The Quick Guide to Underwriting Small Multifamily Real Estate

for the small multif family investor it is one of the best asset classes that you can grow your portfolio as an investor you need to allocate your own risk to each deal now for me I will buy anywhere the reason I adjust my return per area is because a good deal could be a good deal and yes maybe some neighborhoods have longer lease times more turnover but if I'm getting a higher return it still gets me to where I'm trying to accomplished the equity you have is the gum patter that you can utilize to go buy more property what's going on Bigger Pockets it's James danard and we are back on Bigger Pockets YouTube channel and today we're talking about how to underwrite your next small multif family property but first meet my friend Dave Dave literally wrote the book on real estate note Investing For Bigger Pockets and his company PPR Capital wants you to be a part of the real estate investment fund no tenants maintenance or property managers just headache free cash flow Dave and his team at PPR invest in mortgage notes and Commercial Real Estate Nationwide since 2007 Dave's team has never missed a passive monthly income payment so if you're looking for cash flow accredited investors can get started at invest withth p.com that's invest withth p.com now let's get back to underwriting our small multif family deal a small multif family rental property means 2 to four units the reason is classified as small multif family comes down to the financing typically with a 2 to four unit property invest are purchasing those properties with a residential loan that's the kind of main benefit of buying small multif family when you start going above four units you get classed as commercial financing so let's break that down real quick a residential loan gives borrowers access to different types of debt typically it's a 30-year loan principal plus interest and you can Finance it just like you can your residential house average down payments are 20 to 25% a bank is most interested in the borrower what is their credit score how much cash reserves do they have what is their debt to income ratio can they cover the rental property or is the rental property adding to their income basis and they're going to be very very focused on who the borrower is once you go to five units and above they start looking at the property more because it's commercial financing A bank's going to be more focused on what is the income to the property will the income cover at that point and so that is the really big difference residential they're more focused on the borrower commercial they are still focused on the borrower but they're more concerned about the asset the asset needs to have a certain amount of debt coverage so the bank will actually lend you the money so that is the big difference so the difference between a small and larger multif family really comes down to the debt now you hear this all the time on the internet go buy more units go buy larger units and that is a great play We own lots of buildings that are 50 60 units and they do well but what I can say for the small multif family investor it is one of the best fantastic classes that you can grow your portfolio I've been investing in real estate for nearly 20 years and I still buy small multi family 2 to four units it has done amazing things for my portfolio growing the equity creating the equity allowing me to exchange it later for more units and small multif family class is a huge part of everybody's growth in their portfolio so don't ever get worried about larger multif family or smaller multif family they both have a purpose but the key to small multi family family is being able to underwrite the property correctly if you don't know how to underwrite it correctly you won't be able to forecast your cash flow growth correctly over a long period of time you're not going to be able to forecast your Equity gains over a long period of time and that's what creates the gunpowder for us to grow as investors so there's three main things I look at when underwriting a small multif family rental property the first is asset class and location right we hear that all the time location location location buying the right location for the right kind of growth and that is true and very important when you're buying any type of rental propert property you want to look at areas that you think have a high growth that give you the most impact in your portfolio the location of your small multif family rental property can have a lot of impact on your performa and how you're going to collect income if it has negative impacts right busy roads next to commercial maybe not desired commercial does it have bad neighbors is there a lot of crime in the area these are things that can affect your rent growth and not only that it can lead to longer lease times and as a landlord we are trying to turn our properties as quick as possible the longer that property sits vacant the less our return is going to be the lower your vacancy rate the higher your return so those are definitely things you want to look at when you're buying your next multif family deal in addition to look at the Historical Trends as I'm looking at buying any type of multif family property I want to know what the average rent growth is for the year annually is it a 2% increase a 3% increase or maybe it's five as I'm looking at buying that property if I look at the Historical rates with the average appr appreciation that it gets was the average rent growth that's going to tell me what my performance is not going to look like just today but over a one year a 5year in a 10-year period so look at those historical ratings I always want to be in an area that has higher growth the higher the growth the bigger the equity spread I'm going to get the higher the cash flow which is going to give me more gunpowder to go buy more property or get to Financial Freedom faster each investor is different in the locations that they're buying I know many Real Estate Investors that will only buy Class A Properties they'll only buy Class B properties and they won't buy Class C as an investor you need to allocate your own risk to each deal now for me I will buy anywhere but what I do is I adjust my return for the asset class that I'm looking at if I'm buying an A Class Property in an a class neighborhood I might take a less of a return if I'm buying in a C-Class neighborhood or C-Class building I might want a much higher return the reason I adjust my return per area is because a good deal could be a good deal and yes maybe some neighborhoods have longer lease times more turnover but if I'm getting a higher return it still gets me to where I'm trying to accomplish so as investors dictate your buy box what class do you want to be in and if you'll be in any allocate a return for each area and you'll be able to grow quickly the next important step when calculating a small multif family rental property is calculating income what is this property going to pay you annually and how do you figure it out the first step in calculating your income is what are your tenants currently paying often times when we're buying a rental property or looking at a rental property there's already tenants in the property the reason this is important