There are many benefits to investing in multifamily properties, whether you’re just starting out in your investing career or you’re a seasoned investor. In today’s episode, Steven dives into two of the biggest benefits - you’re not gonna want to miss this!
There are many benefits to investing in multifamily properties, whether you’re just starting out in your investing career or you’re a seasoned investor. In today’s episode, Steven dives into two of the biggest benefits - you’re not gonna want to miss this!
Key Takeaways
Steven Pesavento 00:00
When it comes to investing in any kind of asset class, what are some of the benefits that you might want to look for? When it comes to multifamily two that we're going to cover today is the economies of scale and the superior or preferred financing you can get on a multifamily asset. We're going to dive into that and more in this episode, let's get to it.
Steven Pesavento 00:19
This is the Investor Mindset podcast and I'm Steven Pesavento. And for as long as I can remember, I've been obsessed with understanding how we can think better, how we can be better, and how we can do better. And each episode we explore lessons on motivation and mindset for the most successful real estate investors and entrepreneurs in the nation.
Steven Pesavento 00:41
Welcome back to this week's mindset minutes episode on the Investor Mindset podcasts. And I'm Steven pesavento. And each week, we dive into the mindset tips and investing strategies that can help take your real estate investing career to the next level. So this week, we're diving into the fundamentals of multifamily going a little bit deeper, and talking about the economies of scale and some of the preferred financing that ends up being available to people investing in multifamily when compared to other asset classes or commercial assets. And this week, we're focusing on multifamily apartments and some of the core benefits that investors look for when investing in this type of asset class. And join me each week as we share more tips and investing strategies that can help take your business to the next level by hitting that subscribe button, and making sure that you don't ever miss an episode. And if you missed out on last week's episode, we delve deep into growing demand for multifamily. And you want to check that out, you can find that right here. Or you can also find that down in the show notes there you can find a link right to it. So diving in to two big core benefits that people look for when it comes to multifamily. And one of them is the economies of scale that you get when going for commercial multifamily. And the other one is this superior financing that you can find when it comes to commercial, multifamily versus residential, or when it comes to multifamily versus other types of commercial. So let's get into that and more in this episode.
Steven Pesavento 02:06
So one of the things that attracts a lot of new investors or extremely experienced investors to commercial real estate is that we're working at economies of scale, we're working with a much larger asset that's bringing in a much larger amount of money. And therefore the risk is spread out over many, many more tenants. And we're looking at multifamily in particular, we're spreading out that risk across, say 100 individual leases versus when I'm working with a retail commercial building, I'm I might have one or even 10 leases. And so when one of those people are not paying, it can end up being a pretty big deal. The same goes when we're looking at residential multifamily, when we're looking at a four unit or maybe even, you know, a six or 10 unit, those buildings when one person is not paying, it makes a huge impact on the overall net operating income, the money that's coming in every single month, in comparison with the income that would be lost from that one unit. So that is one of the first reasons why a lot of investors are really attracted to this, because we're able to spread out that risk over more units. You know, the second reason is the ability to spread out that maintenance, or those big capital expenditures, over many, many more leases many more sources of income. So when I have 100 leases, and I've got a roof to replace, that roof may still be quite expensive, it still be more expensive than a single family roof. Right or, in comparison, it might be like 100, single family roofs, I think we're gonna see some of the savings and economies of scale on the maintenance of that roof. But it's still going to be expensive. But that is one of the big benefits is that we're able to manage one or a handful of these major capital expenditures, and spread them out over time to make sure that we're investing in a really smart way versus when I have a single family home. And I've got to replace something major on that property. It is directly impacting the income for that property. And that property may be in the hole at this point in time. Now, sure, that can happen at any level, but we're able to spread it out based on the number of leases or the number of income streams, we can be sometimes in a much more secure place. And the other big thing the third big takeaway here is that, you know, maintenance expenses are actually more affordable. It's cheaper to manage the maintenance in an apartment building than it is in a single family home on a per job basis. Because we're able to have on site maintenance staff are able to have people who are experts and have their expertise that are used to fixing specific things within that building. And with that we end up having similar types of fixes and finishes. So we're able to keep all those materials on site and have them available to be able to make quick changes as we go.
