Ways To Get Started Investing in Commercial Multifamily Real Estate

Ways to Get Started in Commercial Real Estate Investing

Investing in commercial real estate (CRE) can be a great way to build long-term wealth, generate passive income, and hedge against inflation. There are several ways to get started, including using traditional financing, partnering with other investors, and leveraging a Self-Directed IRA (SDIRA) to invest using retirement funds. Below are some key strategies to begin investing in commercial real estate.

1. Direct Ownership (Purchasing a Property)

This involves buying a commercial property outright, such as a multifamily apartment building, office space, or retail center. Investors typically finance the purchase through traditional bank loans, private lenders, or syndication.
Steps to Get Started:

• Identify a profitable market and property type.

• Conduct financial due diligence, including cash flow analysis.

• Secure financing through a bank or lender.

• Close the deal and manage the property directly or through a property management firm.

2. Real Estate Syndications (Passive Investing as a Limited Partner)

A syndication is a pooled investment where multiple investors contribute capital to acquire a large commercial property, typically led by an experienced sponsor. This option allows investors to participate in CRE without actively managing the property.
Steps to Get Started:

• Network with sponsors or operators who manage syndications.

• Review potential deals, focusing on return metrics such as cash-on-cash return, internal rate of return (IRR), and equity multiple.

• Invest passively and receive distributions based on the property’s income and appreciation.

3. Real Estate Investment Trusts (REITs)

REITs allow investors to buy shares in a company that owns and manages commercial properties. These are publicly traded like stocks, offering liquidity and diversification.
Steps to Get Started:

• Research different REITs (public or private).

• Invest through a brokerage account.

• Earn dividends and potential appreciation over time.

4. Self-Directed IRA (SDIRA) – Using Retirement Funds to Invest in Commercial Real Estate

One of the most powerful ways to invest in commercial real estate is through a Self-Directed IRA (SDIRA), which allows individuals to use their retirement funds to buy real estate while keeping all profits tax-deferred (Traditional SDIRA) or tax-free (Roth SDIRA).

How to Transfer Your Retirement Account to a Self-Directed IRA

The process of rolling over your existing 401(k), traditional IRA, or other retirement accounts into an SDIRA is straightforward and has no tax implications if done correctly.

Step 1: Choose a Self-Directed IRA Custodian
Unlike traditional IRAs, SDIRAs require a specialized custodian that allows investments in alternative assets like real estate. Some reputable SDIRA custodians include:

• Equity Trust

• New Direction Trust Company

• Advanta IRA

• Rocket Dollar 

• Alto

Step 2: Open an SDIRA Account

• Select the type of SDIRA: Traditional SDIRA (tax-deferred growth) or Roth SDIRA (tax-free withdrawals).

• Complete the application with your chosen custodian.

Step 3: Fund the SDIRA via Rollover or Transfer

• Rollover: If you have a 401(k) from a previous employer, you can roll it over into the SDIRA without tax penalties.

• Transfer: If you already have an IRA, you can transfer funds from an existing IRA to the SDIRA tax-free.

• Funds must go directly from one custodian to another to avoid any tax consequences.

Step 4: Choose a Commercial Real Estate Investment
Once the funds are in your SDIRA, you can use them to:

• Buy an entire commercial property.

• Participate in a real estate syndication.

• Invest in private real estate funds.

How Money Grows in a Self-Directed IRA

• All rental income, capital appreciation, and distributions from real estate investments go directly back into the SDIRA.

• The account grows tax-deferred (Traditional SDIRA) or tax-free (Roth SDIRA).

Tax Benefits and Ramifications

• Traditional SDIRA: Taxes are deferred until retirement, at which point withdrawals are taxed as ordinary income.

• Roth SDIRA: Investments grow completely tax-free, and qualified withdrawals in retirement are also tax-free.

• No Capital Gains Tax: Since the SDIRA owns the asset, there are no capital gains taxes when the property is sold.

