Top 3 Questions to Ask to Find the Best Deals in Multifamily Real Estate

Is multifamily real estate a good investment?

If you're just getting started learning about investing in real estate, this is a very good question to ask. In this blog post, we'll be answering that very question. With no further ado, here are the four reasons why multifamily real estate is a superior investment to the alternatives out there.

Why Multifamily Is a Superior Investment

1. Cash Flow

Cash flow is the lifeblood of any real estate investment. We can be equity rich all day long but if we don't have cash flow, the deal dies.

This is one of the strengths of multi-family compared to let's say a single-family home or a duplex. Let’s say you have a single-family home. You're renting it out. Then, the tenant moves out. Your revenue goes from 100 percent to zero overnight.

This is a huge problem. Imagine running a business where your revenue suddenly drops to zero overnight. We've had this when the coronavirus obliterated entire sectors due to the shutdowns.

Imagine having a duplex. Fifty percent of your revenue is lost when a tenant moves out. Maybe you have a fourplex. A quarter of your revenue is gone when you have a turnover in the unit.

With multi-family real estate, the larger you go, the more stable it becomes and the more cash flow you end up having. The reason is you have 100 or 200 units and that turnover is able to be absorbed because of the scale of the property.

Another reason why we have more cash flow is because the expense ratio per unit is significantly less than a smaller property. You have the expenses spread over let's say 75 units or 150 units.

Then you have full-time management that's able to be supported by the cash flow produced by this property. You have a full-time maintenance staff. So your property management costs are less. If you have a single-family home, duplex, or a smaller plex property portfolio, you are paying much higher fees when it comes to property management. Plus you don't have full-time staff on-site. That property manager may be visiting once every two months.

With the large multi-family property, not only do you have the cash flow but you have full-time staff on-site all the time. So chances are the property is better managed, well-run, and more efficient because you have staff on-site all the time looking after it as opposed to a property manager managing a couple plexes that you own and then they're also looking after a hundred other properties. It just doesn't compare.

So when you're looking to invest, you want that extremely strong cash flow coming in. You can't just be all equity. Again, you can be equity-rich but the deal will just die under the weight of itself if you don't have the cash flow to support the debt and the investor payments. No doubt your investors want to receive their monthly or quarterly returns depending on how the deal is set up.

2. Appreciation

I don't mean hoping the market goes up. There is a big difference between forced appreciation and market appreciation. We are all professional real estate investors or we aspire to be professional real estate investors. The main thing professional real estate investors do is they control everything they are able to in a deal.

We can't control the market — the greater market itself. We know that. That is hoping — that is speculating on future growth. We don't do that. That is not a prudent, conservative way of investing. What we can control — because of the large scale of multi-family real estate — is the valuation of the property. If we own a house on a street or a smaller residential property and it's three bedrooms, two baths, and four other houses on that street or in the area sell for $500K, well guess what? Our house is worth $500,000 because it's valued differently.

With commercial real estate, it's the property's value based on the net operating income (NOI), the cash flow the property produces. This is why we can control the appreciation and the valuation of the property. We can acquire an asset with what we call a value-add opportunity. So we can acquire this asset, we can do some renovations, improve management, reduce expenses, we can raise rents to market value if they were below market value.

Everything is geared towards increasing the net operating income. What does that do? Well, we have controlled everything we've done on that property to increase the NOI which in turn increases the property's valuation. We are forcing appreciation. We are controlling the valuation of the asset, and this is what I mean by appreciation — forced appreciation rather than market appreciation, which we can't control.

Obviously, we can do our due diligence on the markets. We can look for the key market drivers that impact market growth, ensure everybody loves market growth, but we can't control it. Something could happen overnight. But what we can control and what professional investors look for is the forced appreciation aspect. And multi-family — because it's valued using the income approach — has a huge advantage when it comes to investing in this asset.

3. Stability

I don't care what type of investment it is — whether it's real estate or something else. Rule number one is preserve your capital. Because if your initial investment disappears, then it’s game over — you're done playing. You cannot recover. But if you can preserve your capital if something goes wrong, then you can live to fight another day and recoup some of those losses.

