Multifamily Investment Strategy: The 3 Ways You Build Equity in a Multifamily Property
This article is part of our passive investors guide on real estate syndications, available here.
Multi family real estate investing for beginners
Investors have been able to implement multifamily investment strategies to level up and grow there portfolios. Whether you’re a beginner or an experienced investor, multifamily properties offer opportunities to grow your wealth that are unmatched in other sectors of the real estate industry. The multifamily housing market is one of the most stable and profitable markets for real estate investors.
They have been a staple of the real estate investing industry for decades. Multifamily properties were among the first forms of commercial real estate that existed. In time, multifamily properties have evolved into different types and subclasses. Today, you can find multifamily properties in other neighborhoods & sections across the country.
Benefits of Multifamily Investing
Rental real estate, like multifamily, is truly one of the most substantial commercial real estate investment asset classes and provides three core opportunities for active and passive investors.
Those three things are…
- Tax benefits
- Appreciation in equity/values
Apart from cash flow, the accumulation of equity is where all of the value is produced, and money is made in multifamily housing. This article will show three methods to increase your equity in a multifamily property.
Multifamily property real estate definition
A multifamily residential property is often referred to as an apartment building or a rental. It’s generally composed of multiple separate housing units within one or several buildings. Typically, a property is considered a multifamily dwelling when the property site has five plus units. Multifamily properties are built differently to meet various density demands depending on where the multifamily property is located.
For example, suppose we’re talking about a multifamily property in Brooklyn, New York. In that case, we’re likely talking about an apartment building that is highly dense to support a highly dense market where the builder would be building vertically to maximize its land constraints. But if we’re talking about a smaller tertiary market like Charleston, South Carolina, we’re likely talking about a more garden-style apartment community for a low, dense surrounding population.
Here at Willowdale Equity, we focus only on acquiring existing built garden-style apartment communities across secondary and tertiary markets across the southeastern United States. So depending on the market, the lifestyle requirements change for residents, and so do the expectations of what amenities are included and what the average square footage is of a unit.
Related Read: Analyzing A Multifamily Deal
Multifamily investment strategy
Upon acquisition, your multifamily real estate investing strategy should provide added value to the tenant base and the physical property. When you pull this off, the overall result should be that additional Net Operating Income (NOI) will be added to the bottom line. As a result, your multifamily property is worth more and has more significant built-up equity because the next investor is ready to pay for greater cash flow.
Equity is the property’s value minus how much debt is owed on your multifamily property.
Although the main goal for our multifamily real estate syndications is to achieve strong cash flow through the term of owning the deal, building equity is a vital component of your investment strategy.
Return on Investment is higher for multifamily properties compared to a single-family home. The larger number of units within multifamily homes makes them higher-yielding compared to single-family homes. That’s because multi-home investors stand to gain more from rent payments than they would with a single-family home. Multifamily communities generate more cash flow than single-family homes when managed and leased correctly. This is due to the multiple units within the building. Not only due to the property providing stability through diversification, but they also offer economies of scale that result in more cash flow for investors.
Also, the government offers large tax deductions for multifamily housing. These benefits can offset other forms of income and help reduce your taxable income, making multifamily investments even more profitable.
1.) Forced Appreciation
The NOI, not adjacent property comparable values, determines the value of multifamily properties. When you raise income, you increase the value of the property. We do this by “Forced Appreciation,” buying properties where we may add value and bring current rents up to market rates, adding other sources of income, lowering operating costs, and more.
For Example, Let’s say we buy a 100-unit property for $5,000,000 with a current NOI of $300,000. The NOI would reflect a 6% capitalization rate (CAP) (NOI/Value=CAP).
The previous owner was collecting below-market rents and also had some vacant units. We now add $500,000 in improvements to the property, so units reflect the comparable surrounding apartments achieving market rents. This allows us to increase rent by $75/unit, which adds $90,000 in gross income annually.
This now brings the rental properties NOI to $390,000 ($90,000+$300,000=Total NOI). The property’s new value is $6,500,000 (NOI/0.6%=Value).
Adding $500,000 in improvements instantly added $1,000,000 of equity to the property. Additionally, more free cash flow is now available for distribution to investors!
The forced appreciation arm of building equity in a multifamily property is where the sponsor/syndicator adds tremendous value to the already great opportunity they provide by allowing investors to even invest in the deal. This is where advanced expertise and knowledge come into play for the sponsor as they can fully identify all the hidden opportunities to add value to the building by making those physical or operational improvements.
2.) Market Appreciation
Property appreciation is achieved through purchasing at the proper market cycle, and the building’s value rises based on market and economic influences.
For Example, The property has an NOI of $235,000, and the market (CAP) rate for the deals submarket on purchase was a 9% CAP. Giving the property a value of $2,600,000 on purchase (NOI/Market CAP=Value).