Steven Pesavento 05:01
And as well, as long as we have good management in place, and we're managing those expenses. Well, it's actually cheaper because oftentimes what'll happen is when we're hiring outside contractors from a single family or a smaller multifamily type situation, what we're end up seeing is that the cost per job is much higher, we're bringing a contractor in, they've got to drive across town, they're coming in to, you know, fix even something just as small as a leak, or, you know, a toilet that's clogged, it's much more affordable to send someone over who's at the property every single day already working on those things. So we end up seeing a big cost savings there. You know, and one of the big economies of scale that attracts a lot of investors to this space, the reason why a lot of investors who are investing in single family end up graduating to commercial multifamily. And a lot of folks who decide to get started choose to get started here is because the ability to enter other markets more effectively, if I'm buying one single home, out of state, it's much more difficult to do that and manage things from an out of state level, versus when I'm buying 100 homes, or I'm buying 100 units of an apartment building. So it's often hard to buy 100 homes, but it's much easier to find 100 unit apartment building. And one of the benefits is that when we look at the onsite management, when we look at the ability to save money on, on maintenance, we look at the ability to manage one asset versus 100 specific individual assets, it's easier for us to manage and therefore build in the cost associated go and check on that property on a regular basis and asset manage that property from out of state, which is one of the reasons why you see a lot of investors investing, maybe not even in their own backyard as they've grown into commercial because you're able to afford the extra expense of going and looking out of state and you're able to hire a higher quality of management to be able to manage that asset. And that's not saying anything wrong with property managers at the residential level.
Steven Pesavento 07:02
But, you know, a lot of investors, me, myself included, have had issues with property managers where they've been siphoning off money or overcharging for maintenance expenses, or really not caring about that one property of the 10 properties that I have, because they're managing 400. And, you know, I'm a pretty small slice of their income. But when we can go to a management company, and they are bringing in on site management, and then as an asset manager, we're making sure that that manager is doing what they're supposed to, it ends up leading to the ability to have a better run property, which is one of the big advantages that people look for in investing in multifamily. And one of the reasons why a lot of passive investors will invest with operators is because it takes a level of expertise, it takes a level of experience to be able to invest, you know from a distance, or even invest in your own backyard and be able to manage an asset that has this many moving parts, which is why it's always important critical that whenever you're investing, even if you're brand new, and you're active, that you're going to go and partner and work with an existing operator, somebody who's been there and done it, who's already had some of these trials and tribulations. And that's been my MO since the very beginning. You know, I've been working in single family homes, and I've been investing out of state since I got started on over 200 deals in those first three years. And I can first off tell you how hard it is to manage projects out of state. But I can also tell you how important it is and how important it was to have a partner who already had that experience. So that's one of the things that I really encourage people to look for.
Steven Pesavento 08:34
Whenever you're investing that you're looking for somebody who has experience managing things at this kind of scale. And so going into the next part that I want to talk about here with you guys today is the superior financing. So when we're looking at commercial loans versus residential loans, there's some big benefits here. But then when we're looking at commercial multifamily loans versus other types of commercial loans, there's also some big advantages to multifamily. And I'll talk a little bit about what that means. And I'll speculate a little bit on why that is. So on the commercial loans, they're underwritten, and sized, meaning the size of the loan is determined based on the assets, net operating income. In other words, the income minus the expenses equals the net operating income. So versus when we're looking at residential loans. Those are based typically and solely upon the credit worthy and income of the borrower, which means it's less about the asset itself. And in residential, it's more about the person who's buying it. So what does that mean? Well, on the commercial front, when somebody is underwriting a commercial loan, they definitely are worried and they take extra special care to look at who is the manager? Do they have the experience? Do they have the track record, but at the end of the day, they're looking at that asset as a business and if they are going to come back and repossess the business to be able to read coop their dollars, they want to make sure, first and foremost that that business has sound operating principles. So they're going to be looking first and foremost at that. And that's how they're going to end up underwriting that loan.
