What kind of real estate is a home and a passive income stream? We’re talking about the multi-family house, which presents a unique opportunity to live and generate profit within the same structure. Buying a multi-family home involves various multi-family dwelling types, financial considerations, and pros/cons inherent to this type of arrangement. Let’s learn.
What Is a Multi-Family House?
Do you think a multi-family home means three floors with a generation living on each floor? Possibly, your view of a multi-family home is one where the grandparents live in a self-contained apartment connected to the main house where their daughter lives with her children.
The examples illustrate situations with relatives living together, but neither fits the definition of a multi-family house in real estate.
Let’s start with a simple definition: A multi-family house is a property divided into separate residential units.
A multifamily home is any residential property containing more than one housing unit. A duplex, townhome or apartment complex is a good example of a multifamily home. If a property owner chooses to live in one of their multifamily units, it’s considered an owner-occupied property12
Typically, the following conditions also apply:
1. The property has a single owner (an individual or a business) that makes the units available by leasing or renting them (e.g., an apartment complex).
2. If no single owner is described above, the individuals each own an independent unit within one building (e.g., condominium).
3. Each residential unit independently meets the needs of its inhabitants. Thus, it has a kitchen, bathroom(s), bedroom(s), appliances, utility meter, a separate entrance, and address.
With those things in mind, let’s examine each type.
Duplex
A duplex is a residential dwelling comprising two standalone units within one structure. They can sit next to each other, like books on a shelf, but each has its own entrance. The units can be stacked with one residence on the first floor (accessed by a front door) and one on the second floor (accessed by an outside set of stairs leading to the entryway).
Triplex
Like the duplex, a triplex is a single building divided into independent living units. The key difference is that three residences are under one roof instead of two. (We know it may seem obvious, but we promised to start with the basics and build!) In a triplex, the configuration may be a row of side-by-side living units or a three-story building.
Quadplex
Spoiler alert! A quadplex is akin to its twin and triplet cousins but contains four independent residences in one structure. Quadplex units can stand side-by-side; two upper units may top the two lower units.
Apartment Building
An apartment building is typically owned and managed by one entity, whether an individual or a corporation. In the US, apartment units are rented rather than sold.
An apartment building can be considered a multi-family house if there are four or fewer individual units. Buildings with five or more independent units are classified as commercial—not residential—real estate.
Condominium
Condominiums are residential dwellings that are clustered together in one or more buildings. Condominiums have common outdoor spaces and share amenities. Amenities may include pools, visitor parking, and a community center.
The interior of a condominium belongs to the owner; they are responsible for its maintenance. The exterior, along with the outdoor space and amenities, belongs to the condominium association or is owned equally among the owners.
Thus, an owner may paint the living room walls or replace the kitchen cabinets. An owner may not change the siding, remove the greenery, or install a windmill.
Townhouse
Townhouses are like condominiums as individual units are clustered together in a communal setup. Typically, a townhouse shares a common wall with its neighboring townhouse.
Unlike owning a condominium, where the property owner does not own the exterior features, a townhouse owner does. This gives the townhouse owner more freedom with landscaping and patio furniture decisions.
The Multi-Family House for the First-Time Buyer
Now that we understand a multi-family house, you may be excited about putting your real estate to work for you. You may be thinking. I can buy a duplex, live on one side, and rent on the other! What a brilliant strategy!
Many property buyers agree with you. Are you thinking of buying a multi-family house, and are you also a first-time home buyer? You will want to familiarize yourself with the unique aspects of this type of property purchase.
Location, Location, Location, Location
A common phrase in real estate is “location, location, location,” employing repetition to emphasize the relevance of a home’s location. We added a fourth “location” to the phrase as extra emphasis for first-time home buyers considering buying a multi-family house.
With a first home, prospective buyers are apt to be extra particular since they are new to the process. Also, a house is one of the most significant expenditures one makes.
As such, they will want to be sure the location suits their needs. Often, first-time buyers are starting out in their careers or expecting their first child. Is their home location close to public transportation and nearby reputable daycare facilities?
In addition to suiting their needs, a first-time home buyer of a multi-family residence must consider the location’s appeal to potential renters who will occupy the other units. Often, renters can be in various phases of life, each with their own set of concerns.
If you’re a first-timer looking at a multi-family house as a first home, be sure that you’re willing to make tradeoffs. Striking a balance between your preferences and the preferences of anticipated renters is key.
Financial Flexibility
You may have been told that buying a multi-family property can be a financial windfall for the homeowner just starting out. Specifically, the promises of a low down payment and tax breaks are cited. While both aspects can be benefits of owning a multi-family home, they are not guaranteed.
Depending on the state in which you live, you can benefit from a lower down payment. You may be required to use one of the units as your primary residence instead of living elsewhere and using the multi-family house as an investment property.
Tax Benefits
Often, this type of real estate purchase can offer tax benefits. Renting a property involves expenses that can be written off as business expenses.
As a first-time home buyer keen to save money, a lower down payment and tax breaks sound wonderful! The question is this: as a first-time property owner, is your financial situation flexible?
A lower down payment means less money leaving your bank account upfront. However, it often means you’re taking out a bigger loan.
As loans are interest-bearing, you will want to consider that for monthly and yearly budgeting. As the year rolls onward, can you afford the higher monthly mortgage?
Expenses related to the business of renting can be written off. An example is the annual heating, ventilation, and air conditioning (HVAC) service provided to ensure the systems function as they should.
A single-family homeowner can’t write off HVAC maintenance service. An owner of a multi-family home may be able to expense a functioning HVAC system as part of their service to their tenants.
Writing off the cost of a maintenance service is helpful as it decreases the amount of your taxed income. When the service is performed, you still have to pay the individual who performs the service. Will you be able to pay for all home maintenance bills when the maintenance is performed?
