Why Investing in “Value Add” Multifamily Buildings Makes Sense
Well, the answer for me follows a few reasons :
- Lower capital expense to rents ratio compared to single family homes.
- Becoming harder to build in local communities, so, a scarcer resource.
- You are not entirely dependent on comparable sales around you. Appraiser will focus more on the net income to justify value.
- After you get above four residential mortgages, financing commercial mortgages is just easy to do!
So, let’s focus on these point individually :
Lower capital expense to rents ratio compared to single family homes
Think about it…one roof with several tenants under one roof or one tenant under one roof (single family home). It just makes sense. Having to maintain ONE ROOF with several tenants is just more cost effective.
Now, there are some variables that can backfire on this multifamily investor. This includes having controllable utilities, or at least, the ability to bill these utilities back to the tenant or control their usage. The single family home model does not support this as tenants are responsible for all utilities.
However, if you are a long-term buy and hold investor (10+ years hold time), you will find the multifamily investor model to just be more cost effective when it comes to capital expenditures.
Becoming harder to build in local communities, so, a scarcer resource
As building materials go up in cost, and labor supply in is high demand, the cost to build new construction simply surpasses the opportunity to buy at a resale value. Thus, “value add” is the way to go!
Furthermore, multifamily buildings require an R5 zoning (may be labeled differently depending on your location in the US). So, the land itself is more limited that land to build single family housing upon.
So, expensive to build and limited supply of land. Sounds like the perfect opportunity to hold multifamily housing (particularly B and C class) because it’s more expensive to construct that housing that what rents will go for. This means, in my opinion, that any multifamily investor should perform their “value add” and simply hold the property while performing a cash-out refinance of the building once the rents achieve the value that were ideally attained.
You are not entirely dependent on comparable sales around you
As compared to single family homes, multifamily buildings do not necessarily directly compare sales of your building to your neighbor’s building. Thus, you are not dependent on your neighbor to maintain their property to get the achieved value you would like to attain. This requires the multifamily investor to drive the net operating income (NOI) to get value up!
How to get the net operating income up? Well, it is simply getting revenue to increase OR expenses to decrease. Examples of this are : increasing rents, install a laundry facility, find other revenue generating activities related to the building, decrease water expense by installing low-flow toilets (1.6 gallon or less per flush), have vendors compete against one another to obtain lower price/hour repair work, etc.
The most exciting part of this is that you can drive net operating income quickly and FORCE VALUE by immediately increasing revenue and decreasing expenses. The more effective the real estate investor can do this, the quicker they will increase their net worth and ability to grow their multifamily portfolio.
After you get above four residential mortgages, financing commercial mortgages is just easy to do!
Yes, financing commercial properties (5+ units) is just easier to do. Much of what the commercial lender will look at is based upon the numbers the building is currently achieving (net operating income) and your explanation of what you can do to improve this.
However, the commercial lender will want to see that you have liquid cash reserves and experience in real estate investing.
What is fantastic is that your credit history will not weigh as heavily as it does on the residential side. So, as long as you can find a partner with cash or experience, your ability to find the deal and assemble it is really what is required. Then, build the value (lead with increasing net operating income), refinance out of the building by pulling cash out of the after-value-add appraised value, and do it all over again!
Now, keep in mind, we are looking at this from a big picture point of view. The most important point we are overlooking is having a system of property management that will sustain the month to month activity of the property and set long term operating goals for the investors involved. We will save that for another blog post…