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4 Benefits of Buying a Multifamily Home

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  • Posted by: Ivan Inolin
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  • Ivan Inolin
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4 Benefits of Buying a Multifamily Home
You’ll enjoy these perks when you purchase a home designed for more than one family.
Buying a single-family home means purchasing a property that just your family, or another family, can live in. But when you buy a multifamily home, several families can live under the same roof (hence the name).
A multifamily home is defined as a property with more than one dwelling unit. Each unit must have access to its own kitchen, bathrooms, utilities, and so forth, but all of the units are still located under the same roof. Residential multifamily homes max out at four individual units, while nonresidential multifamily homes (like apartment buildings) have five units or more. For the purposes of this discussion, we’ll assume you’re thinking of buying a residential multifamily property, especially if this is your first foray into real estate investing. With that in mind, here are a few reasons to choose a multifamily home over a single-family home.

1. The option to collect rental income

When you buy a home that can house more than one family, you get the option to rent out whichever units you don’t need for your own family. That rental income can then help you cover your property ownership costs, or simply increase your cash flow. It can also help you pay off your mortgage sooner, thereby saving yourself interest over the life of your loan.
2. Easy multigenerational living

Sometimes, family members move in together to help one another out, or save money on housing costs collectively. But living in shared quarters is easier said than done when you’re talking about, say, two grown adults with children plus those children’s grandparents. The benefit of buying a multifamily home is that you’ll have the option to live together, but separately. And having that layer of privacy could make for a more harmonious arrangement.
3. Added tax breaks

When you own a home, you’re eligible for a number of tax breaks, like the option to deduct your mortgage interest or write off your property taxes. But when you own a multifamily home with rental units, you may be eligible to deduct expenses related to the units you don’t live in yourself, such as maintenance, upgrades, and depreciation on the property.
4. Easier financing

Multifamily homes tend to cost more than single-family properties, and as such, you’d think it would be harder to secure a mortgage on them. Not so. It’s often easier to qualify for a property that has the potential to generate income like a multifamily home does, but more so than that, mortgage limits (the amount lenders can loan to borrowers) are higher for multifamily homes than they are for single-family homes.
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  • Posted by: Ivan Inolin
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3 Reasons to Invest in Multi-family Real Estate
Real estate can be an alternative for those unable to withstand the volatility of the stock market. It is also a better investment for investors who wish to take an active role in growing their capital, rather than passively putting their money into a fund managed by someone else. One of the beautiful things about real estate investing is that there is more than one strategy that can be successfully used.

For example, real estate investing moguls Donald Bren and Zhang Xin both built their billion-dollar fortunes by developing various residential and commercial properties. On the other hand, Equity Residential founder Sam Zell created his wealth by slowly acquiring an income-producing portfolio of rental properties.

Other real estate investors have also made millions of dollars from house flipping or purchasing properties that are in disrepair for cents on the dollar and renovating them to later sell them to a new owner.
Key Takeaways

    Owning rental real estate can be a smart way to diversify your investment portfolio and generate a steady income.
    A multi-family property can multiply your income with only incremental added cost.
    Multi-family rentals are typically easier to finance compound returns more quickly and tend to benefit from economies of scale.

Investing in Multifamily Properties

Rental property investing is the preferred investment strategy for investors who want an additional source of monthly income along with a slow but steady appreciation in the value of their portfolio. When it comes to residential real estate, there are two main types of properties that one can invest in: single-family and multifamily.

As the name implies, single-family properties are residential buildings with only one available unit to rent, while multi-family properties, also commonly known as apartment complexes, are buildings with more than one rentable space. While there are fewer barriers to entry when building a portfolio of small homes, there are several advantages to investing in large residential complexes. Here are three reasons to consider investing in multifamily real estate as opposed to single-unit rental properties.
1. More Expensive, but a Lot Easier to Finance

In most cases, if not all, the cost to acquire an apartment building will be significantly higher than the cost to purchase a single-family home as an investment. A one-unit rental could cost an investor as little as $30,000 while the cost of a multi-family building can go well up in the millions.

At first sight, it might seem as though securing a loan for a single-family property would be a lot easier than trying to raise money for a million-dollar complex, but the truth is that a multi-family property is more likely to be approved by a bank for a loan than the average home.

That’s because multi-family real estate consistently generates a strong cash flow every month. This remains the case even if a property has a handful of vacancies or a couple of tenants who are late with their rent payments. If a tenant, for example, moves out of a single-family home, that property would become 100% vacant.

On the other hand, a ten unit property with one vacancy would only be 10% unoccupied. As a result, the likelihood of a foreclosure on an apartment building is not as high as a single-family rental. All of this equates to a less risky investment for a lending institution and can also result in a more competitive interest rate for the property owner.
2. Growing a Portfolio Takes Less Time

Multi-family real estate is also very suitable for property investors who wish to build a relatively large portfolio of rental units. Acquiring a 20 unit apartment building is a lot easier and much more time-efficient than purchasing 20 different single-family homes.

With the latter option, one would need to work back and forth with 20 different sellers, and conduct inspections on 20 houses that are each located at a different address.

