So, you are interested in investing in large multifamily for its allure, scalability, and efficiencies, yet you are deterred by the thought that it is unobtainable for you. I’ll let you in on a little secret: Investing in commercial multifamily does not have to be intimidating.
There is a proven method for flattening your learning curve and accelerating your progress into bigger deals. It’s called “The Stack”. I first heard about this from Brandon Turner of BiggerPockets. “The Stack” is a real estate investment strategy where you level up with each purchase by doubling your unit count.
For example: First, you buy a single-family home, then a duplex, then a 4-plex, then an 8-unit, and so on. Pretty quickly, you will find yourself in the commercial multifamily world operating at a higher level because you continue to push yourself, learn, and grow with each purchase.
You can see how buying a single-family house is much less daunting than closing a large commercial multifamily property for your first purchase. And that’s the point. “The Stack” eases you into getting to the next level. Rome was not built in a day, and neither will your empire.
Now that we have an idea of what’s possible, let’s discuss a formidable path to scale into multifamily using the Stack method.
1. You buy a live-in single-family home (SFR) investment with one of the government-backed loan programs for a low down payment
FHA loans require 3.5% down for borrowers with a credit score above 580, and 10% down for borrowers with credit scores below that range. This credit score requirement may fluctuate based on the market. One thing to note for FHA loans is that if you put down less than 10%, you will have a Private Mortgage Insurance (PMI) for the duration of the loan, or until you can get above 20% equity and refinance to a conventional loan.
PMI is insurance paid to the entity that backs the loan, so they have the added security for guaranteeing such a highly leveraged loan.
This will make your monthly payment higher, and harder to cash flow once you move out and rent the property. If you put down over 10%, you can request to cancel your PMI after you reach 20% equity.
This loan is widely available for many people, depending on their circumstances. Many people have used this loan to get their start with investing or to purchase their first home. Many lenders will be accustomed to working with this type of loan and can walk you through the process. Finding a good mortgage lender can make closing your first property a breeze – that holds true regardless of loan type.
The VA loan and USDA loan both offer 100% financing. This means you can purchase a property with a $0 down payment. USDA loans are similar to FHA loans and also have PMI. VA loans do not have PMI and are often regarded as the best loan program because it provides the best rates, has no PMI, and can be 100% financed.
The only thing you would have to pay for are closing costs, inspections, and the appraisal. The trick, however, is that you can negotiate in closing costs if the deal warrants it, to lower your money out of pocket. On the first purchase I made with a VA loan, I did just that and ultimately purchase a $205,000 house for only $2,100 out of pocket, and on my second VA loan, I purchased a $217,000 house for only $1,800 out of pocket.
This is a quick overview of the loan types you can use in executing the first step in the Stack. The nuance is that all of these loans must be used for a primary residence. None of those government entities will back an investment loan. They require you to “plan” to live in the property for at least 1 year. This “plan” is subject to changing careers, unplanned children, and various other life circumstances that can change the course of the kind of property you need to live comfortably.
The key is to not commit mortgage fraud by stating that you plan to live in the property for a year, but in reality, never move in and immediately rent it. For example, my wife and I lived in the first property that we acquired with a VA loan for just over 1 year (actually 372 days) before we closed on our second VA loan property.
2. After your 1-year timeline is up, you move up to duplex with another homeowner loan
This is where you start to see some growth and experience as a landlord. Your first property was a test run for you to go through the buying process by working with a real estate agent, analyzing properties, working with a lender, and eventually closing your property with the title company or attorney. You will have learned the ins and outs of buying a property or at least feel much more comfortable with the process.
The key is that closing on a duplex now, rather than another SFR, pushes you to learn new things to make this a good investment. You will now have tenants as you rent out the property you had been living in, and also a tenant beside you in the duplex. Learning property management will be key to your continued success. I suggest you start by managing your own properties, if even at the beginning. This may be a necessity at this point to cash flow with that lower revenue that one or two rental units will produce.
With (at this point) only 2 rented units, it will be very manageable for you, even if you are working a full-time job. Landlording on Autopilot by Mike Butler and The Book on Managing Rental Properties by Brandon Turner are great resources to begin that journey. They are where I started as well and provided everything I needed to successfully screen and place a good tenant while operating the property efficiently.
By managing your own properties at the beginning, you will learn what it takes to manage effectively. When you go to hire a property manager later on it will make you a much better manager of the manager, or asset manager, because you have been in their shoes.
3. Purchase a 4-plex that is either a House Hack or pure investment property
At this point, you may have been able to save up from your W2, the cash flow from your other properties, or a combination of the two combined with any equity gained from those properties. To capitalize, you step up one more level to 4-unit property. Now, whether you live in this property or not, there is a high likelihood that the revenue generated will allow you to support property management at this point.
Now that you have 7 units it may make sense to hire out management so you can work on your business and not in your business and focus on continued growth. One thing to consider though is that every dollar in expense is a dollar you could invest back into your portfolio to grow faster. If you can continue to manage on your own, it may be a good idea.
4. It’s time to step into the commercial real estate world and purchase an 8-unit
It’s likely been 2 or 3 years now since you have purchased your first property. You have bought and managed seven units. You have likely had some turnover which has caused you to practice filling vacancies. With that comes repairs to get the units to rent ready again. You have also had issues along the way that you have had to learn to resolve – like backed-up toilets or evictions. By this time, you are much wiser and know a thing or two about owning, operating and financing real estate. You have the confidence to level up to a commercial purchase.
Commercial real estate differs in that it is valued using the income method rather than by using sales comparables like the residential properties you have bought thus far. You have done your research and you know you are now focused on Net Operating Income (NOI) and cap rates to determine the value and what you can pay for a property. And because you have operated similar properties (your duplex and 4-plex) you have a sound understanding of the expenses that will be required on this 8-plex.
And because you are a smart investor, you stick to the same area that your other 3 properties are in because you know it well. This gives you confidence that you know what the units will rent for. So, you know the expected expenses and the expected income, which means you have a good idea for the NOI the property will generate.
After a little research into cap rates for the area, you determine what you can pay for an 8-unit property. You know that value = NOI / Cap Rate. This equips you to pull the trigger when you find a property that meets your criteria. You purchase and operate it and in doing so you find out it wasn’t that much different than the 4 plex.
5. You repeat the above processes and continue to grow and build your portfolio into Apartment Investing
With each purchase, you gain a deeper understanding of how it all ties together. The underlying real estate principles involved in buying and managing your SFR are the same as your apartment complexes: Buy right, finance right, manage right.
Throughout your journey, you have built skills and gained the confidence and experience to continue to knock out bigger deals. Not the mention the cash flow and equity you have built over time that converts to now very impressive net worth. Remember, real estate is a get rich slow game. You can jump into the deep end into commercial multifamily right away, but you better have some impressive prerequisites that will allow you to be successful there.
If you are just starting, buy your time. Real estate is a tried and true wealth builder, and utilizing “The Stack” you can get up to the big leagues and increase your chances of success by growing conservatively but by continuing to push the boundaries of your comfort zone.
Blake Dailey is a multifamily real estate investor and host of the Multifamily Journey Podcast. He has reached his financial independence (Passive Income > Expenses) number through investing in real estate and aims to help others do the same. He helps passive investors impact their lifestyle and wealth by investing in multifamily real estate through his company Growth Vue Properties. Growth Vue seeks to help investors achieve the ultimate asset – Time – by making their money work so they don’t have to.
Find out about investing in multifamily with Blake at thegrowthvue.com or learn more about Blake, read his articles, or connect with him through his website at multifamilyjourney.
Thank you for the guest post on Apartment Investing Blake!