective first "building block" in a real estate wealth-building pyramid. A multifamily home is often the first property acquired by a beginning real estate investor. The capital needed for such a purchase is often relatively small and the potential resale market is quite large, including other investment beginners seeking their first properties. Although multiplexes generally sell less quickly than single-family houses, property turnover is usually still faster than that of small apartment buildings or commercial properties.

For nonowner occupants, a 1031 tax-deferred exchange can move the entire profit from the property's sale into another, larger multifamily structure. Using a different strategy, as an owner-occupant, you can sell your property after two years of living on the premises and receive the portion of the profit that's equivalent to your living unit tax-free (in a two-unit home, for example, half of the profit would be tax-exempt). With careful financing and a good track record of on-time mortgage payments, you can expand your investment into two multifamily buildings. You can then continue this pattern at periodic intervals to constantly increase your net worth.

On the other hand, if you prefer to hold onto your first owner-occupied multifamily property because you enjoy living there or because it's a solid source of present and future positive cash flow, you might consider another alternative. Once refurbishing, renovation and appreciation have increased your equity, you can refinance the property while you're still an occupant, thus taking advantage of owner-occupant qualification guidelines and interest rates. You'll then have down-payment cash for the purchase of another investment property.

But always be mindful to watch the numbers closely. When you refinance based upon appreciation and the improvements that you've made, you'll likely encounter higher mortgage payments. Be certain that increased rents will cover these larger debt service amounts. And keep in mind that you may also have higher municipal taxes if your improvements were taken into account during a tax reassessment.

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