Large multi-family properties are incredibly stable. CBRE took a look at how multi-family performed against other commercial assets over the past two recessions. They found that multifamily was incredibly resilient. So if I’m an investor and am looking to place capital in an asset, I not only get cash flow and appreciation, the control factor, but most importantly, I’m also placing my money in an incredibly stable asset.

Stability is worth the price of admission alone. Multifamily is an incredibly stable asset, unlike some other alternative investments where the values swing wildly. But with multi-family real estate, I can rest easy. It is incredibly stable, so I know my money is secure.

Yes, once again, I also get the benefits of the strong cash flow and the appreciation — the forced appreciation — the stuff we can control. And then the market appreciation, if it comes (as long as we choose the right market), is just the extra wind on our sails to push the deal ahead.

4. Tax Benefits

This is arguably the most important advantage of all. The government, in the tax code, gives real estate investors a leg up. It's called depreciation. We are able to depreciate our asset. We are able to take a paper loss on day one that significantly reduces our tax liability for all the money that we're going to make in the deal. So we have cash flow, appreciation, and stability. Plus our money is being put to hard work in these deals.

Thus, we are making a significant return, but we are able to use the tax code to our advantage and pay a whole lot less tax. Yes, everybody should pay the tax they owe. But we also have to take advantage of the tax code and use it for its intended purpose. The government wants us to invest in real estate. They want us to improve properties. This is why we get rewarded as investors in the form of tax credits through depreciation and cost segregation.

You just don't get that with mutual funds or any of the other three alternative investments below. Plus, real estate is a passive investment, so we're already paying less tax through it being a capital gain. And then we have all the depreciation on top. So multi-family real estate has the cash flow, the appreciation, the stability, and the tax benefits.

The Alternatives to Multifamily Real Estate

Now, let's talk about some alternative investments to multi-family real estate.

1. GICs

The only guaranteed thing about GICs is that you're guaranteed to lose money. Let's say you're able to pick up a five-year GIC at 1.4 percent right now. What's the inflation on an annual basis? Two percent or even more. So right off the bat, we're losing money to inflation guaranteed.

I don't know how you can call this an investment. They should change the name to Guaranteed Loss Vehicle (GLV). Yes, I’ve just renamed it. Because you're losing money guaranteed. I don't understand why somebody would put $200-300K in a five-year GIC when you can invest it in a multi-family asset. You get the incredible stability, you get the appreciation, and you get the cash flow. And you get returns that are well in excess of 1.4 percent, which is nothing.

2. Mutual Funds, Stocks, and Bonds

We can’t control the stock market. So that is speculating, just hoping that the market goes up. Just like the real estate market — we can't control it. We know that the market goes up over time but we cannot control it. We need to focus on what we can control, and control as much as we can in the deal. This is why we have the strength of forced appreciation in multi-family real estate. If I buy a stock in a company, I’m just one little small fish. I do not control the company. I cannot change the direction of the company. I cannot change the market like I can with multi-family real estate when I implement a value-add plan and really drive that NOI up so I can in turn increase the value of my asset. I can't do that with stocks. I can't do that with mutual funds. I certainly can't do that with GICs — or should I say GLVs (Guaranteed Loss Vehicles).

3 Questions to Ask to Find Top Multifamily Deals

Multifamily is far better than GICs, mutual funds, stocks, or bonds. But in order to find a good investment, focus on three questions: who, what, and how — these are the important questions:

1. WHO

Who is running or managing the deal? If you are working with the wrong person, the above four benefits won’t be realized because the person will mismanage the deal.

2. WHAT

What is the opportunity in the deal? If you don't have a good opportunity in the deal the above four benefits won't happen.

3. HOW

How is the team going to make it happen? How will they put it into action? If you don't have a solid business plan, again, the four benefits won't happen.

The Bottom Line

We’ve already seen how great multi-family real estate is. But in order to find those great deals, you have to ask what really matters — who, what, and how. As an investor looking for good opportunities, ask and answer those three essential questions first and all these others things will follow — the cash flow, the appreciation, the stability, and the tax benefits.

If you want to learn more about multi-family investing, join our free Facebook group. I'll put a link right down there below. We have lots of great people involved.