How is value determined?
How to identify value-add opportunities
How long does a project last?
What types of loans are used?
Let’s find out how operating a multifamily property works.
To start, let’s cover how to determine what the value of a property is. Now this is really the first thing that attracted us to multifamily. When investing in stocks, you have no control over performance. Just one tweet from Elon Musk can cause Tesla's stock to slide. And with a single family home, you can run the house beautifully. You can care for your tenants perfectly, and provide a great place to live. But when you go to sell the property, none of your hard work is taken into account. Instead, your property’s value is 100% determined on nearby comparable sales. So in the end, your neighbors determine how much your investment is worth.
With multifamily, it’s different. You’re not just buying real estate, you’re buying the underlying business. And the business is what drives the value of apartment buildings.
The price paid for a multifamily property focuses squarely on the Net Operating Income of a property. As a quick reminder, that’s income after factoring in vacancy, expenses, taxes and insurance.
To determine the price of a multifamily property, all you do is take the NOI and divide it by the cap rate.
The cap rate is the “expected rate of return” for an asset. And while you can’t control a market’s cap rate, currently, cap rates for every market are low, with many between 5 + 6%.
This means that for every dollar that NOI increases, if we use a conservative 6% cap rate, the property’s value will rise by over $16. That’s the real power behind investing in multifamily.
Let’s say we own a 100 unit property, and raise rents by just $5 every month. This means an increase in NOI of $6,000 every year. When divided by a 6% cap rate, this small change results in over $100,000 of increased value.
And we can do this in reverse. One of our favorite things to do is look for properties that don’t have updated technology. And by updated technology, we mean something as simple as a toilet. If we can go in to each of those 100 units, and install low-flow toilets, that could save us another $5 a month on our water bill. Reducing our expenses $6,000 a year will boost our property’s value by another $100,000.
This is what we call “forced” appreciation. While most real estate waits for the market to generate appreciation, we are able to force it by introducing new lines of income, as well as running the property more efficiently.
Opportunities like replacing the toilets are central to the types of value-add opportunities we look for at Wall to Main. Some other small opportunities that generate huge returns include: fixing leaky pipes, installing new fiber-optic internet and introducing it as a package for tenants to buy, updating all lighting to LED, or installing more efficient appliances.
But the true, #1 value-generator we search for is finding properties where the current rent is far below what the rest of the market is charging. Oftentimes, rent at these properties is trailing competing properties by over $100 per month. By just bringing the rent back in line with nearby properties, without having to add any amenities or work on the property, this can bring incredible Day 1 value. Going back to our earlier example of a 100 unit complex, a change like this would impact a property’s value by $2,000,000, without any expense or effort.
Understanding Multifamily Loans
All loans used for multifamily properties are commercial, non-recourse debt. This means that nobody personally guarantees the loan, which tends to be attractive for most investors. This is also a huge reason why multifamily is perfect for a retirement account, as investors using their retirement funds can only take on non-recourse loans within their account.
And when we look at the two kinds of loans, we’ll find that we have agency loans, and bridge loans.
With agency loans, these loans are backed by Fannie Mae or Freddie Mac, just as a loan would be if you were buying a single-family home. These loans have somewhat rigid requirements, the prime one being that a property must be “stabilized”. A stabilized property is one that is currently at least 93% occupied and has been for the last three months. These loans are great for properties of this nature and come with low interest rates and long loan terms as far as commercial properties go – up to 10 years.
But often times, we’ll buy a property that is less than 93% occupied. It’s struggling under current management, leasing efforts have failed and it needs someone new to come in and care for it. That’s when we turn to bridge loans. Bridge loans are intended to create a “bridge” between when a distressed asset is purchased, and when the property can qualify for an agency loan once we have stabilized it.
Because of the higher risk to the bank, loan terms are shorter, often ranging between 3 and 5 years, and the interest rates are a bit higher, although in this market, we’re finding that the difference in rates between agency and bridge debt is growing smaller and smaller.
Passive Investing Timeline
How long should you expect to be a partner in the property? Well, from the time the deal closes, most projects last between 5 and 6 years. This is how long you should expect to have your investment locked in a property. Minimum investments typically range between $50,000 - $75,000.
That said, many projects employ a business case that plans to increase property value and refinance around the third year. This often allows for 50% or more of the original capital invested to be returned to an investor. In our case study video, we touch on how you use this concept to your advantage, but just know that for every $100,000 invested in a project like this, you can expect to have the initial $100,000 locked up for three years, with the remaining $50,000 staying in the project for an additional 2 to 3 years.
After the 5 or 6 year hold, there are two options that can be taken. The first is to sell the property. At this point, you’d receive your initial capital back, as well as your share of any proceeds from the sale. If the property was bought for $5 million and sold for $6 million, if you own 5% of all shares, you would receive $50,000 in proceeds from the sale.
The second option at the end of the 5 years is to initiate a refinance. This is similar to the sale, in that ideally, the property’s value will be greater after 5 years than when it was first purchased. This means that if that earlier property doesn’t sell for, but appraises for $6 million, the same situation would play out. You’d receive your remaining capital investment back, as well as any proceeds from the new, larger loan from the bank.
But the nice thing about a refinance is that the partners still hold on to the asset! You’ve received your investment back, as well as a healthy return. But now, you still retain your overall share of the property going forward. If you own 5% of all shares, you’ll continue to receive 5% of all cash flow and 5% of any future sales or refinance. It’s at this point you have what we’d call an “infinite return”. $0 of your own capital is remaining in the property, while you continue to see income.
Now that you know how multifamily works, join the Main Street Investors and see these concepts put to work for your family.