Buying Multi-family property
Buying multi-family income producing property can be a good way to diversify your income, add wealth to you and your family and to convert your otherwise passive real estate with dead equity into an income producer. Some landowners sell their land via the usage of a 1031 tax-deferred 3 way exchange and invest in this type of property.
Some people start out by buying a duplex, a 4-plex, 5-plex, 6-plex, 10-plex or more. You need to start somewhere! Others will sell a large piece of real estate and go right to a 50 unit complex. I remember I was camping one time at Odell Lake in the Oregon Cascades and I was chatting with a man and his wife about what they did for a living. He was a veterinarian but really made his money in multi-family investing. He started out by trading and old station wagon for a beat up house. He fixed up the house, got it into a positive cash flow position then looked for his next investment. Later he picked up more houses, some duplexes, 4-plexes and eventually larger apartment projects. When I last talked to him he was up to about 50 units that were bringing in about $650/month on average. Not a bad monthly income!
Like all housing investment decisions...housing demand is dependent on jobs. If people don't have jobs they can't afford to buy a house or they can't afford to keep their current house. They have to live somewhere so they rent. Some tenants will rent houses but when they find out they have to pay almost the same amount of money as when they own a property that is when they decide to rent a multi-family property. They have less maintenance and sometimes the owners will pick up the costs of some of the utilities like water, sewer and garbage. The net cost to tenants on a monthly basis is typically less when they rent a multi-family property than when they rent a home. As population grows in the northwest, there will be a continued demand for multi-family housing.
Think about it...every year high schools and colleges churn out thousands of adults into society who have been either living at home, in dorms or with friends. They want to get their own place.
Many of you probably started out in an apartment complex as well. In addition....Oregon and Washington are fantastic places to live as we are nestled between the refreshing ocean breeze and the spectacular clean air of the mountains. Demand will continue in the northwest.
The key on any acquisition is to buy it right, manage it well and have an exit strategy in place when you decide to sell it. You have to do your due diligence.
Selection criteria: Typically, an investment in a multi-family property—be it a duplex, a 20 unit garden apartment or a 300 unit high rise apartment is purchased based on one primary criteria—the Capitalization Rate. The "Cap Rate is a simple formula in itself---the hard part is getting all of the proper data and then verifying that data to come up with some "good numbers".
The Cap rate is calculated as a percentage:
Cap rate= Annual Net Operating Income = $50,000 = 10%
Asking or Purchase Price $500,000
An investor would earn a 10% return for example on an investment in a property that nets $50,000/year (with management) when the sellers of the property are asking $500,000.
Again, the challenge for any investor is to get all the income records and the cost records of the particular investment from the current owner. Through either cost cutting efficiencies or increasing the rental rates on the rent roll will improve the performance of the investment. Furthur down in this paper, I am giving you a sample cash flow sheet with which to calculate your potential investment or your property sale. Feel free to contact me to discuss specific issues.
Other Criteria: In order to finance a property a bank will look at a metric called the Debt Coverage Ratio which is the Net Operating Income divided by the Debt Service. Two banks that I have worked with like to see the DCR at 1.25 or greater. If it is less than that then the investor will need to put more money down on the property or the seller will need to reduce their price. Some banks look at property specific DCR's while others look at the entire financial situation of the investor—which some call a global DCR. Work with your bank to understand this process and to improve your particular situation.
Loan to Value Ratios: In the past, LTV's were required at 75% but in the current financing market, depending on the lender they could be a little higher. Check with credit unions and other conventional lenders to find out what their lending criteria might be. On single family homes we have seen what 100% financed projects have done to the current housing market. This activity coupled with unscrupulous lending practices such as no-doc loans on unqualified buyers or "liar loans" and packaged together as secured instruments in credit defaults swaps (cds's) have greatly hurt our industry. We are in an era of documented loans and the investor will need to invest greater amounts of cash down to buy property. In the long run, this will be good for our economy. Again...check with various lenders in your market area or on the web to find out about their lending ability.
