With demand for rental units rising, many fix-and-flip professionals are now investing in multi-unit dwellings. In the last 10 years, the number of rental households has increased by nearly 25% and this trend is expected to accelerate as aging baby boomers transition to retirement communities and Millennials leave their parent’s homes to become renters.
For fix-and-flip investors, multi-unit dwellings offer several advantages over single-family homes as well as a few challenges, which are discussed below:
1. More Reliable Cash Flow.
A big advantage of investing in multi-unit properties is more cash flow due to rents from multiple units versus just one unit. In addition, cash flow is often more predictable due to multiple units paying rent. Multi-family dwellings are usually sold with an existing tenant base and thus produce positive cash flow from day one. As well, small rent increases can significantly enhance cash flow since increases are multiplied across many units.
2. Larger Pool of Potential Buyers.
Multi-unit dwellings address a much larger market than single-family homes. Potential buyers include both homeowners and investors. Another consideration is that delays in selling have much less impact on multi-unit buildings because of cash flows from existing tenants. Often the rents from a few units are sufficient to cover expenses. The cash flow from the remaining units is pure profit.
Another advantage of multi-unit dwellings is that some units can be rented while others are being rehabbed; the property can continue to generate cash flow during renovation. Rehabbing a single-family home often requires an empty house that generates no income.
3. Provides Economies of Scale.
Multi-unit buildings provide economies of scale. While an investor rehabbing multiple single-family homes may have many roofs and heating systems to replace, a multi-unit building has only one roof and heating system. In addition, rehabbing multiple single-family homes usually involve traveling to several job sites whereas a multi-unit dwelling involves only one job site.
Economies of scale also apply to financing. The underwriting process for small multi-unit dwellings is the same as for single-family homes. Securing financing for multiple houses is an arduous process that involves many applications, financial statements and meetings with lenders. Financing a multi-unit building entails just one application, financial statement and meeting with a lender.
4. Fewer Competitors.
Fix-and-flip investors often compete with dozens of other buyers for properties. In addition to other experienced rehabbers, there is competition from fix-and-flip newbies who lack expertise and negotiating skills and homebuyers who want a residence rather than an investment. Newbies and homebuyers tend to overpay for properties, making it difficult to find affordable fix-and-flip projects. The scenario is different for multi-unit dwellings. Buyers are generally professional investors who use sophisticated tools to determine price. This creates fewer competitors and a more level playing field.
5. Tax Benefits.
Rehabbers of multi-unit buildings can take advantage of tax breaks available to investors and homeowners. Keeping tenants in some units during rehab may allow holding the property for more than a year and qualifying profits from the sale as a long-term capital gain. Investors can also benefit from typical homeowner deductions such as mortgage interest and real estate taxes.
Repair costs for rental units can be deducted while the property is being rehabbed. An investor who lives on-site can also write off depreciation and expenses for his individual unit as a tax deduction.
6. Bigger Sale Payoff.
Due to higher value, the payoff from selling a multi-unit building is larger. For example, if a $160,000 single-family home increases in value by 15%, the sales profit is $24,000 ($160,000 x 0.15), whereas a $350,000 multi-unit building that appreciates by 15% produces a $52,500 profit ($350,000 x 0.15).
Multi-unit buildings are increasing in value due to rising rents nationwide. While a home buyer won’t pay more simply because rents are rising, a buyer of a multi-unit building will factor rent increases into his valuation and pay a higher purchase price.
There are also unique challenges associated with fix-and-flip investments in multi-unit buildings. Higher purchase costs are one challenge. Multi-unit buildings generally cost more than single-family homes and some buyers may have problems secure financing. Another challenge is that more management is required. More tenants often mean more complaints, more issues and more wear and tear on the building. Tenant complaints can be avoided by hiring a property manager, but this can be expensive. Management fees can range as high as 12% of monthly rents, plus expenses.
Other challenges are fewer properties to choose from and more regulation. Single-family homes are plentiful across the US, but some communities have no multi-family dwellings. In addition, multi-unit housing must comply with a slew of government regulations such as accessibility under the ADA (Americans with Disabilities Act), FHA requirements and state and municipal building codes.
Path to Fix-and-Flip Profits
If you are considering an investment in a multi-unit dwelling, there are strategies that may help boost profits. First, be conservative in calculating potential returns. A rule of thumb used by experienced investors is to estimate property monthly rental income, subtract half of that amount for monthly expenses and then subtract the mortgage payment from what remains. If property cash flow doesn’t cover these costs, either negotiate a lower purchase price or look for a building in another neighborhood that does support higher rents.
The first rule of real estate is location, location, location and that maxim also applies to multi-unit dwellings. Choose a building in a neighborhood where rental demand is high; this will help ensure a steady flow of tenants. Avoid sketchy neighborhoods. These make it difficult to attract quality tenants. Renters want close proximity to work, shopping and schools so make sure the property is located near major roads, grocery stores and other essential services.
A recent survey of property managers indicates that most expect rents to rise in 2017. Higher rents increase the value of multi-unit buildings. While more complex as an investment than a single-family home, multi-unit buildings have numerous advantages such as superior cash flow, economies of scale and tax benefits that more than compensate investors for any extra effort. .