Multi Family Commercial Real Estate
Commercial real estate is an increasingly popular asset class among those looking to diversify their portfolios away from stocks, bonds and other equities. Some real estate investors will dip their toes into the water by purchasing a small single family rental property, duplex, or triplex home that they then self-manage. Others, particularly those who want to be truly hands-off with their investments, will instead invest alongside a qualified sponsor who will manage the investment on behalf of the limited partners.
In either case, it is common for investors to begin by investing in multi-family commercial real estate. Multifamily properties are relatable -- most people have lived in an apartment or owned their own home at some point in time. Therefore, multifamily tends to appeal to the masses compared to other property types.
Today, we provide an overview of the multifamily commercial real estate sector, including the pros and cons of investing in this specific asset type.
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What is multi-family commercial real estate?
Multi-family commercial real estate includes any income-generating property used for residential purposes. By definition, multifamily real estate has at least two units. This makes it distinct from single family rental homes, which are also popular among real estate investors.
At the smallest scale, multifamily property can include duplexes, triplexes and quad-plexes (4-units). At the other end of the spectrum, multifamily apartment communities can have 500+ units. Some multifamily commercial real estate has more than 1,000 apartments per property (usually in more than one building).
Regardless of size, multifamily commercial real estate generally operates the same. Individual units are leased to tenants, usually on a one-year basis. In some cases, landlords might be willing to sign a short-term lease (even a month-to-month lease) with tenants, but most tend to be longer in duration.
For this reason, multifamily commercial real estate is sometimes considered more labor-intensive than leasing an office or retail property, which may sign a long-term lease with just a single tenant. However, there are pros and cons to this as well, which we will discuss in more detail below.
Is multi-family classed as commercial property?
A common misconception is that "commercial property" refers to office, retail or other business-oriented properties. However, any income-generating property of a certain size is considered "commercial" real estate. In the multifamily realm, this scale occurs when properties have five or more residential units. This is what triggers the move from "residential" property to "commercial" property.
The distinction between residential property and commercial property is important for anyone who is considering financing the acquisition or renovation of multifamily real estate. Residential properties, especially those that are owner-occupied, tend to attract the most favorable bank financing. Commercial properties, or multifamily units with 5+ units, must use a different type of financing which generally comes at a slightly higher interest rate than a purely residential loan.
Advantages of multi-family commercial real estate investment
There are several advantages to investing in multifamily commercial real estate. These include:
- Range of multifamily product types. Multifamily commercial real estate investments can run the gamut, from small apartment buildings to massive lifestyle centers. Property size aside, there are also many different types of multifamily housing. For example, multifamily commercial real estate includes student housing, senior housing and assisted living. Each of these has its own unique characteristics that, depending on the market, may outperform more generic multifamily housing.
- Low barriers to entry. Because multifamily commercial real estate comes in so many shapes and sizes, the barriers to entry are rather low. Someone can begin by investing in a personally-owned, small apartment building OR they can invest nominal dollars (as little as $5,000 or $10,000 in some cases) in a syndicate that is managed by a professional real estate sponsor. It is much more challenging for someone to purchase an office, retail, hotel, industrial or other property type--which tend to have unique characteristics, complex leasing considerations and higher costs.
- Ability to achieve geographic diversity. Multifamily housing is needed in virtually every market across the United States. The demand for multifamily housing has been, and continues to be, strong compared to other real estate product types. This means that investors can opt to invest in any geography. They might make an investment in a Class A apartment building in San Francisco and then make a similar, “riskier” investment in a value-add apartment complex located in the Rust Belt region of the U.S. The availability of multifamily housing investments across the country allows investors to obtain further portfolio diversity.
- Active or passive real estate investment. Investing in multifamily commercial property can be done on either an active or passive basis. Someone who wants to be very hands-on may choose to invest in their own small apartment building. Over time, that investor may decide to be involved at a high-level, but may decide to outsource routine property management tasks to a local company. Doing so allows an investor to still be involved in the property’s big-picture decision-making without having to worry about middle of the night phone calls or routine repair and maintenance requests.
Meanwhile, someone else might decide to be a fully hands-off real estate investor. Multifamily has many opportunities for those looking to passively invest, as well. It is common for people to invest in multifamily commercial real estate through a syndication, fund, or real estate investment trust (REIT) -- all of which are investment vehicles managed by an adept sponsor who oversees the deal(s) on investors’ behalf.
