Multi-family properties are great ways to create a recurring income that’s less risky than single-family homes. By having multiple renters in a single property, you’re able to shield yourself from taking a loss on the property the way you would if you were relying on a single renter. You can also recoup your costs and generate profits faster thanks to the multiple rent payments every month. But multi-family homes come with significant price tags that are usually millions of dollars. That kind of money can be difficult for even the most seasoned of investors to come up with. So let’s discuss how to raise money for multi-family property investing.
The most common method for raising money for multi-family properties is to get a mortgage from a bank, though they’ll usually fund only around 70% of the purchase price. To make up the difference, you can fund the purchase through your personal savings, retirement accounts, or private financing like hard money lenders. There’s also the method of bringing outside investors through an LLC as either limited or general partners.
Let’s dive into first defining what a multi-family property is and the different ways you can raise the capital to buy one. I’ll also discuss how you can fund the purchase yourself or what you’ll need to consider when bringing on outside investors.
What is a Multi-Family Property?
Multi-family properties aren’t just apartment complexes. Any residential (or commercial in some cases) structure that can safely house more than one family within its walls is considered “multi-family.”
Unlike the difference in zoning between residential and commercial buildings, multi-family doesn’t cut off the number of families that it can house. Homes with basement apartments, side-by-side duplexes, and up are all considered multi-family properties.
How a Multi-Family Real Estate Transaction Usually Works
Most real estate deals involving multi-family properties are done with a combination of private money and bank financing.
Let’s use an example of a multi-family home that’s going for $1 million. An investor interested in buying that property will apply for a loan with their bank or credit union. The bank will then say “We’ll give you $700,000.”
Now obviously, that falls $300,000 short of the asking price. So why would they do that? The answer is: they want you to have skin in the game.
The bank doesn’t care where that extra $300,000 comes from; they just want you to put money down, too. Banks see real estate investments as partnerships and not handouts. If they’re going to front the majority of the money, they want you to show up with some personal risk, too.
Where to Get Money for a Down Payment
So how do investors come up with that extra 20% – 30% for their down payment? There are a few methods. Investors with savings will tap into their own accounts or pull from their 401ks and IRAs. If they don’t have savings or don’t want to touch it, there’s also the option of going to a private lender through friends and family. If friends and family aren’t an option, there’s also hard money lending to help fill the stopgap so you can close on the property.
How to Raise Money for Multi-Family Property Investing
Investors will rarely purchase multi-family properties on their own. The reasons for this vary, but it mostly comes down to protecting their personal assets if something goes wrong.
What typically happens is that an investor will create an LLC as a layer of protection for themselves and their investors. A few types of LLC structures can work for real estate, so it’s best to consult an attorney and accountant for which will be best for your situation. For example, if you’re just going after one property, then a straight LLC could be easiest. If, however, you plan to own multiple properties, an umbrella LLC might be a better idea.
Once the LLC is established, it will own the property. Having an LLC as the owner makes it easier to bring outside money like other investors or private financing.
Investors who join an LLC will be looking for what’s known as a Cap Rate Multiplier. You’ll usually see this term used for multi-family homes, which will be used as rental properties. Cap rate multipliers are the rate of return an investor can expect every year that comes from rent payments of each unit.
The Anatomy of a Real Estate Investment LLC
If you’re planning to bring on investors into your LLC, there are a few ways you can structure their levels of participation. But, again, consult an attorney to make sure you comply with any state laws which would apply.
These are investors who put up cash for investing but have no liability should something go wrong. They’ll receive a certain amount of return in addition to their investment.
These are investors who are more involved in the LLC. They’ll often be the ones signing for the loan with the lender for a mortgage. They will have a higher return percentage than a limited partner but will also take on more risk.
A sponsor is a person who gets the purchase of the property in motion for the LLC but doesn’t actually put any money down to close on the property. They may put up their own funds for things like appraisals or inspections, which are then reimbursed. The LLC will pay them what’s known as an “acquisition fee.” All sponsor fees are paid upfront and are not dependent on profits or losses. The sponsor may make multiple acquisitions for the LLC, but they are not considered a partner.
The Value-Add Investing Method
When investing in a multi-family property, you may run into what’s known as a “value-add method of investing.” This is a method that is usually presented to potential investors and is a plan to show how the LLC intends to earn a profit on the property over time.
Usually, it will be at least a 5-year plan that lays out how the LLC intends to increase the property’s value over time. These typically include upgrades, repairs, or other changes which will allow the LLC to charge higher rents on the units. It may also have an exit strategy that promises the property will be sold in 3-5 years so that the investors recoup their full costs and receive profits in a lump sum rather than over time.
Raising money to purchase a multi-family property isn’t much different than buying a single-family home. The most significant changes come down to how much money is needed to either charge higher rents over a longer-term or to fix & flip the whole property quickly. Whether you’re able to put up the money on your own, with the help of a bank, or with outside investors, it’s important that you understand what it will take to turn a profit.
What are your tips for buying a multi-family property? Leave a comment and let us know.