Over the last year the housing market has seen historic gains. Bidding wars are pushing prices up with some buyers paying 6 figures over asking price. This might inspire many real estate investors to consider getting into fix and flip as a real estate investment strategy.
What if you could fix up multiple homes at the same time and collect rental income while waiting for them to sell? That is multifamily value-add investing. We are going to compare fix and flip and multifamily value add investing to show how it allows you to have your cake and eat it too.
Benefits of Fix and Flip
Fix and flip investing offers a quick investment with a quick return. Usually the property is purchased, renovated and resold within one year.
This short time period limits the amount of time your money is “locked in” the investment and therefore the amount of time it is at risk.
Fix and flip properties are also vacant so there is no need to manage tenants or deal with maintenance complaints especially the dreaded late-night call about an overflowing toilet.
There are also great financing options. You can purchase a property for as little as 10% of the purchase price and receive a loan to cover the remaining cost to purchase the property and the costs of renovations.
Using leverage at this rate on such a short-term investment increases your rate of return
The financial gain is not the only rewarding part. Seeing a run-down and over-looked property go through a drastic transformation is also rewarding.
Negatives of Fix and Flip
Fix and flips are not without risk. If you’ve ever taken on a home renovation you know that projects can end up costing more and taking longer than expected.
When you open a wall, you may find plumbing, electrical or other unexpected issues that increase the cost of your fix and flip.
If the increased renovation costs are too high, a profitable project can end up emptying your bank account.
Because there are no tenants, you have to pay holding costs until the property is sold. If the project is taking longer than expected you may run out of funds to cover holding costs. You may be forced to sell even if the market is not favorable.
You may consider having short term tenants to offset these costs. This may backfire depending on the property you are selling (single family house, duplex etc.) as having a tenant may limit your flexibility to sell the property or cause potential buyers to offer less.
If you have over-estimated the sale price of your property or the market value declines before you are able to sell then this will result in a much lower profit than expected.
Getting your money out of the deal quickly is helpful for risk mitigation but once it is returned you then have to go searching for a new investment. This cycle continues without end unless you think long term.
Why think Long Term
Fix and flip is a short-term investment. Buy and hold investing in multifamily is a long-term investment.
When you sell a property, if you sell at a loss there is no way to recoup it. If you are a buy and hold investor, a drop in your property value may be recouped over time through equity from appreciation when property values improve.
Value-add Sweet Spot
Multifamily investors can also enjoy many of the benefits of fix and flip while also enjoying the benefits of buy and hold investing. These benefits are maximized with the multifamily value-add investment strategy.
This is when an investor or group of investors purchase a large multifamily property with the intent of making improvements that add value to the property. These can be improvements to management, or most often physical improvements to the apartments and amenities within the multifamily apartment community.
The value of multifamily apartment communities is income driven. The physical improvements/ renovations made to the property make it more desirable to potential residents. These residents will pay an increased rental amount.
This increased amount will be greater than the organic rent growth that an unrenovated unit may receive over time. As a result, you are making a larger amount of money in a shorter period of time. As the income the property produces increases, so will the value of the property.
Depending on the cap rate of the market and amount of increased income, millions of dollars of value can be created in a period of months. This is forced appreciation that will be additional to the appreciation that would naturally occur.
Most often value-add investors will hold an investment for 3-5 years in order to optimize its income producing potential and value. Once this goal is achieved the property can be sold, refinanced or investors can continue to hold, benefiting from the monthly cashflow.
Where do you want to be in 10 years?
By increasing the value and then capturing that value through sale or refinance a value-add investor can the purchase additional multifamily apartment communities. Because these are typically 3+ year deals there is less of a need to constantly be searching for the next acquisition.
If a value-add investor holds on to a property and flips the equity into a new property they will now own two income producing assets. This process is a strategy for building a base of multiple streams of income that you can use to determine the lifestyle you wish to lead.
Multifamily apartment communities are large enough to have professional full-time management reducing the workload for owners and investors.
So where would you rather be in 10 years? Enjoying the benefits of all the hard work you did upfront or constantly searching for a new deal in order to maintain your income and lifestyle?