Multifamily: A Shrewd Investment

Four steps to finding properties that pay.

September 1, 2003

Multifamily properties have historically provided the highest rate of return and less variance in rate of return than the average of all property types, according to the National Council of Real Estate Investment Fiduciaries, a group of real estate and financial service professionals whose primary interest is pension fund real estate investments.

How can you get in on that high rate of return? Follow these four steps.

1. Find a market.

Buy properties in areas that show signs the neighborhood’s growing in popularity. Urban areas close to public transportation, shopping, and entertainment have high potential for price appreciation, and neighborhoods with successful condo conversions are prime candidates for future apartment rental shortages.

2. Select a property.

Network with salespeople who work in the areas where you’re interested in buying. Then, look for a property that’s small and easy to handle. That is, the greater the number of units in the building, the more time you’ll spend on showings, rent collection, and accounting tasks. Also consider whether to hire maintenance staff or a property manager, which will affect your time and expenditures.

Once you find a property, run the numbers to make sure you’ll have enough cash flow to cover expenses such as the mortgage payment, maintenance, and capital improvements. Expense improvements over the projected useful life of the building. For income and expense numbers, review property income tax returns covering building operations for the last three years. Ask sellers to furnish the returns, and walk away if they refuse.

The Institute of Real Estate Management (www.irem.org) sells median multifamily building income and expense data compilations. (At the site, click IREM store.) The reports break out income for apartment rent, stores and offices, and garages and parking, as well as expenses, such as maintenance repairs, taxes, and insurance.

Remember to determine how much of your investment money the property will eat up. Don’t use all your available money in case another deal comes along.

Finally, be sure to hire a well-qualified apartment building inspector to evaluate the property’s physical condition.

3. Secure financing.

Consider how long you’ll hold the property. For instance, if you plan to hold the property for 10 years, a three-year balloon mortgage can be risky. Also, if you plan to hold the property for a short time, avoid a prepayment penalty clause.

Once you obtain a quote from a lender, seek another quote from a bank near the property. Regulators encourage banks to make loans in communities they serve. And if lenders know you’re seeking other quotes, you’ll likely receive the best available terms.

4. Decide whether to hold or sell.

Take advantage of neighborhood appreciation by holding the property as a source of income while increasing rents each year in keeping with inflation. In a hot neighborhood, if your building has desirable upgrades, you may be able to base rent increases on the property’s perceived market value. To capture some appreciated value—perhaps to invest in another property—refinance the building based on a new appraisal at the enhanced valuation.

Alternately, if the condo market is thriving in the area, capture the condominium resale value of the property by converting it to condos or by selling it to another investor or condo conversion company. Such companies exist in markets where the economics of conversions make sense.

A well-researched investment makes a shrewd addition to your portfolio. After all, why not put your real estate expertise to work for yourself as well as your clients?

Michael Zaransky is the founder and managing principal of real estate private equity firm MZ Capital Partners, an INC 500 Company, and co-CEO of Prime Property Investors Ltd. He also grew up in a two-flat. He can be reached at mhz@primepropertyinvestors.com.

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