- Multiple income streams. Multifamily commercial real estate also appeals to investors because it provides multiple income streams. Each unit is leased separately to a person or group of people who are responsible for paying rent each month. A thoughtful investment strategy will ensure that, even if the event of 5-10% vacancy or other disruption in cash flow, there is sufficient rent coming in from the other units to cover the mortgage, taxes and other annual expenses. In other words, a landlord is not reliant on a single tenant paying their rent each month.
Compare this to office, retail, hospitality and industrial properties. These commercial real estate buildings are often leased to a single (or very few) tenants on long-term leases. For example, a tech-based startup company might sign a 5-year lease for an office building. Then, two years into the lease, the company might not be able to raise the money it needs to continue to grow and scale. As a result, the company experiences dramatic layoffs and eventually goes out of business. They still have three years remaining on their lease, and now, the landlord has no rent coming in to the property at all. In a best case scenario, the tenant will vacate the property with no trouble and the landlord will release it quickly. However, there are far fewer commercial tenants looking for space than residential tenants, which can make filling office properties more difficult than filling residential units.
- Ability to add value. Another reason people like investing in multifamily commercial real estate is that there are myriad ways to add value. This can be done gradually or all at once. For example, a landlord may decide to renovate each unit as it turns over. The improvements may be simple: paint, carpet, new light fixtures and perhaps a new appliance or two. At a larger scale, an owner might decide to let all leases expire and then fully gut-renovate the apartment building. Investors who want to pursue either a light- or heavy value-add strategy will find multifamily investing to be a great opportunity to execute said business plans.
Drawbacks of multi-family commercial real estate investment
Of course, while there are many benefits associated with investing in multifamily commercial real estate, there are a few noteworthy drawbacks to point out.
- Management intensive. Multifamily commercial real estate is arguably more management intensive than any other form of commercial property. Each unit is leased to a different person or group of people, each of whom has their own priorities and needs. The owner (or property manager, acting on the owner’s behalf) can expect to routinely get calls from tenants who inadvertently locked themselves out of the building, whose toilets are overflowing, or who have other repairs that need to be tended to.
Moreover, landlords also have to carefully screen all prospective tenants. There are strict Fair Housing laws that must be followed, otherwise, the landlord subjects themselves to steep fines and penalties. Once a unit is leased, the landlord then has to follow-up with tenants to collect payments each month -- a process that can be automated to some degree, but which requires careful attention on behalf of the landlords.
- Frequency of lease renewals. As noted earlier, most multifamily real estate is leased to tenants on a one-year basis. Ideally, leases would be staggered to roll throughout the year. However, in some markets, leases tend to turn over at the same time every year (e.g., April 1st or September 1st), which puts a large burden on ownership as they look to have tenants re-sign leases, fill vacant units, and make units “rent ready” for the next cohort of people moving into the building. This is much different than leasing a traditional office or retail building, for example, which tend to be leased to fewer tenants and on a longer-term basis.
- Significant competition. Given the relative simplicity of multifamily real estate, and correspondingly, its broad appeal to investors, investors face significant competition when looking to acquire multifamily property. There are often many groups bidding for the same deal, which in turn, pushes prices up. Many investors will instead look for off-market deals to reduce the amount of competition they face (see below).
How do you find multi-family commercial properties?
There are many ways to find multifamily commercial real estate. Most investors will begin by scouring online listing databases, like CoStar and LoopNet. However, given the competition for multifamily real estate (see above), most properties do not last for long after being publicly listed. These are often scooped up by investors in a month or less (of course, depending on pricing and local market conditions).
Alternatively, an investor can work with a commercial real estate broker to find multifamily deals. An adept broker will have their pulse on the market and will know which owners may be willing to sell, for how much, to whom, and when.
Brokers are also a great source of information about what’s happening in the local market. For example, someone who wants to invest passively may approach a broker to learn more about projects that have been permitted but are not yet under construction. The broker can introduce the investor to the sponsor who’s leading that investment opportunity, and from there, the investor can determine whether or not to invest in that project or with that sponsor.
As regulations around solicitation for real estate investments have relaxed, there is more information available online than ever before. Anyone who is looking to passively invest in multifamily commercial property can also use Google, LinkedIn and other social media platforms to network with others who can introduce them to syndications, funds, and other passive multifamily investment opportunities.
Multfamily commercial real estate investment is an increasingly popular way for investors to diversify their portfolios. There are deals out there for every kind of investor, regardless of how much they have to invest, their investment time horizon, and their risk appetite.
Are you considering an investment in multifamily real estate? If so, contact us today to learn more about our multifamily investment strategy.
Casey leads the investor relations team at Rising Realty Partners and is responsible for growing the community of accredited investors, fostering investor engagement, and raising capital.