Increasing the velocity of your wealth: Transfer single-family to multi-family homes
Investing in single-family homes is a great way to get started in investing in real estate. Once you build some equity in those investments, it might not be a bad idea to look at transferring that equity into multi-unit buildings. Doing so will increase the velocity of your real estate investment.
The first reason is efficiency. Multi-family investments are far more efficient than single-family homes in many ways. Compare buying 25 single family homes compared to buying one 25 multiunit. In order to buy 25 single family homes, you need 25 loans, 25 appraisals, 25 title insurance policies, 25 hazard insurance policies, 25 closings, etc. Then, once you own it, management is so much easier for 25 units in one location, instead of 25 single family homes all over town.
The efficiency of a multi-unit building enables cash flow to increase. One of the quick ways to test this concept is to study the Gross Rent Multipliers (GRM) of single-family homes versus those of multi-units. This is a common “rule of thumb” because the information is readily available, and it is easy to compute by simply dividing the purchase price by the annual gross rent. The lower the multiplier number, the greater return on the invested dollar. The GRM is just a quick and dirty method to analyze a building. It does not take into account things such as owner paid utilities, etc., but often will eliminate a building from consideration immediately, because it isn’t even close to market value.
Shopping for a multi-unit property is different than shopping for a single-family home. You might be allowed to see just a few of the units before writing a contract. Sometimes sellers won’t allow you to look at units at all until you have a fully executed contract with the seller. Then, during the appraisal and inspection process, you should be able to access most of the units.
Obtaining all of the expense numbers from a seller can sometimes be difficult. Collecting your own estimates for insurance, management, maintenance, and repairs is a good idea. That way, you can have a more realistic expectation of how the property will perform.
Contracting on a multi-unit building is the same as contracting on a single-family home, up to four units. Once the five-unit threshold is reached, the contract is a commercial contract. That contract contains provisions that better meet the needs of a multi-family transaction.
As a multi-unit owner, you will want to research how you will hold title. In most cases, the business entity, called a Limited Liability Company (LLC) is a good choice. This is where you should partner with your CPA and attorney to make sure you are holding title using a method which is best for your situation.
Financing for a five-plus unit building is also different. The typical one- to four-unit lender generally will not have access to multi-unit financing. It is a good idea to research lenders to determine which ones are in that marketplace. You will also find that there are not 30-year loans available. Usually, the terms are 5,7 or 10 years fixed, then become due or convert to an adjustable-rate loan. Loan to value ratios are not as precise as buying a single-family home. Most multi-unit lenders will use a formula, called the debt coverage ratio, to determine the loan amount. The debt coverage ratio is determined by taking the annual rent, less all the annual expenses. That number needs to be 1.2 (or 120%) of the total debt service for the year.
Insurance for a multi-family building is also a specialty, crossing over into commercial insurance, instead of residential insurance. Select an insurance company which is very familiar with the specific needs of a multi-unit building. Insurance expense has increased dramatically in recent years, making it very important to shop around for the right coverage for your needs.
Closing day is pretty much the same as a single-family closing, except there are a few additional items. Those items usually include assignments of leases, tenant estoppels, the proration of rents, and the transfer of security deposits.
FHA 4-Unit Purchase
Broadly speaking, a multi-unit purchase is not someone’s first real estate investment due to down payment requirements. However, there is a program available through FHA that makes it easier for the first-time multi-unit investor to get started. The Federal Housing Administration (FHA) has a program in which you can buy up to a four-unit apartment building with low down payment financing. The catch is that in order to get the low down payment, it needs to be owner-occupied. In other words, you need to live in one of the units and rent the other three. The FHA program is subject to loan limits, by county, that could prevent it from working in very high-cost areas.
Build Your Team of Professionals
To be successful in multi-unit ownership, you need to have a team of professionals, experienced in the residential multi-unit world, to make the process go smoothly. That team includes a REALTOR®, property manager, lender, insurance agent, attorney and CPA or accountant. Building a relationship with each one of them prior to your first purchase will increase your likelihood of success. —————————
Duane has been a Realtor since 1982. Living the life of a Realtor and being immersed in real estate led to the inception of his book, Realtor for Life. For questions, e-mail Duaneduggan@boulderco.com, call 303.441.5611 or visit boulderco.com.