Should you invest in single-family or multi-family rental properties? Through the influence of a vast amount of media sources, including HGTV programs, we have been conditioned to believe that single-family investment properties should be the first step to generating passive income. But multi-family investments are another attainable route and can actually be more advantageous. How do they stack up? Which investment property is best? We will share more context on the pros and cons of each, and outline why multi-family investing is a far more superior investment vehicle for a long-term buy-and-hold investor.
For the purposes of this article, a single-family property is a property that contains one unit—a townhome, a detached/semi-detached property, or a condo where only one tenant (family) resides in the property.
Lower purchase price/Higher inventory: Single-family is a less price-sensitive option to real estate investing. Thousands of single-family rental properties are listed on the national markets each year. This gives many market choices in environments with less competition than buying an apartment, depending on the local market. Many people see this route as a more attractive and cheaper way of getting started in real estate.
Less maintenance: One roof means little to no ongoing maintenance required on the property, as would be expected in an apartment building. Maintenance issues are handled as problems arise, and there is no part-time/full-time staff required as on a multifamily property.
Less complicated: Identifying a single-family rental property is fairly easy, given the simplicity of calculating net cash flow from your PITI (principal, interest, taxes, and insurance). It does not require a high degree of financial modeling, market or investment analysis to make a sound investment.
Personally-guaranteed loans: In the single-family space, lenders often require that the borrower has a personal guarantee on the loan. This means, if there is a default, the bank has the ability to pursue the borrower's personal assets, thus creating additional risk on the investment. Being personally liable for default grants the lender the ability to pursue other assets you own.
More emotional valuation: Single-family property value is often determined by the sales comparison approach by an appraiser. The sales comparison approach is a valuation method which implicates that if the property next door to you sold for "x," then likely your property will be worth the same. This subjective approach to valuation was the catalyst for the Great Recession in 2008, where single-family home values dropped about 30% nationally.
Lower risk profile: With multifamily investing, an owner benefits from having multiple tenants under one roof. This presents a lower risk profile, as one tenant vacating does not break or induce stress on the investment. Conversely, when your tenant vacates in single-family, you are left responsible for the entire mortgage payment, which creates more financial risk and stress as an owner.
Economies of scale: With multiple tenants under one roof, you are able to build a larger portfolio relatively quickly! Owning 10, 20, or 100 units under one roof creates a more operational and efficient business strategy compared to having 10 properties scattered across your market. This creates a less management-intensive portfolio. Also, you can typically expect your property management costs to become more profitable, leading to higher cash flow.
Increased cash flow: Implementing an effective business plan on a multifamily property allows you to add valued amenities to the apartment complex such as dog parks, pools, and playgrounds. Additionally, it allows you to charge ancillary income such as pet rent, trash fees, and water bill back fees. Multifamily properties are valued by the income approach, which takes into account the Net Operating Income and is a more objective approach to valuation. This gives an owner more control over the investment returns, thus increasing the value of the property.
Non-recourse financing: Depending on the asset size, there is an ability to secure non-recourse debt on the property. This means there will be no personal guarantee if the loan enters into default—except in cases of committed fraud and negligence to the property. This is a highly favorable reduction of risk on the investment.
Higher barrier to entry: You should expect higher valuations when seeking these types of investments, which typically require a down payment of 25%. In addition to these costs, an investor should also anticipate closing costs, cap-ex (capital expenditures) costs and reserves. Investors typically raise capital to close these assets.
More Complicated: Apartment building investing requires a higher level of expertise on
In short, when comparing the two asset classes, multifamily is a far superior investment vehicle. Although single-family is an easier way to acquire rental properties, this investment strategy has a ceiling on upside potential. By investing in multifamily assets, you are able to receive far more favorable risk-adjusted returns, and more economies of scale and efficiency. If your goal is to amass a profitable rental portfolio, you should take multifamily assets into consideration, as the advantages outweigh those of single-family investing.
Author: Yannik Cudjoe-Virgil
Yannik formed Merlynn Acquisitions in 2017. He has experience in portfolio asset management, real estate investing, investment analysis and financial modeling.
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