Identify when your fix-and-flip clients may be ready for liftoff
The real estate market has changed quite drastically in ways that may make fix-and-flip opportunities less accessible to investors. This is due to a lower supply and a higher cost basis. These clients now may consider a strategic switch to multifamily investments, shifting from quick turnarounds to long-term business plans.
Multifamily opportunities are quite different from the fundamentals of fix-and-flip investments, including differences in how deals are financed and the required day-to-day work. With the right preparation and team, this pivot could be a smart move.
Understanding why this is happening and how your clients can make this shift could open more opportunities for you with your existing client base. This could also give you a chance to engender more loyalty with your clients who may be looking to make a change in their investing strategies.
Current market challenges facing fix-and-flip investors include high interest rates, construction costs and a tighter market. These obstacles likely won’t change any time in the near future.
The days of artificially low interest rates are over. Loans that were 2.5% or 3% during the height of the COVID-19 pandemic are back to 6% or higher. While multifamily properties face the same challenges, the costs fix-and-flip investors face can make it more expensive to fund these projects overall.
Inflation and other market factors increased construction expenses by 3.5% between January and April 2024. Costs continue to rise including the cost of essentials such as copper. These expenses eat into profitability and may make some opportunities less lucrative. Not all multifamily properties require extensive repairs or renovations like a fix-and-flip investment.
The available housing stock for fix-and-flip opportunities is shrinking due to several factors that include banks holding on to more foreclosed homes and homeowners who are locked into ultra-low rates secured during the COVID-19 pandemic, unwilling or unable to sell and refinance without losing those rates.
Investment goals
The major difference between fix-and-flip and multifamily investors is opportunity. Many young people are choosing to rent because of the flexibility renting offers, decreasing the overall demand for fix-and-flip properties. Rising prices also make it difficult for first-time buyers to enter the market.
There’s an especially strong demand for rental housing in cities such as Brooklyn, Philadelphia, Miami and Jersey City, where employment opportunities in industries like health care and higher education are driving a demand for housing. In addition, public initiatives to create affordable rental housing in these metro areas present opportunities for multifamily investors.
The investment goals are quite different between multifamily and fix-and-flip opportunities. A fix and flip is focused on fast moves and short-term capital gains that are then parlayed into the next deal. The income is immediate, but the spend is immediate too, once the next deal comes along.
Multifamily units, on the other hand, are one-time investments distinctly designed to build generational wealth. Whether all units are rented out or the borrower lives in one unit and the remainder are rented out, the income generated from multifamily investments is consistent and grows over time.
Fundamental differences
Fix-and-flip deals are quick. On average, a fix-and-flip property is held for a few months, maybe a year, as repairs are made and the property is put back on the market. Multifamily investments are long-term holds during which time the investor can take advantage of tax benefits like 1031 exchanges and construction or permitting write-offs.
Borrowers must think about multifamily investments in terms of years or decades instead of months. They need to consider estate planning strategies to allow for multigenerational ownership with wealth creation. Fix-and-flip investors are focused on construction, development and sale of the property, while multifamily investments require many more players for a successful, long-term venture. These two opportunities are fundamentally different, requiring different skill sets, strategies and business plans.
Multifamily properties are underwritten in two ways, both of which differ from fix-and-flip loans. First, the debt yield is taken into consideration. Net operating income is a factor to ensure profitability of the investment.
Second is the move from short-term financing to long-term loans. This process begins with an analysis of the deal and an analysis of proposed market rents in the area to determine profitability. Most lenders will also want to take the borrower’s credit score into account, as well as to meet other conditions. Additionally, items not considered for a short-term loan, such as capital expenditures, insurance and taxes, are considered for a long-term loan.
Finally, there’s an educational hurdle. Will the rent be taken to a lockbox, for example? Is quarterly reporting required from the bank? If a borrower doesn’t know what that means or what it takes to meet these requirements, they must spend the time to learn.
Management questions
The good news is that fix-and-flip investors already have a small taste of what it takes to manage a multifamily property. They’ve already cut their teeth on important aspects like renovation and repairs. The migration from one to the other is still not simple, however.
First and foremost, a fix-and-flip investor needs a strong understanding of more than just renovation. They’ll need to know what responsibilities management requires and to build an infrastructure that supports those needs. Who will collect the rent? Who will make the repairs? Who will answer questions from tenants? Who will handle emergencies like a broken water pipe? This infrastructure must be in place before a fix-and-flip investor makes the pivot.
Liquidity is another key piece to address before making the switch. A fix-and-flip investor has lumpy liquidity — they are rich when they sell a house and tight on cash when they enter a new deal. Multifamily investors must keep money off the table to build up liquidity to be successful.
Frank conversations
Before pivoting to multifamily opportunities, fix-and-flip investors need to keep several things in mind from understanding how to retain a reserve to finding the right partners. Hold a frank conversation with your clients about these topics.
A reserve fund is essential to address ongoing needs in a multifamily property, from broker fees to repairs. Tell your clients to pursue the right opportunities. If a deal is very thin, don’t force it, as increases to operating costs may turn such margins into deficits on Day One. The best deal is the deal not pursued.
They need to keep longer time periods in mind. Multifamily property timelines are much longer than fix and flips. It takes time to get a permanent loan and to find renters. Not considering this time delay can put an investor under financial pressure. Plan for it.
Caution your clients to start with one project. Don’t identify and buy 10 properties at once. Get comfortable with the ins and outs of renting out a property, stabilizing it and managing it for the long haul before acquiring more.
Stripping property of any equity can be a big fatal flaw, as increasing the debt can make it more difficult to attract better rates in the loan’s maturity phase. Even though tax-free equity is enticing, it’s not good for the long term. And, as mentioned earlier, find the right partners. Trustworthy, vetted partners are necessary for a successful pivot into multifamily property investing.
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Pivoting to multifamily investments is achievable with the right preparation. The migration from fix and flip to multifamily investment is a natural one, but the investor must be well-versed in essentials like identifying the right long-term investment opportunity, the expected cash flow and any reporting requirements.
This shift requires some adjustment. With the right experts in your corner and solid financial planning, moving into the multifamily market is a sensible move to make.
