Investing in multi-family real estate in the Rio Grande Valley is an excellent way to diversify an investment portfolio and to create both monthly income and capital gains.
Located deep in South Texas, the 43,000 -square mile Valley is bordered by the Rio Grande River and Mexico to the west and south and the Gulf of Mexico to the east. Some of the largest cities in this region include McAllen, Brownsville, Edinburg, and Pharr.
Since 1969 the Rio Grande Valley has quadrupled in size. With a current population of about 1.3 million people the area is one of the fastest-growing regions in the U.S. The most recent report by the U.S. Department of Housing and Urban Development forecasts non-farm payrolls to increase 2% annually over the next several years. Demand for rental housing is also forecast to be strong, with nearly 1,800 additional rental units needed to satisfy demand over the next few years alone.
When deciding how to invest in multi-family property in the Rio Grande Valley, investors are faced with the choice between buying an existing property or developing a multi-family project from the ground up. In this article we will look at the pros and cons of each option and how different investors might make different choices based on their individual investment objectives.
Core, Value Add, Opportunistic: three main multi-family real estate investing strategies
Before deciding between buying and building a multi-family property, experienced investors analyze the real estate investment strategy that best suits their investment objectives. There are three main multi-family real estate investing strategies that lie along different points of the risk-and-reward spectrum:
- Core investing strategy is used by real estate investors who want to minimize risk in exchange for a lower rate of return. An example of a core multi-family investment is buying a Class A apartment building with existing high-end amenities with a low vacancy level and seasoned tenants.
- Value-add real estate strategy is the choice forinvestors who are willing invest capital in property updates and improvements to increase cash flow and create new revenue streams. Multi-family real estate investors use this approach when buying a property with outdated appliances and fixtures, upgrading them, and then increasing rents to match the new market value of the property. Examples of creating new revenue streams are passing through all utilities to tenants, adding a fee-based concierge packaging service, and providing covered parking for an additional monthly fee.
- Opportunistic multi-family investment strategy is used by real estate investors who are comfortable with a higher level of potential risk in exchange for a higher reward. Developing a multi-family project from the ground up is an example of the opportunistic strategy. When done in partnership with an experienced real estate developer the potential risks can be minimized while the return on investment can exceed those generated from the core and value-add strategies.
Matching multi-family investment strategies with investment goals
Developing multi-family property versus acquiring an existing apartment project provides a Return on Investment (ROI) with different risk levels and return time horizons. Developing a project provides more profits sooner but can be riskier than buying a property with an existing smaller but steadier income stream from the existing tenants.
The general benefits of buying vs. developing can be summarized based on the four different criteria of financing, ROI, Risk vs. Reward, and Exit Strategy:
- Buying: Financing is simpler, ROI Timeline is longer with a smaller cash flow stream, Risk/Return level is lower, Exit Strategy is a longer hold time
- Developing: Financing is more complex, ROI Timeline is shorter with higher cash flow, Risk/Return level is higher, Exit Strategy is a shorter hold time
We will take a closer look at the pros and cons of buying an existing multi-family property compared to developing a multi-family project. But first, let’s review some of the variables to consider when buying or building any multi-family investment property.
7 factors to consider before investing in multi-family property
The more desirable the neighborhood that a multi-family property is in the quicker the units will rent, and the more predictable cash flow will be. There are seven factors to consider when researching the area that the multi-family home is – or will be – located in:
- Amenities in the neighborhood such as nearby parks, restaurants, and shopping outlets
- Business district locations for employment
- Schools with good ratings help attract families, while districts with poor ratings deter tenants
- Public transportation and easy highway access for commuting to and from work
- On-site parking sufficient for both tenants and their guests
- Other multi-family properties in the area that a poorly maintained will deter prospective tenants from the area
- Neighborhoods that are in decline or are already in poor condition will discourage tenants from renting
Experienced multi-family real estate developers with an established network in the market can accurately predict up-and-coming areas and avoid areas that are expected to decline. For example, a new distribution center or office building planned for construction will create jobs and the need for housing that existing multi-family properties may not be able to serve.
