Why Purchase a Multi-Unit Residential Property? – Part 1

Are you thinking about building your real estate portfolio, or have you started already? Do you need an income stream? In this three-part series, I will outline why owning a multi-unit rental property could offer benefits that set it apart from single-family rental properties – and I will walk you through the steps and considerations that you can anticipate as you explore this purchase.

Why invest?

Cash flow    

The primary reason to invest in a multi-unit property is monthly cash flow. As the number of units increase in a single building, the Gross Rent Multiplier (or gross rent for the year compared to the purchase price or GRM) will typically go down. When a multiplier goes down, the monthly cash flow will go up. The GRM is just a quick and dirty method to analyze a building. It does not take into account factors such as operating expenses, owner-paid utilities, and vacancies – because it only calculates gross income, not net income — but it will often eliminate a building from consideration immediately if it isn’t even close to market value.

Efficiency

Compare buying a 25-unit residential property or apartment with buying 25 single-family homes or condos. To buy 25 condos or houses you would need 25 loans, 25 appraisals, 25 insurance policies, 25 closings, etc. In other words, it is much easier to buy one 25-unit building than it is to buy 25 individual properties. Then once you own it, management is so much easier for 25 units in one place than to manage 25 single-family homes or condos.

What to consider:

Shopping for a multi-unit property

As you shop for a multi-unit building you are seldom allowed to see all of the units before writing a contract because often just a couple units will be shown. After you write a contract, you can usually get into all of the units during the inspection or appraisal. There are also cases where an owner will not allow you to see any of the units until you write a contact conditional upon inspection. In addition, obtaining the financial numbers such as rent roll, operating expenses, etc. from an owner for you to analyze is can be difficult. Once you do have those numbers, experience will help you quickly determine if an owner’s numbers are realistic, and from there calculate what the reasonable projections are likely to be.

The contract

In Colorado, the contract to purchase a multi-unit building is the same as a single-family home as long as it does not exceed 4 units. Once the 5-unit threshold is reached, the contract is a commercial contract, rather than a residential contract. A number of additional provisions are generally used to allow for due diligence.

Ownership

It is typically not a good idea to own an apartment building personally. Too many things can happen, and you should limit your liability. This is done by creating an entity such as a Limited Liability Company (LLC). Apartment owners with multiple buildings might have an LLC for each building and may even form a Limited Liability Limited Partnership (LLLP) that owns all of the LLCs. It is best to consult with an attorney and a CPA to determine which form of ownership works for you. Once you determine what form of ownership works for you, the next step is to coordinate with the lender’s requirements. Some lenders will let you buy the property in the name of the LLC while others will not. If the lender will not let you initially sign in the name of an LLC, you can work with your attorney to transfer the title to the LLC later, for liability protection.

Financing

Financing for 5+ multi-units is completely different than financing for single-family homes and condos. In fact, the lenders are different and the source of funding for apartment financing is different. Typically, there are no 30-year fixed rate mortgages, but different forms of adjustable mortgages are available. Closing costs can vary substantially between lenders. It is very important to shop around and create a relationship with a lender prior to making a purchase.

In Part 2 of this three-part series, I will discuss areas of consideration for financing and for evaluating a multi-unit property. Be sure to pull together a team that includes a mortgage loan officer, financial planner, accountant, and Realtor to consult with as you move forward.

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