How to Go from Fix n Flips to Multi-Family Investing
By Ed Rogan, Owner, Co-Founder
Your entry into real estate investing could start any time. For most people, new investments start small. In the case of real estate, it’s common to begin with single family homes before moving on to bigger things.
If you’re looking for options to move away from single family investments, multi-family real estate is a great option for scaling up without jumping too far outside of what you’ve already been doing. It’s decidedly different from single family, but if you prepare yourself ahead of time you can transition successfully.
Going from Fix n’ Flip to Multi-Family
In concept, fix n’ flip single family properties and value-add multi-family are the same. You’re taking a property that’s either renting for or valued below market rate and improving it in a way that brings the values up to or above market, but in practice, the process of choosing a project and improving its value is very different.
Depending on the area you’re searching in, single family fix n’ flip properties could be anywhere from $100,000 in an up-and-coming neighborhood to a few hundred thousand dollars in an upscale area. With multi-family, you’re looking at millions.
The added weight of a larger investment means more due diligence is needed for multi-family properties. While there is a certain due diligence in every real estate investment, no matter the size, multi-family due diligence is much more involved than single family.
Though multifamily investing is a complicated business to be in when done properly, with many moving parts and nuances, there are some key steps to follow that drive success. Let’s take a look at these most significant parts of the process, starting with due diligence, which should cover 3 categories:
Looking at the finances of a deal is one of the first steps you want to take. Observe the market where the asset is located. How does it compare to similar properties around the area? Is the market projected to grow or stagnate? Does the future potential of the property fit well into your business plan?
Beyond the market conditions, financial analysis also looks at the T-12 reports (trailing 12 months) including cash flow statements, income statements, and other financials. Don’t take all numbers at face value. Re-do calculations, assess projections, stress test the numbers under different market condition assumptions, and verify everything you read. Sellers will generally paint a property in the best light possible, so your job is to get the full story from the numbers.
Properties can come with a number of legal complications attached. Make sure the title is clean, uncover any existing contracts that would transfer to new owners, look for title restrictions, and generally unearth any hidden legal hurdles. It’s your responsibility to find out these types of issues ahead of time. You won’t have any legal leeway after the sale is complete.
If a property looks okay in the financial and legal categories, it’s time to take a closer look at it physically. Send the seller an LOI (letter of intent) and schedule a tour of the property. Take a trusted contractor from your team (more on your team below). Contractors often notice things you wouldn’t, identifying signs of future problems with the building.
Look at the property itself and the surrounding area. Talk to staff members and residents. Learn whatever you can about the building.
If you’re looking at older buildings in particular, keep in mind that building standards have changed significantly over the last few decades. Renovations may uncover substandard building materials or outdated building techniques that will then need to be brought up to code – a process that can be very costly and through your budgeting off significantly if not included.
Everything you discover throughout due diligence should be included in the final budget for renovations, impacting the price you’ll offer during negotiations. If you’re planning to work with a property manager, bring them into the process and have them draw up their own budget for the project. Compare what they give you to what you came up with privately to make sure their estimates are consistent with yours.
When we evaluate a property, we go through checklists with around 200 items for each category. These aren’t tests designed to disqualify properties, but to make sure we’re investing in something that’s going to give us the right ROI.
Out of every few LOIs we send out, we may only move on to completing the full due diligence on 2 or 3 properties, and from all of this, we typically only acquire 1 property.
Successful due diligence keeps you out of bad deals more often than it finds you great deals.
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Forming Your Team
Good multi-family deals depend on you being backed by a good team. There are generally at least 4 parts to your investment team:
Brokers help you find properties in a local market, sorting out the properties that fit your strategy the best. When you have trusted brokers on your side, it’s much easier to find great deals. Working with a broker on a regular basis gives you some advantages, such as access to private sales you wouldn’t have known about otherwise.
You should also source deals yourself by using public and private databases of owners and contacting them to ask if they will sell. This laborious process of finding properties that are not already on the market, the ‘off-market’ transactions, is attractive because it can uncover some really great opportunities, but it requires considerable time, energy, and persistence to find the good deals. It is an approach we have adopted here at Penn Capital with great success.
Arguably the most important person on your team is your contractor. This is the guy who’s going to be taking care of your renovations and value-add projects. You want to make sure you’re working with someone with a good track record you can really trust. They need to demonstrate not only that they can keep to budget and deliver on time, but also that they can adapt to circumstances on the ground in real time. Seldom do value add deals not uncover surprises once demolition starts; your contractor needs to be able to keep moving no matter what the issues that arise.
How do you find a good contractor for multi-family?
Building trust is a big deal. Start with someone who comes recommended and who has experience with multi-family projects. See how the experience goes and make a decision from there. Pay attention to a few details:
- Are they familiar with multi-family buildings? The quotes for these types of projects are very different than single family, so you need someone who understands the nuances.
- Do they have a good relationship with local government officials? Projects go more smoothly if they know who to talk to when applying for permits or seeking further information.
- Do they have good relationships with vendors? These relationships allow you to get better prices when buying in bulk.
You have to ensure you’ve dotted all your “I’s” and crossed all your “T’s”. This means working with as many attorneys as you need to get the paperwork right. At minimum, you’ll want to work with a real estate attorney who has experience in multi-family deals. If you’re doing to leverage any part of the property, it’s also a good idea to have someone who can work closely with the lender’s attorney.
For anyone considering syndication, you’ll need a competent securities lawyer also, to guide you through all the solicitation and disclosure regulations.
If you’re not planning to actively run your multi-family property, or if you have multiple properties you want to manage simultaneously, a property manager is essential. The right property manager can help you increase the NOI (net operating income) of your building.
A good team is behind every successful multi-family investment. While you might have a similar team for single family acquisitions, everything is scaled up for multi-family.
If you’re used to dealing with single family properties, you need to adjust your expectations about the legal framework governing each type of investment.
The legal definition of a single-family property is 1 to 4 residential units. These are consumer class properties, even if you’re buying them as an investment. Because they’re classed as B2C transactions, there are more disclosures on the property and regulations that protect you as the consumer.
Multi-family properties are residential properties with 5 or more separate units. These are considered to be commercial properties, are treated as such by lenders, and have fewer disclosure requirements for sellers. The expectation is that as these are business to business deals the burden of responsibility for uncovering issues is on the buyer through their due diligence process.
This applies as much to the physical inspection of a property as it does to the examination of documentation, from title insurance issues, to possibility of liens, and the terms included in any sale agreement.
Buying a multi-family property puts you in a different league to single family housing, and doubly so when you start to scale up quickly, as we have done at Penn Capital, so having competent legal counsel can help navigate what can be a complicated landscape, filled with potential landmines.
Benefits & Challenges
Single family and multi-family properties both have their own benefits and challenges. It’s a trade-off, no matter which choice you make. However, multi-family can be a better option if you’re looking to scale up your residential investments, enjoy benefits of scale and get a higher return on your investment.
While single family generally has more consumer protections, multi-family requires more due diligence on the part of buyers. Building out your team takes more time, because you need to form trusted relationships.
Even with all these considerations, multi-family is a great option for any investor looking to build a sustainable pathway to building wealth over the long run, while enjoying the benefits of income distributions along the way. You can buy a large number of units in one go and improve the property value through NOI increases, accelerating your equity returns much more quickly than you ever would with single family properties.
It’s not an ideal investment for everyone, but it might be a great next step after single family fix n’ flips and is a pathway that has taken the team at Penn Capital from zero to six hundred and seventy units in under eighteen months.
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