In today’s quick tip article we explore the differences between investing in multifamily and single family.
Many people start by investing in single family homes and may eventually transition to multifamily properties (apartments). Others continue to grow their portfolio by pursuing both strategies. The beauty of real estate is that there is usually more than one way to approach the investment process and one’s ability to design a strategy is tailored to one’s own investment goals, approach, and individual preference.
- Economies of scale and opportunity to accelerate growth of your cash flow (or as Grant Cardone would say 10X the cash flow). When purchasing an apartment building, you usually purchase multiple units under one roof (or a cluster of buildings), you will work through one loan, one insurance policy, one seller, etc. That not only simplifies the purchase and admin process, but also the management, as you have a single asset with multiple cash flow generating units.
- Income Stability and Diversification. Income stability stems from the lower vacancy risk associated with owning multiple units. More specifically, if a tenant does not renew the lease of your single family rental, that results in 100% vacancy. Whereas the same non-renewal in a 10-unit or 100-unit building, would result in a 10% or 1% vacancy, respectively. Multifamily also offers opportunity for additional income streams via other value add activities such as laundry income, valet trash, etc. .
- Controllable valuation basis. Commercial properties are valued based on NOI divided by the market cap rate. While you cannot control the market cap rate, as the property owner you have ability to directly impact the bottom line (NOI) by improving operations via growing revenue, optimizing expenses, or both (discussed in a prior article). Therefore, by increasing NOI, you have ability to increase the value of the property.
- Larger Tax Deferral Opportunities. Multifamily properties, especially if held for 3 years or more, can also benefit from accelerated depreciation by performing cost segregation (which effectively breaks down every single component of the interior and exterior of the property and depreciates it over the time period applicable for that component vs. applying a 27.5 year average across). While cost segregation is also possible for a single family home, it might not always be cost efficient (i.e. the tax deferral benefits might not be able to outweigh the cost of the study).
- Larger purchase price and more complexity. Needless to state, purchasing multiple units usually comes with a higher dollar ring. The diligence process is also more involved. As such, it is usually a team effort and involves raising capital from private investors. Therefore, being able to control the property 100% by yourself is difficult to achieve.
- Complexity of property management. When purchasing a multifamily property, you are essentially purchasing a business. And while you would in most cases hire a third party property management firm to handle the day to day operations, you need to often oversee the property manager to ensure they are operating in the most optimal manner needed to execute on tour specific business plan (aka as asset management).
- May involve managing investors. As noted above, purchasing a multifamily property often entails raising capital. As such, part of the day to day managements would involve nurturing and communication with your investors, setting expectation, providing continuous education, and ultimately being a good steward of their hard earned money, so at exit/sale of the asset you deliver both the return of capital and return on capital. Investor relations is usually a job in and of itself.
- Different Financing. When financing commercial properties, lenders underwrite both the property and the sponsorship team. Often times, the lender wants to see prior multifamily experience and track record of managing similar assets and would have minimum liquidity and net worth requirements for the sponsors. The diligence process is more involved and as such, a little more expensive (e.g. may involve Phase 1 &2 Environmental reports, seismic studies, etc.). Thus, it is not uncommon for closing to take 60-90 days.
Residential – Single Family Homes
- Smaller dollar ring. Most people start investing in real estate by purchasing a second and third single family home. This is not by coincidence. The purchase process is familiar (as they likely went through the process once when purchasing their primary residence). Furthermore, the price point is more achievable.
- More control. As single family would entail management of a single asset or multiple single assets, it is a bit easier to manage by yourself (it is not uncommon for people to start by self-managing the property, especially if it is within driving distance of where they live). This enables you to also control 100% of the asset and own 100% of the cash flow.
- Less tenant turnover. Most single family homes are comprised of three bedrooms and two baths or two bedrooms and two baths. Generally they are leased by families who tend to stay longer (or at least until it is time for the kids to switch schools). Naturally this reduces the turnover of the property, which (after real estate taxes, insurance, and property management) is the largest single expense.
- May be easier to liquidate. Depending on the market cycle, the single family home may be easier to liquidate, i.e. as the diligence process is less complex, the sale usually takes a shorter period of time (30-45 days). It is not uncommon to have all cash offers, which can further expedite the closing timeframe. All cash offers are not common for multifamily properties.
- Many roofs and higher risk of vacancy. Purchasing single family homes over time can become labor intensive and may entail more deferred maintenance, as you are managing multiple properties possibly scattered over various locations) and dealing with multiple maintenance situations (several roofs, exteriors, etc.). This is also why the property management fees are typically higher in that asset class category. Some economies of scale may be achieved by purchasing small multifamily properties (duplex, triplex, quad).
- Potential limitation on financing. While financing is simpler (the lender underwrites you as an individual and stability of your personal and earned income vs. the income generated by the property), mortgage lenders/agencies typically have a cap on how many units an investor can finance (currently that cap is 10 properties per individual, including your personal residence). While non-agency lending options are available, if you exceed 10 units, those typically come with different (less favorable) lending terms.
- Value based on/caped by sales comps. Unlike multifamily properties, irrespective of how much you improve the operations and profitability of the asset, it will be valued based on sales comps of nearby properties. As such, your property valuation is typically at the mercy of the market.
- Higher volatility. Single family tends to be more volatile than multifamily (see a prior article re this topic). In simple terms, during a recession people are less likely to afford homes (or may even lose their homes to foreclosures) and thus more likely to move into apartments, which tend to be more affordable.
We hope we have provided at least a few points for your consideration, as you embark on your real estate investing journey. Happy investing!
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Disclaimer: The information presented does not constitute legal, accounting, tax, or individually tailored investment advice. Past results do not represent or guarantee future performance.