One option home buyers have entering the real estate market is what type of home to buy. Common options are a single family, condominium or a multi family home. We are going to talk about buying a multi family as an owner occupant.
There are two types of buyers interested in multi families. The investor who wants to obtain positive cash flow through rental income and the owner occupant who lives in the home and uses the additional units to help pay the mortgage. The end goal is usually different between the two.
The investor is usually all about profit and squeeking every possible nickel out of the property. While the owner occupant is concerned on getting some cash flow it is also their home and want to make it as comfortable as possible.
THE ADVANTAGES OF BUYING A MULTI FAMILY AS AN OWNER OCCUPANT
There are two primary reasons an owner would want to buy a multi family home and live on the property.
Rental Income- The owner living in a multi family will have 1-3 units to rent out to help offset the cost of the mortgage and other housing expenses.
Shared Family Living– Often we will see maybe a mom and dad with one of their children’s families pool resources to buy a multi family and be close to one another.
MULTI FAMILY SCENARIO
In my area of the real estate world there are towns like Haverhill, Methuen, Lawrence, Lynn, Malden and Lowell that have a ton of multi family inventory. While other communities may have a very small multi family inventory. For this scenario we are going to take a look at a recently sold multi family home in Lowell MA.
The home was 7 bedroom 3 baths and approx. 3200 square feet. At the time of the sale there was currently one renter paying $1100 a month. Market rent is closer to $1350 and we will use that for calculations.
- Purchase Price of $359,900
- Loan Amount of $341,905 (5% down)
- PITI of $2286.00 including PMI. Calculated at 4% interest rate includes principal, interest, taxes, insurance and PMI.
With a mortgage payment of $2286.00 and $1350 being provided by a renter your left paying only $936 a month for a 4 bedroom 2 full bath unit of about 1700 sqaure feet.
You could not buy an equivalent single family home or rent an equivalent home for anywhere near that monthly payment!
Even if you split the payment between two family member you are only paying about 1150 a month each…. most likely cheaper than renting for both of you meanwhile building equity as you pay down the mortgage as well as price appreciation over time.
This is why many home buyers choose to buy a multi family to live in.
FINANCING YOUR MULTI FAMILY HOME
Financing a multi family home is not all that different than financing a single family home as a owner occupant. Realize we are talking about a 2-4 family. You can still use low money down programs like FHA and Mass Housing and put as little as 3.5% to 5% down.
The one difference is you can use rental income as qualifying income for the loan.
Your lender will most likely not count all of the rental income toward qualifying income. They calculate 65-75% of the rental income as an occupancy rate. Wisdom suggests that between vacancies and advertising for a new renter the unit will only be occupied a certain percentage of the year.
If you are on the fence between a single family home and a multi family home get two pre-approval letters from your lender. One for the multi family and one for the single family. You will qualify for a much higher amount on a multi family based on rental income.
WHAT YOU NEED TO KNOW ABOUT OWNING A MULTI FAMILY AND RENTING
We are going to break this down into two categories legal and financial. As a new landlord it is important to know there are laws governing landlords and tenants as well as some financial obligations when you are collecting rental income.
LEGAL OBLIGATIONS OF OWNING A MULTI FAMILY
Renting out units as a landlord has legal obligations. I am not going to go into great depth about the laws governing landlords, just only make you aware that laws exist for every state that need to be followed. The laws I am covering are for Massachusetts. Every state is different so check what is applicable to your state.
For example, as a landlord in Massachusetts you can only charge first, last and a one month security deposit. Period.
Also all deposit moneys need to be held in a separate interest bearing account and must be returned to the renter with in 30 days of the lease ending. Furthermore the buyer must be notified with-in 30 days of occupancy where the deposits are being held.
Violating any laws regarding deposit monies falls under Chapter 93A and if a buyer brings suit you will most likely have to pay triple damages as well as all the tenants fees for bringing suit.