is because these tenants are typically on month-to-month leases or they could be on extended leases 6 months 12 months even 24 months that is a contract that is legally binding and that's going to tell you what the income is going to be over that duration of time in addition to those leases it's going to break down the actual true net income it's going to tell you what their expenses are what they're obligated to pay and it's really going to show you the financial performance of the property property so anytime that you're looking at buying any type of rental property whether it's a single family or small multif family you need to evaluate the leases the leases are going to tell you what the income are today often times you can increase the rent when you're purchasing a property that's going to increase your return the more money that you can collect per door or per unit the higher your income is going to be so it's really important to always pull comparables to see if a your tenants are paying over market value and your rents could actually come down in a year cuz sometimes that does happen landlords can be really good at artificially bumping their rents by giving concessions free rent and the higher the income more money people will pay so the first reason I pull comparables is to make sure that the current income isn't above market and I'm buying a safe investment the second reason I pull comparables is I want to see if there's upside in the property where's my return going to be in 12 months if I'm buying a rental property that has a 6-month lease and those rents are 20% below Market I'm going to evaluate the cash flow in the income based on what I'm buying today but I'm also going to evaluate it in 12 months if rents go up what is my financial performance am I happy with that income I might not be happy with it to the day I'm buying it but if I can increase the rents with comparable data am I happy with the return after I'm finished but the things to avoid when you're pulling comparables if you're looking at a small multif family let's say it's a duplex and it's a side by side there's no one above there's no one below they're nice clean units with one shared wall that's going to get you a much higher rent comp if you're looking at a duplex that's top and bottom that might get you a lower rent comp because people will pay less typically for people walking on top of each other so those are things to consider when pulling your rent values after I pulled my rent comparables of similar product I need them to calculate the expenses on the property just because you're getting paid rent doesn't mean that's what you're walking home with you have your mortgage cost which you need to pay to your bank to facilitate the purchase but then there's the other expenses in the property that are going to dwindle down your income typical type of expenses inside of small multif family are going to be your property taxes how much is your monthly taxes that needs to come off your rent income then there is your insurance and insurance can vary in all different types of States so it's really important that you price your insurance for the area that you're purchasing in when I buy in Washington state my typical rental insurance isn't that expensive on average I'm paying about $100 a door maybe even a little bit less now if you go into other types of markets let's say Florida or Texas their insurance premiums have gone through the roof and they could be a lot higher so wherever you're looking at buying that property research those insurance premiums you need to work it into your performa because it's going to substantially affect your cash flow taxes insurance and utilities are your core costs when calculating your expenses but then there's other variable expenses that you want to pay attention to and working your performa as an investor when I'm looking at purchasing a rental property I always work in a maintenance expense typically I allocate 1% of my total annual income into a maintenance expense in a reserve account that will pay for any type of repairs over time tenants will give you damage deposits that will often Time cover the move out but items like roof furnaces general maintenance and upkeep can wear out over time and dramatically affect your cash flow so I build in 1% of annual income into my expense and I put that against my performa and lastly are you going to do property management or not the first 10 years of me being a landlord I never used a property manager I self-managed the reason I did that is I wanted the highest performance of the property typically property managers charge 5 to 10% of your gross income in addition to they can charge lease up fees depending on the rate that they're charging that is okay and it can make you very headache free for you as a landlord but you need to factor in for those expenses so to determine are you going to use a property manager or are you going to selfman manage figure out those costs price out those costs and work it into your performance so after I've evaluated the location and potential income of the property lastly I want to evaluate the value of it what is the market value today and what am I paying now many investors are chasing cash flow where they don't really care if they're paying market value because they're getting a great return on their money and they're happy with that they may want a 7% return they can put 20% down full market value and that's what they're getting then there's the other half of investors that are trying to utiliz leverage when they're buy buying small multi family if you are overpaying for that property you are starting with negative equity the more negative equity you have and you overpay it's going to be harder to then refinance and pull out cash later it's going to be harder to pull out any type of investment helck on that property loan to value in your Equity position makes a huge impact as you're trying to grow out your portfolio the equity you have is the gum patter that you can utilize via a 1031 exchange or accessing more debt to go buy more property so checking the value of the property is essential when you're buying a multif family deal so spend the time figure out how much Capital you have what are you trying to accomplish what is it going to take for you to buy that asset and what is your minimal return so I want to thank everyone for tuning in for how to underwrite your next small investment property if you enjoyed it like And subscribe below and for more information about how to underwrite and analyze your next deal check me out on J flips on Instagram or James danner.com [Music] 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Channel: BiggerPockets

Views: 49,355

Keywords: multifamily, small multifamily, multifamily real estate, rental property, multifamily real estate investing, multifamily investing, small multifamily investing, multi family, investing, multi family real estate, how to invest in multifamily, real estate investing, apartment investing, invest in apartments, duplex, triplex, quadplex, how to invest in real estate, real estate investing for beginners, real estate, how to analyze a rental property, biggerpockets, james dainard

Id: I2RYMuadLjs

Length: 12min 52sec (772 seconds)

Published: Thu Feb 01 2024