Most first time homebuyers don’t set out to be landlords. But maybe they should.
That’s where multifamily homes come in.”Multifamily” can mean everything from shiny new duplexes to huge, old subdivided Victorians. And they have the potential to open up some interesting possibilities for the right buyers.
Why buy a multifamily home?
As a society, we have a lot of hang-ups about multifamily properties.
When your mental image of the traditional American dream has always been a large detached house and a yard for the dog, it can be easy to rush past the less attractive but objectively smarter options.
That being said, the average American moves about 11 times in their life—so don’t worry. Your first house probably won’t be your last. It can, however, act as a stepping stone to the one you really want.
Let’s take a look at a quick (and fairly simplified) case study.
They’re just starting out. They’ve got decent jobs, and have really buckled down to save up enough for a down payment of about a 10%. In a perfect world, they’d like to quit renting and cut down on what they pay for housing each month—but they realized that might be asking a lot in their current market.
After getting preapproved by a lender, they’ve determined what they can spend on a house, and after much searching, they find two options.
Option one: a single family home
Jimbob and Lupita’s first option is cute little craftsman that could use a few cosmetic updates, but nothing serious. They’ll need to take out a $170,000 loan to pay for it, which—assuming a 30 year fixed loan and an interest rate around 5%—puts their monthly payment at about $900.
It’s close to what they’re paying for their current two bedroom apartment, but at least they’re building equity.
Option two: a duplex
While the duplex is at the very top of Jimbob and Lupita’s budget and would require a loan of about $210,000, it’s in good condition and needs minimal work. With the larger loan, their monthly payment will be right around $1100. Since they’re good with budgets, it’s still comfortable for them, but only barely.
Though the home has a one bedroom unit and a two bedroom unit, Jimbob and Lupita decide to downsize a bit. They move into the one bedroom and rent out the two bedroom for around $900 a month.
Effectively, their mortgage payment shrinks to $200, leaving them room to pay off their home even faster or put money toward a new property.
Where to find multifamily properties
If Jimbob and Lupita’s hypothetical scenario sounds pretty sweet, fear not. You can get there too. It will require some extra math and legwork to do right, however. First up: finding the right property.
You can find multifamily homes anywhere you can find single family homes, whether it’s online through services like Zillow or through a local realtor.
But because of the nature of multifamily properties—that is, that they have higher occupant turnover and tend to be treated like the investments they are—there are other options to consider when looking.
Owners are a lot less attached emotionally to investment properties, and you’d be surprised how often they’re willing to sell if the price is decent.
A good tactic is to drive around the neighborhood you’d like to buy in and look for properties that could use a little work. That gives you both leverage when making an offer and some room to increase your investment (and your rent prices) with a little sweat equity after closing.
An even better tactic? Get in touch with landlords currently going through an eviction. Thanks to laws that help protect the rights of renters, evicting truly awful tenants is an expensive and time consuming process that can leave many landlords looking for the exit sign.
Luckily for a smart shopper like you, evictions are public records in most parts of the country. Just do some research as to how to get your hands on this info (it varies by area) and you’re golden.
Foreclosures and short sales
When owners can’t afford their house, it either goes back to the bank (a foreclosure) or gets sold for less than the outstanding loan amount (a short sale). Either way can mean a deal for the next buyer.
The one downside? The process of buying foreclosures and short sales can be fraught with legal issues and hidden costs. So while you might save some cash, the end result might not be as worth it as you expect.
Buying from a wholesaler
Wholesalers snap up property at a discount and then immediately sell it to investors. If you’ve tossed out traditional methods of property searching and are still reluctant to do the legwork yourself, consider searching a wholesaler out. Just be careful and really do your homework—not all wholesalers are good at their job.
What to look for in a multifamily home
Not all multifamily properties are built the same. While most of the factors you look for in a single family home (solid foundation, good school system, you know the drill), still apply there are some quirks that you need to pay attention to.
1. Location, location, location. Sometimes clichés get it right. Location is going to have a lot to do with what kind of properties and tenants you can find, not to mention how much you’ll pay and how much you’ll be able to charge for rent. This is one area where it really pays to buckle down and do some research.
2. How many units? The more units, the more rent money. Of course, the math is not quite as simple as that. More units means more work for you, more cost when things go wrong, more complicated taxes (take a gander at all the tax rules here), and more difficulty qualifying for loans. Above 4 units, and you’re automatically ineligible for some programs. For first-time buyers, a duplex is always a solid choice.
3. A polite, timely tenant. Yup. You heard right. In some situations, your property might come with a tenant or two already installed, and since a sale doesn’t generally alter a tenant’s lease, you’ll want to make sure they’re up to snuff.
4. Resale value. While not quite as important as other factors on this list, any homebuyer would be remiss to not consider what happens if they decide to sell. Demand for multifamily homes is typically lower for a multitude of reasons, so be certain you won’t need to dump the property in a hurry, or risk doing so at a loss.
Financing your new investment property
Most people will tell you that financing an investment property is tricky. And they’re not exactly wrong.
If you’ve done your math right, though, the extra hassle is more than worth it. That’s because you can count your a portion of your projected rent as income, making it easier to qualify for a larger loan.
Though exact requirements will depend on the lender you work with, here are a few of the key differences you could encounter:
- Higher down paymentr required
- Higher credit score required
- Properties with more than 4 units will not qualify for Government loans
- Higher conforming loan limits, depending on number of units
Why occupy the property at all?
Wondering why you shouldn’t just rent out the whole thing and rake in that sweet, sweet rent money?
If this is your first time buying a investment property, occupying one of the units—at least for a little while—is in your best interest. The reasoning for this is twofold.
First, it allows you to see how you like being a landlord. Maybe it’s a sideline that really fits with your lifestyle, or maybe it’s actually kind of a pain and additional rental properties won’t be in the cards. Either way, the risk is minimal.
Second, there’s a good chance your lender will offer you a lower interest rate if you live in the property yourself.
When you give it some thought, it makes sense. If a person falls on hard times, which of their mortgages are they most likely to pay—the mortgage for their rental property, or the one for the home where their family lives?
Of course, you can make the most of it by planning on occupying one of the units yourself. The more a bank trusts you, the less you’ll pay. Plus, as an owner-occupant, you’ll also be allowed to make use of an FHA loan, which is specifically created for first-time homeowners, with benefits like a lower credit threshold and options for down payments as low as 3.5%.
Acting as neighbor/landlord
Okay, so you’ve done your homework and determined that a multifamily property could work for you financially. Awesome.
But what about that whole landlording thing? How does that work?
If you’re trying to wrap your head around the landlord part of the equation, we’ve got a great post on the basics of being a landlord that covers everything from setting rent to attracting tenants.
However, if you’re planning on occupying the property yourself, there’s also the neighbor part of the equation to consider. While it’s great to be friendly with your neighbors, you should always keep in mind that this is primarily a business arrangement and act accordingly.
Here are a few tidbits to keep in mind:
- Make your requirements regarding things like noise level and communal outdoor spaces clear in the lease agreement.
- Document any changes you decide to make to the lease–verbal agreements won’t help you in court.
- Avoid throwing your power as landlord around unnecessarily. It doesn’t exactly make for comfortable living situations.
- Study up on your rights as landlord as well as the rights of your tenants. Knowing your stuff can make conversations much smoother and keep you from getting sued.
Filed Under: Buying/Selling, Real Estate Investment
Tagged with: buying a duplex, buying a multifamily home, buying investment property, how to buy a multifamily home, investing in multifamily properties, multifamily homes