Personal Flexibility
If you plan to rent the self-contained units to tenants and choose to manage the property yourself, being flexible is critical. We don’t mean you must sit in a pretzel-like configuration to discuss the water heater. We mean you need to be willing to be available for your tenants.
The exact terms within rental agreements vary widely, but the basic premise is that you provide both a physical location and a set of services to your tenants. If the water temp plummets, the power goes out, or a window becomes stuck, you may be responsible for providing a prompt resolution.
If you have another job, you will need to be able to juggle its requirements along with being the owner/manager of a multi-family home. Whether you have dependent children or care for a relative, these are also situations to consider.
We aren’t discouraging a first-time home buyer from purchasing a multi-family unit. Instead, we encourage you to consider the location’s relevance and the types of flexibility needed.
Real Estate as a Source of Passive Income
According to Investopedia, the U.S. Internal Revenue Service (IRS) defines passive income as money and losses derived from an entity with which one is not actively involved. The act of providing living space and collecting a fee from its occupant qualifies as passive income, with these exceptions:
1. The living space owner is not a real estate professional.
2. The property is not rented to a corporation or business in which the individual has business dealings.
3. Income generated by leasing tracts of land is not considered passive income.
Maybe you’re wondering how renting can be a form of passive income if the act of renting relies on you performing actions such as fixing leaky faucets and flickering light bulbs. Your actions do not generate a living space, nor do your actions keep the living space in existence. Your actions maintain and uphold the living space.
Think of it this way. If you’re a teacher, you instruct and guide. If you’re an architect, you perform calculations, measurements, and drawings that become blueprints. You may rent a living space as a shelter, but you do not shelter people. The multi-family house provides shelter, and you’re involved peripherally.
The Pros of Buying a Multi-Family Home
We’ve looked at the multi-family home from multiple standpoints. We’ve addressed the types, their potential for a first-time buyer, and the nature of the income they generate.
Now, let’s dive deep into a multi-family home’s positive and negative attributes. Remember, as with many things, the pros and cons vary from individual to individual.
Multigenerational Magic
A multi-family home can be a winning solution for families with more than one generation wanting to live near each other without necessarily sharing a bathroom.
You may be caring for an aging parent or supporting a sibling with special needs who is mostly self-sufficient. Perhaps you’re a newly married couple who want to save money. A multi-family structure offers physical and metaphorical boundaries with your extended family.
Redirect Rent to Minimize Mortgage
Envision a situation where you live in one unit of a multi-family structure while renting the others. Theoretically, you can use the monthly rent to pay off the mortgage on the entire structure.
The solution sits on three assumptions:
1. You own the entire structure.
2. The other units within the structure are not vacant.
3. The tenants pay the monthly rent in full.
Let’s throw in some numbers to make the abstract idea more concrete. Presume you own a triplex. You are approved for a loan; the monthly mortgage amount due is $3,600. If two tenants pay $1,000 each, you will collect $2,000 per month. If you direct the rental payments towards the mortgage, that is $1,600 out of your own pocket instead of $3,600.
Behold Business Expenses
We discussed the idea of first-time home buyers purchasing multi-family units. We noted the appeal of tax breaks associated with this kind of property purchase while recognizing that the benefit to the property owner comes via deductions, and they still pay for the expenses themselves.
Owners of a multi-family structure should understand which expenses associated with renting qualify as deductions. For federal tax purposes, expenses incurred to maintain and manage the property qualify. Tangible items may be deducted, such as tools and supplies used to aid maintenance and management.
Property Potential
As the owner, you can add to and upgrade the structure. Add-ons like wrought-iron rails to replace warped wooden ones or private decks boost the appearance and versatility of tenants. Upgrades like smart appliances will make tenants’ lives easier or more efficient.
What do you get from that? Add-ons and upgrades may mean you can charge more for monthly rent. The greater the rent that is paid, the more you have towards the mortgage. Do you see where this is going?
The Cons of Buying a Multi-Family Home
Limited Availability
The number of single- and multi-family homes available at any time can vary. However, outside of the simple number of structures available, one also must consider that multi-family structures have characteristics that affect their availability.
Some multi-family units are considered commercial, not residential, real estate. Zoning laws and tax treatments unique to commercial real estate vary by state and municipality. If you’re new to property management and renting, consider how the structure is classified.
Less Privacy
Any shared space reduces privacy. Proximity can result in knowledge. Having their neighbors know they do yoga on the patio is not a big deal for some people. For others, a neighbor living within yelling distance is a neighbor that lives too close.
Living in a duplex provides more privacy than living in a triplex. A common area in a condominium complex offers less privacy than a yard surrounding a single-family dwelling.
Individuals need to know their comfort level with proximity to others well before putting a down payment on a multi-family unit.
The Fluctuating Facets of Property Management
When you decide to rent property, you take on many tasks unless you hire a property management company. We see five facets involved with property management.
Some of these include:
1. drafting and reviewing leases (or hiring an attorney)
2. learning the tax implications unique to rental properties
3. repairing and maintaining physical structures
4. screening potential tenants
5. managing risk through insurance policies
Conclusion
Evaluating a multi-family home as an option requires research, financial analysis, and an assessment of one’s interpersonal and management skills. Accompanied by the premises and pointers presented in this post, you are on your way to determining whether a multi-family house is your place to call home.
If you have more questions on the wide world of real estate (and who doesn’t), you’ll find a wealth of information in my books, Essential Advice for Buying Your First Home and Navigating Through the Mortgage Loan Process. I just released a second book, A Look Into the Secrets of Credit Repair: How to Fix Your Score and Erase Bad Debt. It’s available on Amazon in print, kindle, or audiobook format.
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