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Buying Your First Multifamily Property? Here's What to Expect

Published: 07-31-23 Category: Buying

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A multifamily property with several hundred units.

Thanks to explosive, nationwide growth in recent years, multifamily properties have recently risen in popularity for commercial real estate investors. People always need housing, and multifamily properties tend to stay in demand and resistant to recession.

If you've never bought commercial property, though, you should take the time to educate yourself on multifamily investing and perhaps work with a commercial real estate broker. But, that said, we've put together this quick guide on what you should expect when buying your first multifamily property.

Let's get started.

What Is a Multifamily Home?

Buying Your First Multifamily Property? Here's What to Expect

A multifamily home is a building or complex that contains several residential "units," each with its own kitchen, bathroom, living spaces, bedrooms, and amenities.

Multifamily housing is more common in denser, urban areas, though multifamily growth in smaller cities and suburbs has risen sharply in recent years.

What Are the Differences Between Single-Family and Multifamily Homes?

The main difference between single-family and multi-family homes is the number of units present in the same lot or building. Single-family homes have a single residential unit, while multifamily homes generally have two or more residential units.

An example of a multifamily property is your typical apartment complex. The complex contains several residential units that the owner leases to tenants. In addition to the individual units, many multifamily buildings have shared common spaces, like hallways, stairwells, yards, and parking lots/garages.

Other types of multifamily properties include:

Duplexes;
Triplexes;
Townhouses;
Garden apartments;
Student housing; and
Condominiums.

Depending on the type of multifamily building, some individuals might buy out or rent-to-own their specific unit, while the owner rents out the others to tenants who are simply interested in renting temporarily.

Loans for Single-Family and Multifamily Financing

One major difference between single-family and multifamily housing is the type of property loans you'll need. Loans for multifamily property will be commercial loans, so they'll typically require higher down payments, have higher interest rates, and feature shorter repayment schedules.

Commercial loan amortization periods are usually five or ten years, unlike the typical 30-year mortgage for a residential single-family home. Also, many residential loans have fixed interest rates, while most commercial loans have variable interest rates.

What's a Reasonable Price for a Multifamily Home?

The average price per unit for multifamily real estate in the US was $212,181 in 2022. However, multifamily prices can vary significantly depending on the market and general tenant demand.

A better way to judge whether a price for a property is reasonable is to look at the cap rate. The cap (capitalization) rate is equal to the net operating income (NOI) over the current value of the property. A cap rate between 4% and 7% is ideal for multifamily properties.

Calculating cap rates can be tricky because you don't necessarily know the value of the property. You can estimate the value of the property by looking at nearby buildings and accounting for appreciation and value from property improvements.

What Are the 50%, 70%, and 1% Rules for Multifamily Properties?

The 50%, 70%, and 1% rules are different ways of thinking about multifamily investing profitability. You can use these three rules to calculate expected returns and profit margins when buying commercial property.

#1 – The 50% Rule

The 50% rule is a quick calculation investors use to estimate the profitability of a multifamily property. Simply take the monthly expected rental income of the property and divide it by half. This 50% is for repairs and other operating expenses, so don't count it when comparing investment profitability to loan repayments.

It's very easy to drastically underestimate monthly operating expenses when buying your first multifamily property, so the 50% figure gives you a more accurate picture of expected monthly cash flow. You can also filter potential properties with the 50% rule to see if investing is worth your time.

#2 – The 70% Rule

The 70% rule is a method to estimate how much you should pay for a distressed property. According to the 70% rule, you shouldn't pay more than 70% of the total after-repair value (ARV) of a property minus the estimated repair costs.

Here's how this works in practice: Say a duplex has an ARV of $500,000 and needs $50,000 in repairs. The 70% rule says you shouldn't pay more than $300,000 for the property:

$500,000 (ARV) x 0.70 (ARV %) = $350,000;
$350,000 ? $50,000 (Repair Costs) = $300,000.

The 70% rule is more like a guideline, not a hard-and-fast principle of multifamily investing. Investors should be conservative with their property improvement estimates and consider all possible repair and maintenance costs.

#3 – The 1% Rule

The 1% rule is a tool for comparing the gross income of a given property to its price. The 1% rule says you shouldn't buy a property unless the expected monthly rental income is at least 1% of the price. If the property doesn't currently have any tenants, use the 1% rule backward to set a lower bound on rents.

For example, the 1% rule says a $300,000 property needs to generate at least $3,000 a month to be worth it. Like the other rules, the 1% rule is just a guideline and not a law of multifamily investing. If the 1% rule makes margins too tight, you can use the 2% rule instead.

What Is a Good Return on a Multifamily Investment?

Traditional wisdom holds that the ideal return on a multifamily property is between 14% and 18%. However, actual average returns on multifamily units often fall short of this ideal percentage. According to recent studies, multifamily investing across the country averaged a 9.75% annual return.

This number is lower than the often-quoted traditional wisdom, but it's worth noting that similar reports found that multifamily investment generates the highest returns compared to other forms of commercial real estate.

Note that several things can affect potential returns, such as: