3 Types of Multifamily Investing- Knowing Where The Risks And Opportunities Live

Core

Value-Add

Development

Description

This property is occupied in excess of 90%, often recently built, and has a predictable stream of distributions. There is little opportunity to improve operations or push rents higher above what general market conditions will allow.

Often an older property with some or all of the following issues: deferred capital expenditures, under-market rents, poor property management, maturing debt, and/or poor economic occupancy. These deficiencies at the property create an opportunity for the next buyer who can successfully correct these issues and stabilize the property.

Ground-up development or total repositioning of a property from one use to another (such as hotel to multifamily),

Risk Level

Lowest risk level for real estate

Moderate risk level for real estate

Highest risk for real estate

Expected returns (measured by IRR)

6-9%

12-18%

16%+

Hold times

5-10 years

3-7 years

3-5 years

Distributions

Should occur on a regular basis, be it monthly or quarterly, for the duration of the hold time.

Are often only at refinance and/or sale of the property. Investors can expect to receive no distributions during the renovation process.

Are often only at refinance and/or sale of the property. Investors can expect to receive no distributions during the renovation process.

Construction

This property type is often recently built or renovated prior to acquisition, resulting no major capital needs during the hold period. Ongoing maintenance of existing systems will need to be accounted for in budgeting.

Renovation of units and the common area is to be expected. Speed and cost management is crucial to minimize cost and time overruns. This requires sourcing an experienced contractor who can stay on budget.

Upwards of 80-90% of the budget can be expected on construction hard and soft costs. Cost overrun mitigation measures must to be used to protect against exceeding budget costs and planning.

Debt

Leverage on this property type can vary from 0% to 70% sourced from agencies or life insurance companies. Given the low-risk nature of these products, there are many different debt options. The debt term often matches the hold period, with the rate being fixed to eliminate any payment changes or the need to refinance during the hold period.

Many value-add project utilize short term, higher interest rate, higher-interest-rate debt provided by bridge lenders or local banks. Given the higher cost of debt for this project, timing and execution of the business plan of renovation and stabilizing the property is crucial to allow for a sale or refinance to lower-cost debt.

Development projects utilize short term, higher interest rate, higher-interest-rate debt provided by bridge lenders or local banks. There are very few long-term debt solutions, forcing the project to be sold or refinanced at maturity.

Rents

Are driven by what the market will allow. If a large amount of supply enters the market or a sudden surge in population happens, the property’s rents will move in line with market conditions. There is little room to change rents as a result of changes at the property.

Rents are below market, and the property is not occupied at a stabilized level at acquisition. This shortfall creates an opportunity for the new owner as they can improve property management, renovate units, and re-tenant the property, ultimately increasing revenue. The main risk is the rents do not rise to proforma levels after repositioning.

Rents are projected based on future expectations of the market at the time of delivery of the product. Given the long lead time and uncertainty in the future, conservative underwriting is encouraged to avoid underperformance of leasing activity, which will negatively impact returns.

Exit

Capitalization rate, or the net operating income (rents minus expenses) divided by the property’s value, will drive the final sale price of this property. With net operating income expected to grow at a constant rate, the market cap rate at the time of sale will be a significant factor in determining the sale price and final distribution of each project.