Whether you’re in the market for a new home for your family or looking to invest in real estate, buying a multi-family property could be the answer to your housing and financial needs. We’ll discuss some of the benefits of multi-family and how you can get started building a winning portfolio.
What Is A Multi-Family Property?
A multi-family home is a building that houses separate units where more than one family can reside. A multi-family home will have a designated kitchen and bathroom for each unit. Each unit will likely have a separate entrance, separate utility shut-off valves and utility meters.
Some examples of multi-family home types could be a duplex, townhome, condo or small apartment. The biggest distinguishing factor in multifamily properties is each has their own legal address. If you rented your finished basement to a friend and your family resides upstairs but you share a kitchen and front door, this would not be considered a multifamily property.
It is important to know the distinction between a multifamily home and commercial property. Properties with five or more units are considered commercial real estate. Commercial loans are different and have their own qualifying criteria and approval process that isn’t as user friendly as applying for a residential loan. Multi-family properties are often referred to as investment or rental property and can be purchased with a residential loan.
Residential Loans: For Properties with Four Units Or Less
Fannie Mae, Freddie Mac, and the FHA all define single-family homes as properties with four units or less. This is the type of loan we’re discussing in this article.
At Least 51% Of The Building Is Residential In Nature
Single-family home loans may also be available for buildings with commercial space as well as residential space, as long as the building is at least 51% residential in nature.
Why Buy A Multi-Family Property?
Multi-family units are in high demand among real estate investors. It takes a lot of time and effort to build a winning portfolio. Investors like that a single transaction could add up to four additional units to their portfolio with minimal effort.
Multi-family homes are great for beginner investors because they can acquire a property with up to four separate units and start building home equity fast. A popular investment strategy many new investors take advantage of is living in one of their units while collecting rent on the others. The investor enjoys both the benefits of homeownership and real estate investing.
Cash Flow
In a multi-family property each unit is paying into the owner’s mortgage, as opposed to a single-family home where the owner is solely responsible for the monthly payment.
For example, Anna and Chris are a young couple looking for a new home. They fell in love with a single-family home and a duplex. Both homes are $250,000 and in great locations.
If they choose the duplex, their monthly mortgage expense after their tenant has paid rent would be just $600 a month.
If they choose the single-family home, their monthly mortgage payment would be $2,000. They could save $1,400 per month if they choose the duplex.
Rental Income Counts Toward Mortgage Requirements
For those who are self-employed or experience seasonal or sporadic income, rental income that you will potentially earn from the property can be considered income when you’re applying for the mortgage to purchase the home. This additional, steady income could help you qualify for a conforming loan with a better interest rate.
Gain Property Management Experience
Owning a multifamily home is a great hands-on experience for budding investors or property managers. Managing a few units at a time will give you practical hands-on experience that will come in handy when you’re ready to grow your portfolio.
You will need to provide a lease to your tenants that complies with local and state guidelines, and you’ll need to collect rents and process requests to maintain the property. Through this experience you will learn your strengths and weaknesses when it comes to real estate investing and property management.
Build Wealth
Investment properties build equity pretty quickly. The down payment for a multi-family property can be substantial and the additional rental income being paid monthly helps grow the home’s equity fast. You can then access that home equity with a cash-out refinance to help renovate the property, make necessary repairs or even purchase more investment properties.
The flexibility and additional income that multi-unit properties provide are great for those new to real estate investing.
Tax Benefits
There are tremendous tax benefits to real estate investment. Expenses like property tax, insurance, mortgage interest, repairs and improvements, advertising your property for lease and your property management costs can be deducted.
In addition to those standard deductions, your property might qualify for additional tax benefits of depreciating rental properties. This is done by convincing the IRS that the property in question has a determinable useful life. This deduction is meant to offset the cost of maintenance on a property over time. So if you plan to hold your investments long term, it may be worth exploring property depreciation with your financial advisor.
If you plan to be an active investor with multiple properties in your portfolio, you should talk to your tax advisor about the ins and outs of 1031 exchanges. A 1031 exchange allows you to sell one investment or business and buy another without incurring capital gains taxes as long as the exchange is completed according to IRS rules and the new property is of the same nature and character as the one being sold.
A 1031 exchange is a deferment, not a credit or reduction. Taxes may not have to be paid at the time of sale, but they will need to be paid eventually.
You can see there are very specific guidelines for a 1031 exchange, so you’ll want to speak with a professional financial or tax advisor to cover all your bases when planning your purchase.
Hedge Against Other Investments
Real estate values are a bit steadier than investments like stocks. Inflation causes the value of stocks to drop but the value of a multi-family property will likely hold steady and in many cases increase in value. The rental property business can’t be outsourced and there is always a need for housing.
For Owner-Occupiers, Reduced Or Free Rent
Multi-family property owners can occupy their investment property and offset their living costs with the rent they charge tenants. This is called house hacking. Remember our friends Anna and Chris from our earlier example? By choosing a duplex and renting the other unit, they’re able to cover a significant portion of the mortgage while building equity in their home with someone else’s money.
