Why Location, Location, Location Begs Repeating in Multifamily Investing

Location: a word so nice we say it thrice. The saying Location, location, location is oft repeated in real estate—for good reason. As the money managing site The Balance puts it, “You can buy the right home in the wrong location. You can change the structure, remodel it or alter the home’s layout but, ordinarily, you cannot move it. It’s attached to the land.”

When buying a single-family home, you may think of location in terms of its convenience in relation to shopping, entertainment and recreation, the school district it sits in, and more. Prices for single-family homes can vary widely based on where they are located, even if the construction and layout of the homes is similar. But the old saying about location doesn’t just apply to single-family homes.

The same multifamily building in two different locations may command very different rents because of the location. It could be said that location is even more important for a multifamily property because the building must attract tenant after tenant, so it has to be right for more than one person or family.

As an investor, you care about having full occupancy rates. Before you worry about vacancies, though, you must consider how location affects your ability to qualify for the loan you want and need.

Just like property values differ based on location, loan terms also vary based on location. As location factors improve, there is less risk to the lender, and therefore the lender is more willing to improve the loan terms. These factors include:

• The economic conditions of an area
• Proximity to job centers
• Proximity to universities or military bases (more on that later)
• Transportation
• Population

In this article we’ll highlight how location is more than location itself. Understanding the intersection of location and loan terms is critical for making a profitable investment. Read on to learn how a multifamily property’s location affects your risk, reward, and loan.

Risk vs. Reward

In real estate investing, risk is calculated in numerous ways. One way is to determine the capitalization (cap) rate of a location. When looking for a multifamily property, it is impossible to separate the location from the cap rate. The cap rate is used to quickly determine the value of a property based on its income. Cap rates are a product of the economy, like interest rates.

Each location has a different cap rate. Urban centers like San Francisco, Seattle, New York and Los Angeles have very low cap rates because there isn’t a lot of risk in multifamily investments there. Low cap rates reflect low risk, and thus, lower expected returns.

Rural areas with populations of less than 20,000 may have cap rates of up to 9 percent—read: very high—because they are a much riskier investment. Rural areas are inherently riskier for multifamily investments because of the lack of people, jobs, and income to spend on higher rent.

Investors like higher returns, but in order to get those returns, they must take on more risk. Lenders have to account for risk by offering more conservative terms in less desirable locations, including higher interest rates and lower leverage. To invest in rural areas, the borrower must bring more to the table in the form of a larger down payment.

Two locations where risk and reward plays out in an interesting way are college towns and military bases. Most people think an area where a large university or military base is a major employer is a positive because of stability. In reality, these areas are not more stable. Buying a multifamily property near a university or military base can be riskier than you may think.

Lenders typically view these big players as risks because if the military base or university closes, the whole town can turn into a ghost town—and then there aren’t any tenants for multifamily properties. Loans can be harder to secure in these areas, and may be subject to more conservative terms in order to mitigate risk for the lender. But how can a borrower navigate these more conservative terms?

Federal loan options for risky locations

Most multifamily loan programs will change terms based on the location. Let us reiterate: the worse a location, the worse the terms will typically be. Banks and other lenders constrict leverage in riskier locations. This usually means higher rates and lower leverage.

Federal loans are largely no different. Fannie Mae, Freddie Mac, and LifeCo’s loans work the same. As you get farther and farther away from urban centers, a borrower’s ability to maximize leverage and get the lowest rates are constrained and reduced.

HUD loans can be a favorable option to borrowers looking to invest in riskier locations because they don’t have the same aversion to more rural areas—the pricing isn’t tiered based on location like other loan programs. But that isn’t to say that HUD won’t discriminate based on location. If the deal appears too risky, HUD will simply turn down a deal rather than adjusting the terms. However, HUD loans can create an opportunity for savvy investors with the right qualifications.

New investors are often surprised when the terms in more rural areas don’t match those advertised for big cities. They love the potential returns in small towns, but don’t necessarily account for the additional risk from investing there.

While there’s no right or wrong approach to choosing where to invest, there are tradeoffs in the interplay between location, risk, and reward. Lenders are professional risk-calculators and make it their business to understand the ebbs and flows of risk versus reward. You would be wise to do the same. The economy is ever-changing, and as an investor, it’s your job to calculate how and where you will find your greatest returns.