Pros and cons of buying existing multi-family property
The biggest advantage to buying an existing multi-family property is that the investor knows what he or she is getting.
Properties with tenants in place paying rents that are in line with the market averages provide an immediate income stream. Investors acquiring existing multi-family property also have access to the historical income and operating expenses. This in turn makes financing an existing property faster and less complex compared to developing a new multi-family project.
Some of the biggest cons to investing in an existing property include the eventual need for additional capital investment in upgrades and improvements, and an unforeseen change in the neighborhood. A new multi-family development nearby can force an owner to update property amenities to stay competitive and maintain rental rates. A large employer unexpectedly laying people off or a local shopping center unable to compete with a new national retailer opening its doors can quickly reduce the attractiveness of the neighborhood an existing multi-family property is located in.
Pros and cons of developing multi-family property
Multi-family real estate developers with deep connections in the market they operate in are often able to profit from near-term changes in the economy by building in the path of future growth and development.
They have more control over the seven factors that make a neighborhood desirable for multi-family development. Instead of reacting to changes that owners of existing properties are forced to make, the developer can proactively leverage its knowledge of upcoming changes in the market to build to suit the future demands of the market demographic.
Two of the biggest challenges in developing multi-family property are the ‘soft costs’ of new development and the costs to finance a real estate project from the ground up.
Soft costs in development that are sometimes overlooked by beginning investors include building permit fees and planning and zoning approval, tap fees to connect each unit to the city water and sewer system, impact fees for road improvements and drainage, site improvements such as sidewalks and landscaping, and consultant fees paid to surveyors, architects, and engineers, and furniture and fixtures for operation.
Financing a new multi-family development is also more complicated than buying an existing property. Construction loans are short-term loans used to cover the cost of buying the land and building the property and – with an LTV of about 75% / 25% – require the real estate developer to have access to more capital. Once construction is finished the developer obtains traditional longer-term financing. Usually there is a gap period between the time the construction loan matures and must be paid off and the new long-term loan is funded. When this occurs, developers obtain a short-term interest-only bridge loan until the permanent financing comes through.
The advantage of partnerships in multi-family investing
Partnership investing is a popular vehicle used in both purchasing and developing multi-family property. By aggregating investment capital with an experienced multi-family real estate developer, investors can:
- Realize the time savings of passive investing. Active investments require the buyer to do everything itself, including locating property, conducting due diligence, arranging financing, and managing the investment. Passive investments allow investors to contribute their money in exchange for someone else’s time.
- Leverage the expertise and financial strength of the managing partner. Investors in partnerships can take advantage of the skill, connections, and market knowledge of the managing partner to reduce risk and maximize returns.
- Own high-value multi-family property with high return values. Real estate investors acting as a group can develop new multi-family property or purchase existing buildings that would be too capital intensive or complex to buy as an individual.
The importance of choosing the right multi-family investing strategy
Before investing in a multi-family property, experienced investors select an investment strategy the best fits their investment and portfolio diversification objectives.
Core property investments come with a higher cost in exchange for a lower level of cash flow and reduced risk. Opportunistic real estate investments are on the other end of the risk-reward spectrum, offering investors higher returns in exchange of increased adjusted risk.
There are pros and cons to buying an existing multi-family property or developing property from the ground up.
Real estate investors can see, touch, and feel an existing building but run the risk of neighborhood dynamics changing due to competition or economic changes. Developing and financing new multi-family property is more complex but provides the investor with the advantage of building in the path of progress and to value engineer cost-effective Class B construction that will command rents similar to Class A.
There’s no right or wrong answer to buying an existing property versus investing in a new multi-family development project. Experienced real estate investors analyze the differing levels of risk and reward, short-term vs. long-term holding periods, and overall return on investment before deciding if buying or building is the right choice for them.