Steven Pesavento 10:11
And one of the benefits that you can see with that is that we're looking for businesses that have an opportunity to be run well, and the bank is essentially vetting that opportunity, they're putting an 80% of the money down, they're essentially saying, Hey, I'm going to give the stamp of approval that this is going to go well, because we're gonna sign off and put majority of the money up, right, our investor partners, as an operator that our investor partners are going to bring, you know, that extra 20%, and maybe some of the funds needed to renovate that unit. But the bank is essentially putting up most of the risk capital and they're going through their own underwriting process to determine, well, is this a safe bet for us? If things do happen to shift in some kind of bad direction? Are we going to get paid back our money at the sale of this property? Or at absolute worst case scenario? If we had to take this back? Are we gonna be able to, you know, make our money back and run this asset? And the answer is, absolutely, that's the intention when they're going in, right. And so sure, there's times where they have to write off debt, because they made a bad that that's going to happen anywhere, but in commercial in particular, looking at the asset versus looking at the borrower themselves. And so as a single family investor, you can often find that you're running in this level, where you hit the 10 loans, or the eight loans or the 12 loan mark, and ends up being coming difficult to get additional financing. Even if you're an expert. Even if you've got great assets, that show they're going to make a lot of money, it can be difficult to go out and get those loans. So on the commercial side, you're going to get that benefit. But furthermore, what you're going to notice here is if you dive deeper into the financing on some of these properties, and you compare multifamily commercial, specifically to commercial, other types of commercial assets, like storage, or industrial, or office, which are all great asset classes, but all have different advantages. What you're going to notice here is if we just did a little bit of a comparison, it's always different. These are just example numbers.
Steven Pesavento 12:06
But in this quick comparison, if the multifamily property would potentially see a 4.5 interest rate with a debt to service coverage ratio of 1.25. debt service coverage ratio means how much debt is on the property that is covered by the amount of income that is going to be coming in. So it's a percentage, essentially, they want to make sure that, you know, the higher the DSCR, the higher that debt service coverage ratio, the more secure the property is, because there's more income coming in. So a lower one means potentially more risk is what they're saying. But what you're going to notice here is that the multifamily property has a DSCR DSCR, of 1.25. And a commercial property that's equally positioned from a risk perspective, other than the asset itself, with equal income is going to see a DSCR of 1.5. Right, and this is an example. So it's always going to be different. So don't take this as gospel. But what you can see here is that not only are they they're looking to make sure that asset for the other type of commercial assets are earning more money in net operating income, they are requiring it because there's more risk associated with it. And what I didn't share with you is that the typical rate is going to be, you know, if it's 4.5, for multifamily, you might see 5% for that other type of commercial asset, right. So we're actually seeing a little bit higher on the rate for other types and multifamily is getting that benefit of lower. And so what does that mean? Well, there's a lot of things that it can mean. And it can mean that, you know, the government's decided that multifamily is really important.