Gross Rent Multipliers: Another measure that some people like to work with is called the gross rent multiplier. It is a way to compare one property to another when they have similar expenses. The equation is as follows:
Price of the Property =Gross rent multiplier
Gross Annual Rents
Holding the price of the property constant and varying the Gross annual rental income, you can see the effect of the GRM number and how you might use it to compare different properties. To me, it is only an initial number to use as the most important one to use is the Cap rate but this gives you an idea when comparing properties.
Price of property Gross Rent GRM
$1,250,000 $140,000 8.9
$1,250,000 $165,000 7.6
$1,250,000 $190,000 6.6
The terminology that people use is:
"The property is trading at ___ times rents".
Or "Property is selling at ____ times rent" in a particular market.
Generally, the lower the number the better the deal BUT you have to take into account the expenses of the deal before you can really make that decision. That is why the Cap Rate is the best measure. Sometimes an investor simply can't get accurate data on an investment so the GRM measure will help in understanding the value of the investment
This would be done using the GRM metric in this way: a multi-family property that was on the market sold with a GRM of 7.6 and you know the gross rental income or the rent roll on the potential acquisition then you can re-arrange the equation as follows:
Price of property = Gross rent multiplier X Gross Annual Rents
= 7.6 x $100,000(as an example)
Value of Property = $760,000
Again...this gives you a general idea as to how to use this metric in seeing what properties might sell for in an area if you have limited data. Information needed would be the GRM's on sold properties in an area. Feel free to give me a call to discuss this info and I can get it for you.
Cash Flow Statement
An annualized pro-forma or Cash Flow statement will be different for most properties as the Income and Cost inputs will vary but it will look similar to this on an annualized basis:
Income
Scheduled Gross Rents __________
+ Laundry Income __________
Gross Potential income __________
Less vacancy rate (5-10%) __________
Effective Gross Income ___________
Less Expenses
Management ___________
Electricity ___________
Garbage ___________
Repairs & Maint. ___________
Insurance ____________
Property Taxes ____________
Net Operating Income ____________
Less Debt Service ____________
Net Cash Flow ____________
Plus Principal Reduction ____________
Total Return ____________
Capitalization Rate: NOI/Price ____________
Cash on Cash Return _____________
(Total return/Price)
Gross Rent Multiplier _____________
(Price of property/Gross Rents)
Feel free to print this out and use this in your analysis as a basis for your investing. There are some technical issues imbedded in this process so give me a call and we can discuss this information.
Acquisition Process:
1) Give me a call to discuss your initial investment thoughts in any given part of Oregon or Washington. There are properties that are on the market and some that are not on the market that we can discuss.
2) Get your financial information in order to present to a bank in the event you might need financing.
3) Visit your prospective lender and find out what their criteria is in lending on multi-family property.
4) When you know what you can afford (whether it's $100,000 or $10 million) and have established your investment desire then you will have your "hunting license" to go out and find an appropriate investment. At that point, I am looking forward to working with you to find and close that deal. If you currently own a property, I will be happy to help you sell your property as there is another investor out there that will want your property and my goal is to bring that investor to the market.
I have presented some initial, simple information on multi-family property investments. There are many more things that can be discussed like management and accounting systems, tenant issues and other benefits of investment. Many owners have friendly long term relationships with their tenants. I like to see my tenants improve themselves each year. If they get a better job and then want to move into buying a property then that is where I help them in there next phase of their lives. Multi-family owners have the opportunity to minister good will to people.
Of course, sometimes there are problems to deal with and those weigh heavily on the landlord but those issues can be avoided by having a good tenant selection process. We all started out from living with our parents at a young age and then we moved on. The multi-family investor serves a very important role in the real estate industry and can be rewarded both financially and psychologically.
I look forward to talking with you in the future!
Jim Worl,
Washington and Oregon Real Estate Broker & Investor
James M. Worl Investment Real Estate LLC
360-751-1440
Longview, Washington
