When it comes to investing usually the stock market is a choice for most people however, Real estate is an alternative for those who are not able to endure stock market volatility. Real estate investment is also a better option for investors who has the capacity and ability for capital growth. Many strategies in real estate can be successful in positive capital growth for an intelligent and sensible investor.
Why is Multifamily better than Single Family Real Estate?
Investing in rental property is the ideal investment strategy for an additional income stream and also an appreciation in the portfolio value. There are two types of residential properties that one can invest in single-family and multifamily.
Single-family properties have only one available unit to rent while multi-family properties have multiple rentable units. In single-family investment, there’s one source of income and multiple potential expenses. A lot of times the additional income stream is a complete wash with the unforeseen repair or maintenance expenses. However, there are several advantages to invest in multifamily properties from economies of scale to considerably fewer shared expenses. Here are three reasons to consider while making your investing decisions in multifamily properties as opposed to single-unit rental properties.
Financing:
Usually, an acquisition cost for a multifamily property is much than purchasing a purchase a single-family home as an investment. A one-unit rental property can be purchased for a few thousand dollars while a multi-family property could cost the millions.
At first glance, it seems like that securing a loan for a single-family property would be a lot easier than the multifamily property, but the truth is that a multi-family property is more likely to be approved by a bank easily for a loan than the average home. Multifamily financing looks at the property and its ability to generate income. Rents minus operating expenses. This number needs to be at least 125% of the cost to service the debt or the bank will not lend on the property. Multifamily properties are mostly income-generating properties even it has a handful of vacancies or a couple of tenants with late rent payments. In a single-family scenario if a tenant moves out the property would become 100% vacant and no cashflow. That’s the reason that multifamily properties are the less risky investment for a lending institution and can also result in a more competitive interest rate for the landlord.
Valuation:
Single-family property is valued by the price per square foot that the neighbor received in a recent comparable sale. You have no control over the value. Multifamily property value is based on the net operating income, NOI, earned by the property. This number is divided by the local capitalization rate, cap rate, for the type of property. If the seller has not kept up with rents, or you identify expenses that can be reduced, you can improve the NOI and the value of the property. Also, multiple unit property acquisitions are much easier and more time-efficient than purchasing multiple single-family homes. For multifamily property acquisition there’s one lender, one loan regardless of the number of units in the building however for the purchase of multiple single-family homes there could be multiple lenders and multiple separate loans for each property.
Taxes:
Ordinary income vs Capital Gains: it’s important to understand the difference between the two. Income tax is paid on the earnings from employment, interest, dividends, royalties, or self-employment, etc. Capital gains tax is paid on income resulting from the sales or exchange of a property or an asset.
Depreciation is recognized as a paper loss when you file taxes. For residential properties there are two options; straight line over 27.5 years or accelerated through a cost segregation study. Depreciation provides a paper expense against the income generated by the property. This paper expense improves the overall cash flow by reducing the taxable income and thus the income taxes for the multifamily property owner. Upon sale, assuming the property sells for more than the purchase price, the depreciation is recaptured. Additionally, investment real estate held over two years is subject to the capital gains tax rate instead of the ordinary income tax rate. The tax rate for capital gains is lower than the individual ordinary income tax rate.
For investors wanting to defer the taxes, they can elect to defer the taxes by using a 1031 exchange as long as they follow the rules and invest in a replacement property.
Multifamily real estate investing can be a lucrative option, it only gives investors access to easier and better financing opportunities but also an ability to grow one’s rental portfolio.
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