Additionally, in some cases, this route would also require an investor to open 20 separate loans for each property. All of this headache could be avoided by simply purchasing one property with 20 units.
3. You're in a Position in which Property Management Makes Financial Sense

Some real estate investors do not enjoy the actual management of their properties, and instead, hire a property management company to handle the day-to-day operations of their rentals. A property manager is typically paid a percentage of the monthly income that a property generates, and their duties might include finding and screening tenants, collecting rent payments, handling evictions, and maintaining the property.

Many investors who own one or two single-family homes do not have the luxury of contracting an external manager because it would not be a financially sound decision due to their small portfolio. The amount of money that multi-family properties produce each month give their owners room to take advantage of property management services without the need to significantly cut into their margins.
The Bottom Line

Much like stocks, real estate investing allows for one to be successful through several different strategies. One of the most popular ways to invest in real estate is to own a collection of rental properties. Properties that only have one residential rental unit are commonly referred to as single-family properties, while apartment complexes that have multiple rental units are known as multi-family properties.

There are many advantages to owning multi-family real estate. These include access to easier and better financing opportunities, the ability to quickly grow one's rental property portfolio, and the luxury of hiring a property manager.

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Understanding The Tax Benefits Of Multifamily Investment
When modeling the potential profitability of a multifamily investment, there is a common tendency to focus only on the return generated by a property’s cash flow as measured by metrics such as internal rate of return or cash-on-cash return. This isn’t necessarily wrong, but it doesn’t tell the whole story. It ignores the tax benefits associated with a multifamily investment, which can be a major component of total returns.

Multifamily owner/operators who proactively manage their potential tax liability may be more likely to realize higher returns than those who don’t. I encourage up-and-coming investors to utilize three specific strategies.

Depreciation

The physical structure of a multifamily property consists of a complex network of mechanical systems including electrical, plumbing, air handling and roofing. These systems are expensive and have a long useful life. But their physical condition deteriorates over time with exposure to the elements.

Depreciation is an accounting concept that allows the property owner to “expense” a portion of the physical structure’s value each year to account for its deterioration. This expense appears on the income statement and serves to reduce the property’s net operating income, which reduces the tax liability in turn.
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Depreciation is what is called a noncash expense, meaning that it reduces income but does not reduce the amount of cash available for distribution. The more depreciation that can be taken in a given year, the larger the potential tax benefit.

Cost Segregation

IRS accounting rules govern how much depreciation can be taken in a given year and dictate that a multifamily property can be depreciated in a “straight line” over 27.5 years. For example, a property worth $1 million could take $36,363 ($1,000,000/27.5) in depreciation per year. However, an advanced technique known as cost segregation can potentially accelerate this amount.

A cost segregation analysis is a study conducted by an expert consultant or engineer that seeks to perform a top-to-bottom inspection of the property and separate the physical assets into four categories: personal property, land improvements, buildings/structures and land. Based on the classification, the depreciation can be accelerated by taking it over a shorter period of time. For example, personal property can be depreciated over five or seven years, while improvements such as sidewalks or paving could be depreciated over 15 years. The net result is that the allowable depreciation in a given year can be greatly increased, resulting in additional tax savings.

The exact math can be complicated and should be left to the qualified experts, but the larger point is this: Performing a cost segregation analysis and accelerating the allowable depreciation on the appropriate assets can lead to major tax savings, particularly because the typical multifamily investment holding period is five to 10 years. I encourage investors to perform a cost segregation analysis when appropriate because it can be a significant contributor to their investment returns.

Depreciation and cost segregation are tax mitigation techniques that can be used during the ownership period, but there is another technique that can be used upon sale that can potentially defer capital gains taxes indefinitely. It is called a 1031 exchange.

1031 Exchange

Successful property owners face a common challenge: a big tax bill upon sale. The difference between a property’s cost basis and the sale price is known as a capital gain, and it can be taxed at a rate between 15% and 28%.

Section 1031 of the Internal Revenue Code allows a property owner to defer capital gains taxes on a profitable sale by reinvesting the proceeds into another property of “like kind,” and there is no limit to how many times it can be done. In theory, there could be a successive series of exchanges that defer capital gains taxes indefinitely, which allows an investor’s income to grow tax-free over a long period of time.

Like the cost segregation study, the rules of a 1031 exchange can be complicated, but there are several key points to remember:

• The new property must be “of the same nature or character” as the old one.

• The new property must be “identified” within 45 days of the close of the sale, and the purchase transaction must be completed within 180 days of the sale.

• The amount of money invested into the new property must be the same as the sale proceeds from the old property. If there is a difference, it is known as “boot,” and it becomes taxable.

• The new property and the old property must be titled similarly.

Any errors in the transaction or violations of the rules can cause the transaction to become taxable. So, it is important to work with an experienced professional, known as a qualified intermediary, to ensure that everything runs smoothly.

Summary And Conclusions

Smart investors think beyond just the traditional, cash flow-driven metrics such as internal rate of return or cash-on-cash return. While these are important measures of an investment’s return, they don’t always tell the whole story. Proactively managing an investment’s tax liability by maximizing depreciation through cost segregation and deferring capital gains taxes through 1031 exchanges can magnify returns and allow profits to grow tax-free over time.

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