Many Mass. first time home buyers consider purchasing a multi-family property to help defray the cost of home ownership. By living in one unit and renting the remaining unit(s), the rental income received can be used to help pay the mortgage and lower your monthly housing expense. However, buying a multi-family property is not as simple as cashing the rent check every month. There are several additional issues to keep in mind if you decide to buy a multi-family property rather than a single family property or condo.
1. Qualifying for a Mortgage
For our purposes, we will define a multi-family property as a two, three or four unit property. These 2-4 unit properties will qualify for a regular residential mortgage. Down payments can range from 3%-20% depending on the type of loan program you can qualify for. The projected rental income from the unit(s) can be used as part of the borrower’s income to help qualify for the mortgage loan. The amount of the monthly rent used by your lender will be determined by the appraiser and be based on the fair rental market value of the unit(s). However, only up to 75% of this rental value can be used toward qualifying for the mortgage as lenders will discount this based on vacancy rates, repair expenses & other related concerns. The mortgage lender will also require that after closing, the buyer still have money left in savings for emergencies. These are called “reserves” and your lender will require between 1 and 6 months of reserves. Reserve requirements are higher for 3 & 4 unit properties than a 2 family home. Properties with five or more units are considered commercial properties, and as such require commercial mortgages (and much larger down payments and reserves).
2. Property Specific Due Diligence
You have found a potential property you like, and that your loan officer tells you that you can qualify to buy. Before running out & putting in an offer, do a little leg-work on the specific property.
How is the Property Classified? It is very common for multi-family homes to have additional apartment units created without proper zoning, permitting or building inspector approvals. For example, many landlords convert the large attic of a two-family into a small studio or one-bedroom apartment. Or, a single family home that has added an “in-law” apartment and is now being rented and posing as a 2 family. Owners who have done so without permits or approvals can create huge headaches down the road. There will be issues with your lender’s ability to close on the transaction, insurance coverages and possibly future tenants. Be sure to confirm with the city or town to make sure the property is a “legal” 2, 3 or 4 family as the seller has represented.
Get a detailed breakdown of expenses: Be sure to confirm what the landlord is responsible for paying & what the tenant is responsible for paying – water & sewer, gas, electric, oil? Have the units been separately metered? How much will the taxes & insurance be? Insuring a multi-family home is more expensive than insuring a single family home.
Buying A Property With Tenants in Place: If you are ok with buying a multi-family property with tenants in place, you will need to check the current lease. How long is the lease term or is it month to month? What is the rental amount? Are the current tenants paid up to date, or are you buying into bad tenants? How long have the tenants been there for? Do the units occupied by the tenants look like they are well maintained or do you need a Hazmat suit to enter the unit?
Buying A Property With A Vacant Unit: If you don’t want to keep the current tenants, you can ask the seller to have the tenants vacate before you buy. If there are leases in place, obviously the lease must be honored, but in the case of a month to month tenant, many sellers will be willing to deliver the unit(s) vacant. Often times the seller will want the buyer to have their mortgage commitment in place prior to giving the tenant notice, so you will need to be flexible as to the timing of the closing. When buying a property that tenants are vacating, be sure to do a thorough walk-through prior to closing to make sure the tenants did not damage the unit when moving out.
3. So You Want To Be A Landlord
You will need to make adequate provisions for rent losses due to vacancies. Even in the best case scenario, you will have vacancies. No apartment ever stays rented 100% of the time. Even in the case of normal tenant turnover, you will lose at least one month of rent. Worst case scenario is you end up with a bad tenant who stops paying rent. You will need savings in place to cover both of these scenarios.
You will also need to make adequate provisions for repair & maintenance expenses. These expenses are vastly underestimated by all first time home buyers, especially on multi-family properties. Problems in a tenant’s unit needs to be repaired quickly. Your tenant will not care that you do not have enough money saved to repair broken pipes when they do not have running water.
Be sure you go over in detail with your insurance agent the coverage that you have on the property. Lenders will require you to obtain rent loss insurance, but apart from that confirm what is or is not covered in your policy – slip and fall, lawsuits by tenants, etc.
Massachusetts has some of the most stringent Landlord-Tenant Laws which regulate nearly every facet of being a landlord including leases, deposits, lead paint removal, utilities, rent increases, and evictions. You will need to become familiar with these requirements. For a more detailed breakdown visit