How to Invest in Multifamily Real Estate: Weighing the Pros and Cons of Each Investment Method

Investing in multifamily real estate is a great way to diversify your portfolio while generating passive income and creating generational wealth. In a previous article we discussed and explored these benefits in greater detail.

The objective of this article is to inform you of the different ways for you to invest in this asset class, and to weigh the pros and cons to help you make a more informed decision on which one is right for you. I encourage you to do your own research as well, as this post is not all-encompassing and may miss other important considerations that are relevant to your needs.   

The three methods we’ll discuss here are the direct ownership method (purchasing a property yourself), investing in a REIT (buying shares a real estate investment firm), and investing through a real estate syndication.

Direct Ownership

Direct ownership involves purchasing an entire multifamily property or a significant stake in one yourself. This affords you complete control over the investment, but also requires knowledge of how to operate a multi-tenant property and to be mindful of the risks beyond your investment amount. While this is the most straightforward way to purchase a property, it can also be the most complicated because of the knowledge and expertise required to manage these assets, and the liabilities and risks associated with being a direct owner.

• Pros

  • Full Control
    

    • As a direct owner, you have complete control over the property. You will be responsible for management decisions, hiring and staffing, setting rental rates, property improvements, and so much more. While it can be challenging, you will get to run and operate the property without going along with management decisions you may not agree with. The property is a business, and you are the CEO.

  • Potential for Higher Returns

    • Direct ownership offers the potential for higher returns because there are no partners or other investors to share the upside with, and you’re not required to pay fees to anyone else to run the property for you. Ultimately, it will be your knowledge, experience, and wisdom that will allow you to generate the highest returns. Keep in mind that uncontrollable market factors will greatly influence your investment returns as well.

  • Sense of Ownership
    

    • While owning a multi-tenant property on your own can be challenging, great satisfaction can come from the sense of ownership it provides. You are responsible for the livelihood of your tenants, which can be stressful, but if you successfully create a welcoming, clean, and safe environment for your tenants to enjoy, it can be an incredibly rewarding experience.

• Cons

  • High Upfront Costs

    • Acquiring a multifamily property requires a substantial initial investment, including the down payment, closing costs, and potential renovation expenses. If you’re purchasing a property on your own you will likely have to qualify for the loan, which means meeting significant liquidity and net worth requirements as well.

  • Management Responsibilities

    • Direct owners are responsible for maintaining and operating the property themselves, and while some functions may be outsourced, like property management and construction management, the burden of management responsibilities will be on you. You will be held accountable when complications arise, which requires you to be prepared for everything and anything that could go wrong.

  • Market Expertise

    • You will need to be an expert on your market to understand how to optimally manage and operate your property. This aspect is often underappreciated by even the most sophisticated owners. Each market has its nuances with tenants behaving differently based on wants, needs, and cultural differences. What may be desired in one market, like high-end interior finishes, may be of very little value to tenants of another market. Being mindful of your market allows you to optimize the financial performance of your investment.

  • Risk Exposure

    • Direct ownership exposes investors to various risks. In addition to a loss beyond the initial investment, you expose yourself to risks associated with the actions of your tenants, permitting and other physical property requirements, lawsuits from contractors and third-party vendors, and environmental risks just to name a few. You also may be personally liable for the loan, exposing you to financial risks greater than just your initial investment.

Real Estate Investment Trusts (REITS)

 

REITS are companies that own, operate, or finance income-producing real estate. Investors can buy shares of publicly traded REITs through a major stock exchange with ease, making investing relatively straightforward and easy.

• Pros

  • Diversification

    • REITS allow investors to diversify their real estate holdings without directly owning properties. As an investor you’re purchasing a fractional share of the entire portfolio, which means your risk is spread across multiple assets. The losses and gains are averaged out across the portfolio, which plays a part in lowering the volatility (ups and downs) of your investment. Hopefully the performance of the poor-performing assets will be balanced by the ones that perform well.

  • Liquidity

    • Publicly traded REITs offer liquidity, allowing investors to freely buy and sell shares when they want to. Unlike purchasing a property outright, it’s a simple process to convert your investment back into cash.

  • Ease of Investment

    • REITs can easily be purchased through a major stock exchange, and for a small amount of capital. This provides REITS with one of the strongest advantages if you are an investor with only a small amount of capital to invest.

  • Professional Management

    • REITs are managed by experienced professionals, with larger teams to handle acquisitions, asset management, and other operational tasks. While there is no guarantee that they will be competent and savvy investors of capital, there is a requirement for a higher level of sophistication to manage a REIT, and therefore it creates a barrier of entry to eliminate less-sophisticated investors.

  • Limited Risk Exposure

    • When you purchase shares of a REIT your downside is limited to your investment amount. You are not personally liable for the investment decisions made on behalf of the firm.

  • Audited Financial Statements

    • Investments are regulated by the SEC and financial statements are audited by independent accountants, providing an additional layer of verification and scrutiny for accurate reporting.

  • Passive Investing

    • REITs offer investors the opportunity to invest passively, meaning once they’ve purchased their shares they can focus on their active businesses and careers and rely on the REIT to work for them.