There are fair housing laws that need to be followed. A combination of Federal, State and local laws combine to prohibit discrimination on the basis of race, color, national origin, ancestry, sex (gender), sexual orientation, age, marital status, religion, military/veteran status, blindness, hearing impairment, receipt of public assistance or housing subsidy and children, with some exceptions.
A good rule of thumb is screen tenants based on their ability to pay and their references…. only.
Eviction is a legal process that needs to be followed. You can’t just throw a tenant out on the street with going through the eviction process set forth by Massachusetts state law. Eviction can only be done by getting an Order of Exectution by the courts.
Lead paint falls under federal law. Let’s face it in Massachusetts most of the multi family homes are older and certainly may contain lead paint. As a landlord you could be held liable for a child who has been determined to have lead paint poisoning because of your multi family unit.
If you know you have lead paint you cannot discriminate against family with children from renting. It is the landlords responsibility to remove or cover lead paint if there is a child under 6 living in the home.
I just touched upon some of the legal obligations a landlord has when renting out a unit in their multi family home. Take the time to read the pamphlet Landlord Rights and Responsibilities. The pamphlet touches on just about everything you need to know and is an excellent resource for new lanlords.
Remember ignorance does not exonerate you from the law. Do your homework.
FINANCIAL OBLIGATIONS OF MULTI FAMILY OWNER OCCUPANT
Owning a multi family brings on some financial obligations as well as legal. It is important to discuss this with your CPA. Think of owning a multi family and collecting rents as a small business.
Collected Rents Are Income- Any rent you collect is considered as income as should be treated as such on your tax returns. But like running any business you can offset the income with expenses.
Capital Gain Taxes- Capital Gains taxes are paid on the profit you earn on the sale of business any business asset. When you sell your multi family you will most likely have to pay capital gains on appreciation above what you paid for the home. This only applies to the portion of the home that was used for rental income.
OFFSETTING RENTAL INCOME WITH EXPENSES
While collecting rents will be considered income, don’t forget to write off your expenses against the income. Again, this can be a complex topic so I will just touch upon it, but this is definitely a conversation to have with your accountant.
When you are an owner occupied owner of a multi family expenses only apply to the percentage of the area you are renting out if the expense covers the entire building. Basically you take the square footage of the house measure up the rental unit or units and find what percentage the rental unit(s) are of the total square footage.
If the expense is specific to the rental unit(s) itself than the expense can be applied at 100%.
Allowed expenses could be repairs, advertising to rent, capitol improvements, replacing appliances, travel, etc…. Properly tracking your expenses and taking every deduction allowed can significantly reduce your tax liability against the rental income.
THE LEASE OF RENTAL AGREEMENT
Your lease or rental agreement is critical. Don’t skimp on it and just download an agreement from the internet. Hire an attorney with experience in Tenant Landlord Law. Discuss any concerns with your attorney so it may be addressed in the agreement.
For example will you allow pets or not, will you allow smoking on the premises, can you retain a key for emergencies, when can you enter the property and what kind of notification must be given? Now in Massachusetts with the legalization of marijuana that should be addressed in a rental agreement.
It is much easier to address situation directly in an agreement than to try to address issues strictly based on the law after the fact. For example you have the right to enter a tenants apartment under certain conditions with reasonable notice. But where the law fails is what is reasonable notice?
FINAL THOUGHTS ON OWNING A MULTI FAMILY HOME
Owning a multi family home as an owner occupant can certainly provide many benefits for you and potentially your family. I know many homeowners who bought a multi family as their first home and a few years later move onto a single family while retaining the multi family and collecting multiple rents.
In most cases if you are splitting cost with another family member or collect rents from additional units it can definitely afford you with the ability to own your own space for less than a comparable rental or the cost of a comparable single family home.
If you choose to rent for income to apply towards the mortgage and expenses seek out the appropriate professionals like an attorney and an accountant to guide you. Remember ignorance is not an excuse when it comes to your legal and financial obligations.