The magic formula ▶️ (NOI/Market CAP=Value)
Additionally, the borrowed capital from the lender for the deal was $1,425,000. Let’s say in one year; the deals sub-market CAP changed/compressed from a 9% CAP to an 8% CAP; this brings the value of the property to $2,900,000 ($235,000/0.08=New value)
We now have a total of $1,475,000 of equity in the property (not including the principal paydown of $20,000 towards the loan, which would also increase equity).
Apartment communities across the United States continue to appreciate at an accelerated rate as capitalization rates (CAP rates) continue to compress, making every dollar of income worth a higher multiple to the next buyer of a multifamily property. Even smaller secondary or tertiary markets are seeing those same CAP rate compressions. Also, bottom interest rates have played a significant role in this compression and high inflation rates.
But in markets with the most robust local economic growth due to employers expanding their local footprint or population migration, we’ve seen massive appreciation, like Austin, Texas, which has seen 30%-%40 growth.
The property’s equity rises when the property’s debt is reduced, thus increasing investors’ equity. This equity is split among investors when the property is sold or refinanced.
For Example, Let’s say the property is worth $5,000,000 on purchase and the lender gives us a $3,750,000 loan that reflects a 75% Loan to Value (LTV). And let’s say the loan terms are a 10-year term and 30-year amortization at a 4% interest rate. Each month a portion of your mortgage payment will go toward interest and another portion toward your principal.
In three years, we’ll have made a principal paydown of $206,000 towards the $3,750,000 loan, adding a total of $206,000 of equity to the deal. In year three, when we go to refinance the deal, let’s say the property is now valued at $7,100,000.
We now have a total of $3,556,000 worth of equity in the property ($7,100,000 Value -$3,750,000 Loan=$3,350,000 + $206,000 Principle Paydown= $3,556,000 of Total Equity).
The principal paydown of debt is the most common understanding to beginner investors on how to build up equity. The beauty of multifamily is that you have several, hundreds, or even thousands of tenants paying down your mortgage each month. Just by being on the ownership side, you’ll allow yourself to win and build long-term wealth. That’s long as you have the fortitude to be there for the long term and ride out any interim market fluctuations.
Related Read: The Exit Strategies for Multifamily Investors
New real estate investors & multifamily properties
Multifamily real estate investing is perhaps the best way for new investors to grow their wealth. With multiple tenants, real estate investors can limit vacancy risks. Multifamily properties generally have better financing options than single-family homes because they are lower risks that come with the scale of units. The economies of scale from having hundreds of tenants on one site help reduce your operating costs on the management side and the cost to fix various ongoing items.
It will become a better tool for scaling out and expanding your real estate portfolio for that real estate investor with big ambitions.
Frequently Asked Questions About Multifamily Investment Strategy
There are several ways to invest in a multifamily apartment community, but most ways require a ton of knowledge, expertise, time, and resources. The most effective way of capitalizing on the power of the multifamily asset class would be through a real estate syndication. This is where you can invest as much as $50,000 as a passive investor/limited partner (LP) to share in all the cash flow, returns, and tax advantages of direct ownership.
The best time to invest in multifamily was yesterday! Multifamily is an asset class with many underlying solid fundamentals that will continue to drive value for decades to come. People need a place to live, and that trend isn’t going anywhere soon. Currently, there is a housing shortage across the United States, while inflation also drives up rents which, as a result, increases property revenues and values.
The three key attributes that make a multifamily property such a significant investment vehicle are its ability to provide considerable tax advantages, produce robust and steady cash flow, and preserve invested capital through a solid risk-adjusted asset class.
The 2% rule in real estate is a calculation used amongst real estate investors to quickly analyze and underwrite the return potential of a rental property. The calculation goes like this, if the rent you can collect on the property is 2% of what you paid to acquire the property, you’ll be able to cash flow and earn a solid return on your investment.
Multifamily Investment Strategy - Conclusion
The goal should always be to add value in some way; luckily, every property has its own needs and unique opportunities and ways to add value to it. Also, it’s worth noting that adding value doesn’t necessarily mean financially making improvements; it could also mean professionally managing the property with a strong property management company. Or add more staff to meet the needs of the existing and future tenant base. If you buy right and understand the fundamentals of the market the deals in and what it needs to measure up to comparable apartments, you’re now in the driver’s seat. Once you’re in that driver’s seat, you can realize the build-up of equity through Forced Appreciation, Market Appreciation, and Amortization.
Here at Willowdale Equity, we offer passive real estate investment opportunities to invest alongside us. You can visit our how it works page to learn more about the whole process. You can also join our private investor club to access exclusive investment opportunities, which contain continued learning about multifamily real estate from our exclusive resources.
You can also join our Free 5 Day PASSIVE real estate investing video mini-course to learn everything you need to know about passive real estate investing over the course of 5 days.
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