It’s no secret that the pandemic has drastically impacted commercial real-estate (CRE) across the globe: First, offices everywhere sent employees home to work remotely, and shops and restaurants shuttered their doors; then, as the pandemic subsided, hybrid work arrangements became more popular, and the food-and-goods delivery ecosystem has burgeoned, diminishing the need to eat or shop on location. All of these changes have resulted in upheaval in the CRE market. But despite this, multifamily developments—an interesting hybrid of residential space and CRE—are in high demand, and offer excellent investment prospects.
But what exactly is a multifamily development? What are the risks and benefits of investing in such a project? Why is it beneficial to go “ground-up”? And why are multifamily developments so trendy right now? Here is what investors should know about these properties and why—in a volatile real-estate market—they have the potential to offer a fantastic ROI.
Defining ‘Multifamily Development’
A multifamily development houses two or more families in separate apartments or attached adjacent units, each with its own entrance; all of the units also share some infrastructural elements, such as roofing or heating systems and any possible amenities, such as a pool or gym.
Properties with two to four units are generally considered residential buildings. However, in most states, a multifamily development falls under the CRE umbrella if it contains five or more units, and is subject to stricter lending guidelines (and generally a higher down payment) when the developer seeks to obtain financing.
Why Ground-Up Construction Makes Financial Sense
One significant advantage of building ground up is that banks are typically more willing to lend money for financing these projects than to refurbishment of Class C or Class B buildings. On a new development, there is a much faster “recapture period” (the length of time it takes to regain your initial investment). Once the construction is completed and the building is leased up, the developer can get a new loan in order to capture all its equity. This is considered a “loan-to-value,” based on the expected value of the new development’s net income, as opposed to “loan-to-cost,” which only factors in development costs. This is a brand new asset, and it will appraise higher than a Class C or Class B building with added value.
The Importance Of Gaining Community Buy-In
When building a multifamily development ground-up, it’s necessary to go through an approval process before beginning construction in which the developer obtains permissions from various municipal authorities. (This process differs based on where the potential development is located.) This process, by necessity, involves some finessing, but one of the ways to ensure it goes smoothly is to be mindful of getting community buy-in.
Find out what the community wants: Is it a certain number of units remaining at a lower rental cost so as to be affordable to teachers, firefighters or individuals earning at or below the city’s average median income (AMI)? Is it a menu of convenient or desirable retail establishments at the development’s ground level, such as a market, coffee shop or a 24-hour gym? Is it a building that meets certain environmental and green energy standards? Communicating and working with the community to ensure that everyone gets something they want is crucial. In addition, using local contractors—designers, builders, architects, engineers, traffic study conductors—can help pave the way to a “yes” from each of the stakeholders whose approval is needed to move forward.
Potential Pitfalls And What To Watch Out For
There are some common issues developers face with multifamily developments—most of which are avoidable. The biggest of those is not doing the legwork to obtain community or municipal buy-in on a project. Another big error: Not getting the proper clearance to build in designated historical areas, or not having up-to-date information about what types of buildings can and can’t be erected according to historical preservation standards.
Not knowing the location well—being unaware of traffic patterns, demographic information about the surrounding community or proximity to highways or business centers—can also cause problems, both for obtaining financing and approval, as well as ultimately recouping on the investment.
On the financial side, failure to negotiate a good PILOT (payment in lieu of taxes) plan can result in an unfavorable tax rate in perpetuity on the new development.
A Boon For The Future Of The Community
When multifamily developments are built in a thoughtful way, they add value to the areas in which they are situated. Ground-up developments that feature the kinds of commercial amenities and spaces communities want (restaurants, stores, entertainment venues) can help to revitalize neighborhoods—particularly in 18-hour cities that are trying to draw young professionals looking for more affordable quality of life.
Moreover, as millennials delay home ownership and continue to rent longer than the previous generation did (for a number of reasons), developers and investors can be confident that—even as the CRE world is in flux—multifamily developments will continue to be in high demand for the foreseeable future.
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