Potential Considerations

• Prohibited Transactions: The IRS restricts using the SDIRA for personal use (e.g., you cannot live in or personally manage the property).

• Unrelated Business Income Tax (UBIT): If an SDIRA uses leverage (e.g., a mortgage), income from that portion may be subject to Unrelated Debt-Financed Income (UDFI) tax.

Top 5 Things to Look for in a Multifamily Investment

Before investing in a multifamily property, ensure it meets the right criteria for long-term success.

1. 1. Location & Market Growth: Look for strong job growth, population increase, and rental demand in the area.

   2. Cash Flow & Rent Growth: Ensure the property generates consistent positive cash flow with increasing rent potential.

   3. Occupancy & Vacancy Rates: Healthy occupancy rates above 90% indicate stable demand.

   4. Value-Add Potential: Opportunities for renovations and operational efficiencies can increase property value.

   5. Exit Strategy & Returns: Ensure the property aligns with your investment goals and provides strong projected returns.

Investing as an LP with a Trusted Operator

Become a limited partner in someone else’s deal and understand what you need to look for to ensure you know what you are getting yourself into.

• Put your money to work for you with a proven operator that you trust and has a proven record of success.

• Make sure that you know the operator, that you have met, talked multiple times, if possible, meet them in person.  It is very important that you trust the operator and that he is and has done what he says he has.

• Ask the operator for their proforma or copy of their underwriting on any deal they are trying to pitch you.

• Make sure you know what a good market looks like

• Understand what type of returns you should be getting for the asset class you are investing in.

• Be careful with operators promising 20% 30% and up Cash on Cash.  If it’s to good to be true it probably is.  This could happen but it may be a very risky proposition.

• Understand the different asset classes

• Know what the typical expense ratios look like for any asset class you plan on investing

• Ask the operator for their business plan and how they plan on executing the plan look at how they plan to do the following:

  • Add additional incomes

  • Increase Operating Income

  • Reduce Expenses

  • Capital Expenditures (How Much the Plan on Spending, what is the ROI, when do the plan on finishing, do they have a contingency budget)

  • What is their plan on rent increase and traditionally over the past 10 years how have rent increased compared to their plan

We highly recommend that you invest as a passive investor (LP) before trying to buy your own deal.  

“Please make sure that you work with an operator whose goals align with your own.  If you are looking to buy Class A assets don’t get with an operator who is doing Class C.  Also, if your goal is to run your own operation and to do your own deals then look for an operator who is willing to mentor you, this is the fastest way to success”

 Expected Returns in Multifamily Real Estate Over a 10-Year Hold

Multifamily investments provide attractive returns over the long term. Below are typical return metrics:

• • Cash-on-Cash Return (CoC): 5.0% – 8% annually

  • Internal Rate of Return (IRR): 10% – 18%

  • Equity Multiplier: 2x – 3x over 10 years

  • Annual Appreciation: 3% – 5%

  • Cap Rate at Exit: 5% – 6.5%

Case Study Invest 100K with Cash-on-Cash Returns of 6% per Year and a Multiple of 2.5x.

The following case study is of an investment that I myself have done.  These are what typical returns will look like. These returns are conservative as the investment has outpaced the returns thus far, but we want to show how your money will grow over time with these types of returns. The table below shows the detailed cash flows for the first and second investments, demonstrating how the money grows over a 10-year period.

1. Investment 1 $100K give you $250K in 10 Years a 2.5X Return

2. You Reinvest $81K from Investment 1 into Investment 2 with 6% Cash-on Cash Return

3. Investment 2 Refinance in year 5 you get 75K back and you can reinvest that again into another deal total payout in year 2 is $99,300

4. Notice that by year 5 in investment 1 you have all your initial capital back and you’re reinvesting the same money.

5. 100K initial investment turns to $452,500 over 15 years this is more than 4.5X your returns.

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