Taking the Reins: The Power of Control in Multifamily Investing
Control is a bad thing if it leads micromanaged employees to quit or suffocated children to resent their parents. But when it comes to real estate, control is invaluable.
Many investors are attracted to real estate as an asset class because of its stability and proven resilience. My brothers and I have enjoyed contributing to the light-hearted debate between single family and multifamily investors, each respective side a die-hard believer in their own superiority. And while this blog is by no means an essay declaring multifamily as the best asset class of all time (even though there is an argument to be made for it), I am arguing that there’s a particular advantage of multifamily that single family investors simply can’t dispute.
But first, let’s be clear. A single family property equals a house. A multifamily property equals two units or more. Our 170 unit apartment complex in Atlanta is a multifamily property, but this property is as much of a “multifamily” property as the duplex on the corner with the peeling blue paint and overgrown grass.
Now that we’ve established this context, here’s the kicker. Multifamily real estate provides an investor with more control over the investment, because investors are able to improve the property condition and force appreciation, leading to higher property values and appealing to higher quality residents. Single family investors cannot relate.
Let me explain why.
HGTV is Lying To You
Despite what you might see on TV, property values are not always rising, and investing isn’t as easy as it looks. The real estate market can grow stagnant, or even dip. This makes banking on natural depreciation a flawed investment strategy in the long run. But multifamily allows investors to force appreciation.
You see, single family houses are valued using the “sales comparison” approach. This approach involves comparing the subject property to nearby properties that have recently sold and have similar characteristics.
Meanwhile, multifamily properties are valued based on the Net Operating Income (NOI) the property generates. The NOI is the difference between a property’s gross income and it’s operating expenses.
As a single family investor, you have zero control over what nearby properties are selling for, unless you have a monopoly in the market and those were your properties.
Multifamily investors can influence how much revenue a property generates, and they can find creative ways to decrease the operational costs at a property. Both of these changes would increase the NOI, which would increase the property’s value.
Value-add investing is the investment strategy my brothers and I use, and it’s the process multifamily investors use to increase NOI.
When my brothers and I did our first fix and flip, we were banking on the nearby “comps” in the area in order to justify the price we needed to sell our property for in order to make a good profit.
Now, with our multifamily properties, we’re “adding value” to our apartment complexes. We’re able to justify higher rents by improving the community and revitalizing older properties. But we aren’t reliant on what nearby multifamily properties are selling for. Instead, we can make our property more valuable by reducing expenses or increasing revenue.
Some of the ways value-add investors like us increase NOI at a property include:
Increasing rents to market rates
Reducing expenses through preventative maintenance
Improving the curb appeal at a property to attract residents willing to pay market rate
Adding amenities, like a pool, playground, grill area
Improving the interiors of the units, like adding stainless steel appliances, painting, changing the floors, updating light fixtures, etc.
Charging pet fees
Even if the real estate market takes a dip, a multifamily investor can still force appreciation at a property by taking measures like the ones above to increase NOI and increase the property’s value.
This ability to influence NOI and thus influence property value gives multifamily investors more control. They aren’t completely at the mercy of the volatile economy, public opinion, or sensational media.
However, there are some caveats and limitations to the control multifamily investors have.
Things You Cannot Control
Right now, many multifamily investors are becoming aware of the factors they have no control over. These include insurance, eviction policies, interest rates, and the cost of labor and materials.
Weathering The Insurance Storm
According to Yardi Matrix, Florida interest rates are expected to rise by 45%-50%. Similar increases are expected across the country. What’s causing these premium increases? The answer is probably what you’d expect - weather. Markets that are more vulnerable to natural disasters, storms, flooding, and more should expect higher insurance costs. While multifamily investors can’t control their insurance premium, they can control where they choose to invest.
Some markets are also facing eviction backlogs, causing hearing dates to be delayed for months longer than expected. As a result, investors are unable to remove non-performing residents, update the units, and move in paying residents. This will certainly cause delays in business plans and renovation timelines.
Investors can mitigate this factor by pre-screening residents before they move in, offering debt-forgiveness for residents who hand over the keys in order to not have their missed payments hurt their credit.
Interest rates have gone up at unprecedented rates in recent months. For investors who have floating rates on their debt with no rate cap, this is a big concern.
Buying properties using floating rate debt should consider paying for a rate cap, or should simply use fixed rate debt.
Cost of Labor and Construction
The rising cost of labor and materials needed to complete a renovation project at a multifamily property has seen an increase. Inflation and supply chain issues have exacerbated this issue.
Investors should make sure they have an excess amount of cash reserves on hand in order to account for unexpectedly higher costs.
Investing in multifamily real estate isn’t easy or inexpensive. But it is a viable option for those investors that want to invest in a tangible asset that doesn’t fluctuate to the rhythm of the masses.
Multifamily real estate is an investment where investors have control through value-add strategies to increase the property value and attract residents. Although this doesn’t mean every factor is under your control, there are “levers” an investor can pull and strategies that can be employed to mitigate the impact of things like insurance, interest rates, and rising costs.
Because when we invest our money into an asset, we want to know what it’s worth, and that we have some say in that, rather than hoping it’ll go up with enough time and good luck.
In multifamily real estate, luck is appreciated, but control is key.