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Acquisition_vs._Development_The_Benefits_of_Buying_a_Multifamily_Home_with_Tenants

The choice between investing in acquisition or development must be made in line with goals. While development is a good option for wealth creation, acquisition may be better for investors seeking a dependable cash flow and wealth preservation.

 

Acquisitions vs. Development: The Benefits of Buying a Multifamily Home with Tenants

Jan 19, 2018

Acquisition and development are the primary methods of direct investment in real estate, and they differ in more ways than they are similar. Acquiring a multifamily asset with tenants through a real estate investment company could be an ideal strategy for establishing a dependable, predictable cash flow—and for preserving the investor’s wealth. Development, on the other hand, with its higher risk and faster exit, is potentially more profitable. Before choosing the investment method that is best for you, consider the benefits of buying a multifamily home with tenants in light of your investment goals and willingness to take on risk.

Buying an Existing Building Simplifies the Financing

Institutional financing for development can be extremely complex, with high down payments and collateral requirements, and intricate structuring. Individual investors in a development project may find themselves committed to parameters that were determined before their arrival and over which they have very little control. Even if investors are not directly involved, problems in financing—delays or an outright inability to find financing—can directly impact them.

Acquisitions, however, are simpler in terms of financing. An investor who partners with a real estate investment management company can buy entire buildings or just a few units in one building, with management handled by the firm. A relatively simple commercial mortgage is usually sufficient for financing.

Of course, regardless of the method investors consider, they need to evaluate a multifamily investment property carefully before making a final decision.

A Building with Tenants in Situ Means Immediate Return on Investment

Investors may reduce their risk by acquiring a building with stabilized occupancy—one where occupancy rates and rents are in line with local averages, without significant tenant turnover or additional capital investment needed. Investing in a multifamily home with tenants already in place (in situ) means the paying tenants produce a steady cash flow. The investor doesn’t have to wait for the results of a lengthy unpredictable lease up. Since the cash flow is derived from a large number of rent payments, minor fluctuations in occupancy should have little effect. In addition, the property may begin to appreciate.

By contrast, real estate development begins with a plan to establish a building with stabilized occupancy. Many aspects of development—from permitting to community acceptance to labor and materials costs—are unpredictable and may be problematic. The complexity of the long-term planning required to develop multifamily housing results in a high level of uncertainty. Every investor should consider the real possibility of major delays or that the project will stall indefinitely—and never come to fruition.

Tenants in Situ Mitigate Expenses—and Risk

Acquiring a property with tenants in place reduces a number of expenses and risks. At a minimum, with tenants in situ, investors do not need to budget for the up-front expense of marketing multiple units for rent. Instead, they can respond to tenant turnover as needed. In addition, carefully chosen properties in fine condition to rent don’t require repairs or upgrades. Tenants in place also provide the investor with the assurance of relatively stable income. With mandatory renters insurance, investors can share the risks of major hazards, such as fire or natural disaster, with tenants.

Seeking certainties and reducing expenses and risk have implications for developers, as well. The development process is divided into distinct stages, and an investor can potentially enter at any point, but the most common point of entry is at the beginning of the development. A successful project may produce highly satisfactory returns. However, investors can expect their ROI to reflect the risk level at the time they enter the project.

A Longer Holding Period Helps Preserve Wealth

Ideally, development takes 2-5 years from beginning to completion, when investors typically receive their ROI and end their association with the project. The holding period for acquired assets can be longer, sometimes stretching beyond 7 years before the depreciation clock and, perhaps, the need for capital improvements dictate an exit. Although the assets may produce positive cash flow, their long holding periods are especially valuable for investors looking to preserve their wealth.

Choose the Type of Investment That Is Right for You

The choice between investing in acquisition or development must ultimately be made in accordance with your goals. In short, development is a good option for wealth creation, particularly for investors who can take on a moderate level of risk. Acquisition may be the better path for investors seeking a dependable cash flow and the security necessary for wealth preservation.

Investors interested in either development or acquisition might also consider taking advantage of a 1031 exchange. By exchanging like-kind properties through an intermediary, they can defer capital gains taxes at the end of the holding period. If an investor continues making 1031 exchanges for the rest of his or her life, the asset will be “stepped up” to fair market value in the estate, and the deferred tax bill will be erased.

The benefits of buying a multifamily property versus investing as a developer are summarized in the table below:

 

Financing

Timeline for Return on Investment

Risk/ Return

Exit

Acquisition

Simpler

Earlier

Lower/Lower

Longer hold

Development

More complex

Later

Higher/ Higher

Shorter hold

 

CWS Capital Partners is a fully integrated multifamily real estate investment management firm that offers everything from due diligence and risk management to transaction support and property management. We also own and manage luxury multifamily investment communities in major markets across the country and employ a team of experts who can help you hone your investment strategy.

For more articles like this one, check out our investment strategy blog posts.

Contact us today to get started on your next investment.

 

The information provided here is for your general informational purposes only. It should not be considered a recommendation or personalized advisory advice. CWS has made this third party information available from authors it believes are knowledgeable and reliable resources. However, its accuracy or completeness cannot be guaranteed and sentiment may change due to legal or economic conditions.

All investments involve risk including the possible loss of principal. You should familiarize yourself with all risks associated with any investment product before investing.

Advisory services are provided by CWS Capital Partners LLC, a registered investment advisor.

Securities offered by CWS Capital Partners LLC are through an affiliated entity, CWS Investments. CWS Investments is a registered Broker Dealer, member FINRA, SIPC.


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