Buying a house is intimidating. For many, buying a property with multiple units seems even more complicated. But investing in a multi-family home is actually a solid, low-risk investment opportunity that can give you financial stability and a lot of potential to build property value! Whether you’re ready to invest in your first multi-family or are a first-time buyer who wants to make a smart financial decision, this unique market provides you with the opportunity to make passive income, build equity, and access unique tax benefits as well.
There are many different ways to invest in real estate. Properties with two, three, or four units, otherwise known as residential multi-family (or small multi-families), are a great form of investment because they bring in additional rental income that you won’t get from a single-family without falling under the category of commercial real estate (buildings with five units or more). Even though residential multi-family can provide additional income, the government treats them very similarly to single-family homes and provides incentives to homeowners to pursue these investments through low down payment mortgages and tax deductions.
There are many different benefits and strategies to investing in a residential multi-family. Let’s take a closer look at some of them.
Buying a multi-family home can sound financially intimidating, but it doesn’t have to be. Although a multi-family is more expensive than a single-family home, there are both conventional and government-backed loan options that allow you to pay a smaller down payment, such as the FHA loan. If you’re able to qualify for one of these options, your money down could be as low as 3.5% of the sale price. This gives a lot of flexibility to someone who has a solid credit score but can’t cut a hefty check for a down payment.
Investing in a residential multi-family ensures stability for your mortgage payment. In fact, if you calculate your value-to-rent ratio correctly before buying a property, your mortgage payment can be covered completely by rental income. By making a purchase that takes into account the prices of rent in your area, your property can generate a passive income that allows you to live rent-free and could even cover maintenance costs as well.
What’s a value-to-rent ratio?
- Calculating a value-to-rent or purchase-to-rent ratio is pretty simple. Many real estate investors’ rule of thumb is that the ratio should sit around .7 percent, never going lower than .5 percent. Serious investors looking strictly for cash flow look for a higher ratio, but .5 - .7 percent ensures that the property you’re interested in will provide solid supplemental income based on the predicted rent it will make each month.
- Say you’re looking at a two-flat in Avondale that’s listed for $600,000. After doing some research, you determine that the average monthly rent for the two units will be $3,350 combined, which means that the ratio stands at .55 percent. If you’re planning to rent out both units, that’s a fairly good value and will probably cover most of the mortgage and building costs--you might want to ask your agent to come in with an offer at a lower price to see if you can boost that ratio a little bit. Even if you’re planning on occupying one unit and renting out the other, you know that you’re buying a property with a good value-to-rent ratio.
In a single-family home, you are solely responsible for the entire mortgage payment unless you rent it out, and all repair and improvements costs have to come right out of your pocket. A multi-family has the potential to help pay for itself since the rental income that it generates can go directly back toward the property. This flexibility gives you extra cash flow in your personal finances for saving or for home improvements.
Residential multi-family homes also give you the opportunity to build equity in your property without having to foot the bill yourself. As your mortgage is paid off, you gain equity little by little. In a single-family, you’re doing this yourself, but rental income allows a property to gain equity for itself.
Building equity in your property is important for several reasons: first (and simply) because it reduces your amount of debt to the loan association and gives you the opportunity to own more of your property. Secondly, equity in your home can be borrowed against with a HELOC (home equity line of credit). This allows you to take out a loan if you need money for large purchases, like home improvements or future investments. You don’t want to take out a loan unless it’s financially necessary, but building that equity ahead of time opens up that option if you ever need it.
Home improvements are another great way to build equity because they increase property value. Significant improvements can also raise the value of rent, which is another great advantage. You can put aside some of that extra cash flow to pay for renovations or, if you’re willing, you can put in some sweat equity and boost that property value at a far lower cost.
Multi-family properties are great candidates for home improvement because you can get messy repairs done without sacrificing all of that income. If you want to rehab the kitchen of a single-family, you will either have to leave it vacant or sacrifice the use of a kitchen for the duration of the project. If you’re looking to update your two-flat, however, you can easily rent out one unit and renovate the other while still covering part of your mortgage with rental income. This flexibility allows you to build the value of the property and of each individual unit while still getting financial assistance from those rented units.
There are numerous unique tax deductions that come with investing in real estate. As a rental property owner, you can write off maintenance, repairs, property taxes, mortgage interest, legal fees, and even travel expenses from driving to and from your property for repair work, showings, and meetings. Make sure to save those receipts!
In addition to these deductions, you are allowed to write off taxes based on an estimated depreciation of your property set by the government (even though over time, your property actually appreciates). Without getting too far into the details (since we’re not tax experts), let’s just say it can increase your return and make tax season a little bit less stressful each year.
Beginning Your Search
Combined with the benefits of property ownership, investing in residential multi-family can function as an adaptable and dependable way to generate supplemental cash flow. If you’re looking for a low-risk, hands-on way to invest, residential multi-family homes are a great opportunity. If your primary objective is to buy your own property, a two-flat can help boost your income and give you access to building equity and tax deductions that wouldn’t otherwise be available.
Our Advanced Search function here at Chicago Real Estate Source is an easy way to explore residential multi-family property options here in the city. You can search by neighborhood, list price, and amount of units to help guide your search. With years of experience in Chicago, we are always available for your questions and to help you begin to explore the potential of financial stability in multi-family properties.