When most people think about investing in multifamily real estate, they think of buying a property with multiple living units and renting it out to generate income. This is certainly one way to go, but being a landlord isn’t right for everyone and it isn’t the only way.
There are three main ways to put your investment capital to work directly in multifamily real estate. In addition to buying rental properties, you could also participate in a multifamily crowdfunding investment opportunity, or you could purchase shares in a real estate investment trust (REIT).
The best option for you depends on a few different factors, including the time and capital you want to commit to the investment, your risk tolerance, how much income you expect from your investments, and more. Here’s a rundown of the three main multifamily investment options, and a list of considerations that can help you decide which is the best approach for you.
Buy a multifamily property
Buying a physical multifamily property is the most obvious way to invest in multifamily real estate. You could buy a duplex, triplex, quad, or even larger property, then rent the units to generate income. Generally, two- to four-unit multifamily properties are considered to be residential in nature for financing purposes, while those with five or more units are considered commercial real estate.
There are a few potential drawbacks to consider here. For one thing, buying a rental property is a very hands-on way to invest in multifamily real estate. Even if you hire a property manager, there’s a substantial time commitment involved.
Rental properties can also be quite inconsistent as far as income goes. Things like vacancies and maintenance costs are difficult to predict with any degree of accuracy, and expenses like property taxes and insurance can fluctuate significantly from year-to-year.
In addition, rental properties can be rather illiquid (tough to sell quickly) and generally require large initial capital commitments.
On the positive side, investing in rental properties can be a great way to generate income and build wealth over time. Nine out of 10 millionaires earned their fortunes because of real estate, so there’s clearly potential for strong returns here.
Participate in a crowdfunded real estate investment
Real estate crowdfunding is a relatively new type of investment, but it has the potential for excellent returns.
Here’s a general idea of how it works: Let’s say that an experienced real estate investor wants to buy an older apartment complex for $5 million. They want to spend $2 million fixing up the units and adding amenities, and then rent the apartments out to generate income. After a five-year holding period, the developer anticipates selling the property for $10 million.
However, they can only get a $4 million loan from the bank and have $1 million of their own capital to invest. So, in order to raise the other $2 million, the developer may choose to list the opportunity on a real estate crowdfunding platform and offer a piece of the action to individual investors.
There are several reputable crowdfunding platforms, such as Realty Mogul and CrowdStreet. Crowdfunding opportunities are added frequently, so if you’re looking to invest in multifamily real estate, this could be one way to look.
To be clear, crowdfunding is generally a high-risk type of real estate investment. The risk can be well-justified by the return potential, but it’s important to realize that because there is typically some sort of value-adding strategy (such as a renovation), there’s significant execution risk to consider.
Buy a residential REIT
This is the easiest and lowest-cost way to invest in real estate. Real estate investment trusts, or REITs (pronounced reets) are special companies that are designed to help investors put their money to work in real estate. Many REITs are publicly traded, meaning that you can buy them through a broker with a simple click of the mouse, just like with any other stock.
REITs are required to pay out at least 90% of their taxable income to shareholders as dividends, so these can make excellent passive income investments -- especially in retirement accounts like IRAs.
Most REITs specialize in a single type of real estate asset. Some buy office buildings, others buy shopping malls, and some REITs invest in mortgages and other financial real estate assets. And for our purposes, some invest in residential property.
There are some residential REITs that buy single-family homes, but the majority invest in apartment buildings. AvalonBay Communities (NYSE: AVB) and Equity Residential (NYSE: EQR) are two examples of REITs that primarily invest in urban apartments. Mid-America Apartments (NYSE: MAA) invests in lower-cost growth markets. Some multifamily REITs are specialized, such as American Campus Communities (NYSE: ACC), which owns and operates student-focused apartment communities on or near college campuses.
Which is best for you?
There's no one-size-fits-all answer here. The best multifamily real estate investment for you depends on a few factors, so here are some of the things you might want to consider:
- Capital requirements: The three different investment types are discussed here in order from most capital intensive to least. To buy a multifamily property, it's smart to prepare to put at least 20% of the purchase price down and to overestimate your closing costs and reserve requirements. Crowdfunded real estate investments tend to have minimums of $25,000 or more, but I've seen lower figures. And REIT investments can be made by simply buying one share of the company.
- Liquidity: There are three different levels of liquidity here. You can decide to sell a multifamily property whenever you want, but it can take several months before an acceptable offer comes along. On the other hand, your money is generally tied up with crowdfunding for several years. With REITs, you can choose to sell immediately with the simple click of a button.
- Your desired level of involvement: Even if you hire a property manager to handle the day-to-day operations of a multifamily rental property, it's fair to say that this option will require a substantial time commitment from you -- especially in the shopping and purchasing phase. Meanwhile, the other two options are mainly passive ways to invest in multifamily real estate.
- Risk tolerance: While there are varying levels of risk within each of the three categories, generally speaking, crowdfunded real estate is the option with the highest-risk/highest-reward-potential. Crowdfunding generally involves a lot of execution risk, while the others are often intended to produce stable income and steady appreciation.
- Income requirements: If you plan to rely on your investment for income, this should be taken into consideration. Many crowdfunded investments don't produce immediate income, for example, so if you need income, it's important to find a multifamily investment that will provide it.
In a nutshell, the best course of action is to decide where you stand on these things and choose the multifamily real estate investment(s) that makes the most sense for you.