• Cons

  • Limited Control

    • Although investors have limited liability, they exchange this for having control, specifically over which properties are bought and how they are managed. Investors may have voting rights on high-level decisions, but this has little influence over investment and management decisions. 

  • Fees

    • REITs charge fees to handle the hefty costs associated with payroll and management of the portfolio. These fees are associated with property acquisitions, asset management, and dispositions (property sales), all of which are passed through to the investors. You should also factor in the costs of buying and selling shares as well.

  • Market Volatility

    • REITs share prices can be subject to market volatility, and they may not always reflect the underlying value of the real estate assets. Market sentiment can greatly differ from actual product values.

  • Investment Mandates

    • REITs are required to invest in accordance with their investment mandate, and irrespective of investment cycles. This means they may be forced to buy properties at inopportune times and at unattractive prices. They do not have the flexibility of choosing when to buy and can’t pivot as easily as other investment vehicles.

  • Tax Implications

    • REIT dividends are taxed as ordinary income, which may be less favorable than the tax benefits of direct ownership.

 

Real Estate Syndication

Real estate syndications pool funds from multiple investors to purchase and manage properties. Syndications are led by a sponsor, the general partner (GP) who assumes all the major risks associated with the investment. The GP takes an active role in the investment, sourcing, underwriting, acquiring, and executing the business plan through the sale of the asset, and the limited partners (LP’s) take a passive role in the investment, contributing capital in exchange for participation in the profits.

• Pros

  • Access to Larger Deals

    • By pooling capital, syndications allow investors to purchase much larger assets than they would be able to purchase on their own. When acquiring multifamily properties, the number of units plays an important part in covering fixed costs. By example, it wouldn’t be cost effective to hire a full-time maintenance technician and property manager for a four-unit property, but if you spread the costs of their salaries over 100 units, these costs become more manageable. This holds true for other fixed costs as well.  

  • Upside with Limited Risk

    • Investing as an LP grants you unlimited upside while limiting your risk exposure to your investment amount. The lender won’t hold you accountable if the property defaults and you won’t bear many of the risks associated with direct ownership.

  • Passive Investing

    • Many of us are preoccupied with our active careers and businesses, along with all the other responsibilities we have in our daily lives. This doesn’t provide us with the time to learn or manage multifamily investments. By investing in a syndication, although you forgo some of the upsides of direct ownership, you free up time to dedicate to your primary method of earning income.

  • Sponsor Expertise

    • Syndications are typically led by experienced sponsors who handle property acquisition, management, and the eventual sale of the property. Sponsors dedicate their time to researching markets and have the wisdom and experience to make important financing and operational decisions. You’ll still want to vet your sponsor to ensure they have the necessary experience to make informed investment decisions, and you’ll want to know their investment strategy to ensure that it aligns with your risk and return profile.  

  • Strategic Investments

    • Syndications allow investors the flexibility to be selective in the assets they invest in. Typically, when a sponsor identifies an asset to purchase and creates an investment strategy, they will send you a business plan with quantitative and qualitative information on the deal in addition to details on how the property will be financed, the total equity requirement, and the anticipated profit over the hold period. Investors can selectively choose to invest in a property and strategy they feel is right for them.

  • Tax Benefits

    • Unlike REITs, whose dividends are taxed as ordinary income, investing in real estate syndications offers tax benefits that can be offered through deductions. One of the ways investors can enjoy these tax benefits is by utilizing depreciation to offset income.  

• Cons

  • Reserved for Accredited Investors

    • Syndications are not as regulated as REIT’s and therefore there are restrictions on who can invest in them. One such requirement is for the investor to be accredited, meeting minimum net worth and liquidity requirements.

  • Limited Control

    • Although investors can be selective about which properties to invest in, they forgo control over the operational and management decisions in exchange for limited liability.

  • Fees and Profit Sharing

    • Syndication deals often involve fees and profit-sharing arrangements which can reduce overall returns for investors. The sponsor receives incentive compensation for actively managing the properties and performance-based compensation for exceeding minimum return requirements.

  • Risk of Sponsor Performance

    • It’s crucial to research who you select as your sponsor to manage the deal, as they will greatly influence the success or failure of the investment. This risk can be mitigated by getting to know sponsor personally, researching their track record, and understanding their investment strategy.

There are a fair number of pros and cons to each investment strategy, which is why it’s important to carefully weigh each before making the right investment decision for you. Direct ownership provides you with the most control, but at the expense of greater risks, liabilities, and your time. REITs enable you to passively earn income with asset diversification, but just as your losses are mitigated so are your returns. Syndications provide you with more flexibility in asset selection than a REIT, but limited control in operations and management compared to direct ownership.

IronOak primarily invests in properties through syndications, serving as the sponsor with one or multiple limited partners in each deal. Our investment strategy focuses on older properties that benefit from strategic improvements and enhancements to create value for our investors. As an owner/operator ourselves, we find this work to be extremely rewarding, as we take great pride in improving the living conditions of the tenants we serve.  

If you’re interested in investing in multifamily real estate and are considering investing through a syndication, we encourage you to fill out our contact form and one of our team members will reach out to you for an introductory call.