Real wealth through multi-family real estate
Why Multifamily?
First, let's define what a multifamily is and isn't.
A multifamily property is a type of residential real estate that consists of 5 or more housing units within one building or complex. These properties are designed to accommodate more than one family or household, hence the term "multifamily."
So a duplex or fourplex wouldn't count as multifamily.
An 8-unit , new-build, multifamily building in Edmonton
Here's the reasons we like multifamily:
1. Safety
The reason we have the "5 or more" criterion in our definition is because the banks and CMHC also use this.
Years ago, when I was learning how to evaluate multifamily properties, one of the courses I took was from an ex-CMHC multifamily property underwriter. His job at CMHC was to look at mortgage applications and multifamily properties and see if the property was safe to issue a mortgage on.
One of the things he taught us was that banks consider the house you live in to be the safest real estate type because people don't want to lose their home. The number 2 safest real estate type was multifamily and that house you were thinking of buying and renting out comes in at number 5.
The reason for this is people who buy and manage multifamily properties usually have more expertise than the mom and pop real estate investor that buys a single-family home. They bring in property management and other professionals, screen tenants and do routine maintenance. They typically know what they are doing and that makes the investment more secure.
2. Better financing
Because banks see this as safer, we can get better interest rates and terms than you could if you were to buy a single family home to rent out. Most homeowners have seen recently what a difference a few percentage points can make on a mortgage payment. That's amplified even more when you buy an 8-unit property. This effects cash flow, meaning we don't have to take money out of our pockets every month because our payments are lower.
3. Values are calculated differently
With a single family home an appraiser will use comparables or "comps" to decide what the value is. They look at similar properties and compare yours to those to come up with the value.
With multifamily, they treat it like a business and the value is based on numbers, not comps. I'm going to explain how this works, but if this bores you just click here to skip past it and get to "the point".
To explain how this works you need to know two numbers:
1. Net Operating Income or NOI - NOI is calculated by subtracting operating expenses from gross rental income. It represents the income generated from a property after deducting all operating expenses but before accounting for financing costs and income taxes.
2. Capitalization Rate or Cap Rate - is a key metric used to evaluate commercial real estate investments. It is calculated by dividing the property's NOI by its current market value. As NOI increases, the cap rate improves, making the property more attractive to investors. Since cap rates are inversely related to property values, a higher NOI leads to a higher property value and vice versa. We typically know what the cap rate is for an area and building type.
Using an example:
If we have a property that has an NOI of $54,000 and the CAP rate for this type of building and area is 4.5% we can calculate the property value:
Stay with me for a minute... I want to show you what happens when rents go up $100/month.
If we raise rents by $100/month and we have 8 units and we have 12 months of the year, we get a $100 x 8 x 12 or $9,600 increase to our NOI. Let's plug that number back into our formula.
We increased the property value by over $200,000 just by having rents go up $100/month!!!
We could also lower expenses to improve the property value.
The Point - We can significantly improve a multifamily property value by increasing revenues or decreasing expenses. With single family homes (up to fourplexes), you can't do that. You are stuck comparing your house to your neighbours'. When rents are going up in a market, like they are now, multifamily properties appreciate significantly.
4. Cost per unit is less
If I buy an 8-unit multifamily for $1,600,000 that's the same a buying each unit for $200,000. That's typically cheaper than buying 8 separate similar condos. That translates into lower mortgages and better cash flow.
5. Incentives
Right now we're in a housing crisis that the government doesn't know how to solve. What they have done is offer incentives to people like us to build more housing, but there's a catch...
Most of these incentives are for multifamily properties purposely built to be rentals. That's what we do !!!
Here's one huge unfair advantage that multifamily has over single family. It's called the MLI Select Program offered by CMHC.
In a nutshell, MLI select lets us buy a property with only 5% down (remember the leverage benefit in the Why Real Estate lesson?). Now this would normally mean high mortgage payments and negative cash flow, but no.
To keep payments low, they offer up to a 50-year amortization period. That means if a person borrows $400,000 to buy a single family home they will be paying $2,338 in mortgage costs with a 25-year mortgage and 5% interest in a non MLI Select mortgage. With an MLI Select 50-year mortgage at 5% the payment is only $1,817. What do you think that does to your cash flow?
There's a bunch more, like no GST, but bottom line is the government is making it so easy to make money right now. They want to see real estate investors succeed and they are doing everything possible to see that we do. It doesn't get better than this for risk or reward.
4. Vacancy impact is less
If you buy a condo and rent it out and it sits vacant for 3 months, you have to keep paying the mortgage. Negative cash flow.
If, on the other hand, you went in with a bunch of other investors and bought a multifamily, if one unit is vacant the other units may still be bringing in cash and maybe even enough so that no-one needs to take money out of their pocket to pay the mortgage. There's safety in numbers.
5. Economies of scale
The easiest way to explain this is with the common example of property management.
If a single family home owner brings in a property manager to look after their rental, the advertised price will likely be around 10% of the rents. With multifamily it's around 5%.
So if rents are $1500/month a single family owner pays an extra $75/month for property management fees. What does that do to your cash flow.
It used to be that investing in multifamily had all these little benefits that added up to a large benefit over single-family. Today we have a lot of really big benefits that stack with the other benefits (and even a few small ones I haven't listed) that make a HUGE difference.
I know my numbers. What I have seen in the last year or so is that I can make as much, if not more money, doing passive investment (I put up money only and someone else looks after the property) in multifamily than if I did it all myself with a single-family.
I hope this has been educational for you. If there's something you don't understand or question, please reach out and I'll do my best to clear it up.