As a California home builder during the early 1990s, I experienced first-hand the boom-or-bust cycles of residential construction. So when I moved to Lincoln, Neb., later in the decade, I began building one or two small rental properties per year, which I hoped would help insulate my business from those inevitable cycles. My strategy proved at least partly successful: Even though the recession of 2008 wiped out my home-building company, my apartments have provided a significant financial cushion that helps keep me afloat.
If you’ve been thinking about building or buying a rental property, this may be a good time to jump in, because multifamily construction is actually booming. Census Bureau numbers show that while single-family housing starts for February 2012 climbed nearly 24 percent nationally, multifamily shot up 60 percent. And numbers for small two-to-four-unit residential projects — the focus of this article — were 73 percent higher than the previous year.
Sizing up the Market
I used a simple strategy to plan my Lincoln projects. First, I would find out who the competition was and what they were building, which told me where oversupply was likely. Then I would try to find out how long it took to rent out typical one-, two-, three-, and four-bedroom apartments, which gave me a good indication of where demand was strongest. Back then, I gathered this information informally in conversations with friends who were real estate agents. Nowadays, it’s much easier to get a feel for the market by looking on craigslist or other online bulletin boards to see what’s being offered and how long the ads remain before the units are taken.
For example, in Lincoln, a college town of 250,000, most new complexes under construction when I was getting into the market offered only two- and three-bedroom units. One-bedroom and studio apartments were mainly available in old, rundown buildings, creating a niche for newer stock. But at the time it made little sense for me to build these units, because the local going rent — $300 to $400 per month — would barely cover my mortgage payment. So I focused on four-bedroom units, which had the lowest vacancy rate and were renting for $900 to $1,200, an amount that would easily pay the mortgage and expenses with a few dollars left over.
Today, most new apartments that aren’t subsidized housing are being built in urban locations that can attract high rental rates, with designs geared toward younger, educated professionals (“echo boomers”) and empty-nesters. To attract them, the big boys can offer large-complex amenities like health-club fitness centers. As a first-time multifamily builder, you won’t be able to compete with a seasoned developer, but you can look for a property close to restaurants, cafes, health clubs, universities, and libraries. Another option is to rehab a rundown apartment in the right area of town, though this can involve some risk because of the uncertain costs of renovating an older building.
I discovered a slightly different market niche and built my first four-bedroom apartments near ethnic enclaves where culturally appropriate services like ethnic groceries and foreign-language video rentals were within walking distance. Nobody else was cultivating this market, which created an opportunity for me. If you’re a small operator facing well-capitalized professional competition, a good strategy is to find a unique niche that nobody else serves.