Steven Pesavento 13:50
So there's some really big benefits, which we're going to talk about in next week's episode. But because they see it as something they want to incentivize, maybe they can offer a little bit lower terms because, you know, the government's backing a lot of these loans. The other big thing though, the big takeaway is that the banks are seeing this asset as being one that is more conservative that is more secure, meaning they're willing to allow a higher debt ratio to income on the property than other types. Because in the past, as we talked about in last week's episode, in the past, multifamily has been hit more softly, they've been able to recover more quickly and they've been hit less hard than other types of commercial asset classes. So finally, just finishing this off for you guys here. The other big thing that I want to share just as a little nugget, that's a great takeaway is that there's less or a limited liability when it comes to investing in commercial. So for passive and limited investor partners, people are putting cash in the deal but are not actively managing. The operating team is actually taking on the burden of that viability of signing on the loan and holding the responsibility for managing that asset. So that's one of the big advantages of going in to this kind of direction versus doing direct ownership, where you're signing your name on the loan for that single family, or, you know, that small commercial property, or you're taking on the risk of, you know, what happens if somebody slips and falls, that falls on the operator, when it comes to commercial, and we're gonna get into that in just a second here, but that's gonna fall in the operator. So as a limited partner, you're going to have limited liability, you're not, they're not gonna be able to come after you, in most cases. And I always have to warn, and I should have said this at the beginning. But of course, I'm not an attorney, and I don't play one on TV. So don't take anything that I'm saying as legal advice. But with that said, the operators, they typically have a reduction in liability as well, because most commercial loans, typically they're non recourse. And what non recourse means is that the asset itself is enough for the bank to say, I'm satisfied that if something was to go wrong, I'm not gonna have to go after you as an individual, I believe that the asset should be able to stand on its own. And of course, there's some different clauses, or clawbacks or badboy clauses that say, if there's any kind of gross negligence, they can come after that operation team, if, for some reason, you know, something major goes wrong. But if you're an operator, and you're reading the loan documents really closely, and you're doing everything aboveboard, for the most part, you're going to have a lower liability than if you're personally guaranteeing the loan. And so even though management's taking on that liability, and they're still going to be taking on way more than the limited partners, they're actually going to see less liability than going out and investing in that single family space.
Steven Pesavento 16:43
So for all of you guys listening, please comment below, what are some of the benefits that you're looking for when investing in real estate assets. And which one speak to you the most, I'm looking forward to hearing you down there below. And if you're listening on the podcast, drop over to the YouTube page, drop some comments there, or hit us up on Instagram at Steven pesavento. So in conclusion, these are just a few more of the benefits of investing in the asset class of multifamily, specifically commercial multifamily. And, you know, experienced investors need to be making smart investment decisions. And so you really got to educate yourself on what it is that you're looking for out of an investment, and are these some of the benefits that you'd be looking for are these some of the benefits that end up making your investment, a little bit more secure in a better place. And so, you know, we talked about this, the economies of scale can be a really big driver for experienced investors, focusing on commercial real estate, because we're able to go after much bigger deals, we're able to have much better returns, and we're able to better manage those assets than if we're managing, you know, single family or smaller assets. So obviously, that's one of the big benefits. And when we dive into it, we saw that there's some superior lending available for multifamily and some very much more superior lending options when it comes to commercial versus on the residential side, when we're coming from an investing standpoint. So these plus many others are just some reasons why a lot of investors are choosing to add multifamily assets to their portfolio. So to learn more about multifamily, from an active investor perspective, or if you're interested in passive investing, I really encourage you to keep educating yourself learning more. And we've got some great resources at the investor mindset.com/multifamily, where we're going to be putting together resources and a full editorial on this topic, and many more, and bringing the other interviews with some of the best multifamily operators in the industry.
Steven Pesavento 18:46
So I encourage you to jump over there, educate yourself and dive a little bit deeper, so that you can take your investing career to the next level. So with that, I just want to thank you guys so much. It's been so amazing to serve you and put together so many of these episodes. So I want to leave you as I always leave yen, I want to remind you guys to live a life worth inspiring others and you can do so today by applying some of what you learned and making some smart decisions in your own investing career. You know, never stop learning because that's the way that we really can get ourselves to the place where we want to be. And so if you love this episode, I really encourage you to hit that subscribe button. Make sure you never miss a future episode. And like I said, Jump back and check out some some past episodes. We've got some phenomenal interviews with people like Jay Pappas and the author of one thing, Chris Voss, the author of never split the difference in tons and tons of phenomenal high level real estate investors who are going to jump in and be able to help you get your mindset and your investing career in the right place. So with that, I encourage you guys to drop a five star review if you love this, and I will see you guys on the next one.
Steven Pesavento 19:53
Thank you for listening to the Investor Mindset podcast. If you like what you heard, make sure to rate reviews, subscribe and share with a friend, head over to the investormindset.com to join the insider Club, where we share tools and strategies from the top investors and entrepreneurs and how to take it to the next level.