Single Family or Multifamily? 5 Reasons Apartments Should Be Your Next Investment
Whether you're brand new to investing or a seasoned investor, investing in single family homes or apartments is an often contemplated topic.
Investing in real estate has created more millionaires throughout history than any other asset class. As we know, though, real estate is quite broad. You have segments like mobile homes, land, self storage, apartments, single family rentals, and so on. For the purposes of this post, I want to focus on the last two. It's been debated for a long time whether one should grow their wealth using multifamily or single family rentals. Not only that, but a recurring question: "is it possible to get started in multifamily as a beginner?"
Before going into specifics, it's a fair assumption that most people look to single family investing because it's easy to understand; homes are all around us. You're much more familiar with houses...people all around are taking out loans to purchase them, and maybe you're one of these people. Needless to say, it's not as common to see this with multifamily buildings. Let's analyze 5 categories to help understand the pros and cons of each investment opportunity:
1) Income & Returns
Evaluating investment returns and income, especially in real estate, is a difficult topic to discuss broadly, because real estate is hyper-local. However, generally, the reliability of income from multifamily investments will be greater than that of single family. One contributing factor is vacancy. If you own a single family rental, it contains 1 unit. When 1 unit goes vacant, you are at 0% occupancy. In contrast to a 100 unit building, when 1 vacancy occurs, it leaves you with 99% occupancy. A 2nd reason is that multifamily buildings are purchased as an investment. Nobody is in the marketplace buying multifamily properties as their primary residence. This matters, because as soon as returns or cashflow are no longer sound, the capital investments in multifamily assets will disappear. Stack this against single family, where only about 25% are purchased by investors. In today's environment, identifying single family markets to invest in that produce solid cashflow & returns has become increasingly difficult, given rising prices.
The topic above goes hand & hand with how these asset types are valued in the first place. If you've ever bought a home, or just like to poke around on Zillow, you are likely familiar with the "sales comparable" approach to valuation. All this means is the house you own is going to be similarly valued to the house down the street that has similar features. Said differently, the price you buy or sell your single family rental for is going to fluctuate based on the ebbs and flows of the market. There's very little control.
When looking at multifamily property, these are valued on what's known as an "income approach" to valuation. In other words, it's valued like a business. If expenses can be decreased and/or income increased, that has a positive affect on NOI. A higher NOI means a higher valuation. Read: more control. So how do we increase income or decrease expenses?
3) Professional Management
In the single family market, it's very difficult as an investor to find good, reliable management. Reason being, the income produced from the individual home isn't as high. If rent is $1,000/month and the management company's fee is 10%, that's only $100/month in income. Compared to a 100 unit multifamily property, the income could be $100,000 and management might take a 6% fee, earning them $6,000/month. Not only is that better for the management company, but a lower fee is more attractive to investors. Much of this topic has to do with scale.
Would you rather have 100 single family houses, which contain 100 roofs and 100 yards, all spread throughout your city? Or 100 units paying rent under 1 roof? This is the advantage of scale. It all comes down to efficiency.
That efficiency leads to stronger lending terms, lower costs, and more negotiation power with vendors & contractors. If enough units justify it (typically 100+), you can even have a full time manager on-site.
Many people will make the argument that it's hard to come by a truly passive investment - at least in real assets. Most investments involve vetting, some form of relationship being built, and the beloved tax work associated with the investment. That said, think of passivity as a spectrum. On the far left, you have 100% passivity, and the far right, no passivity at all. You have to ask yourself where you want to be on that spectrum. Purchasing single family rentals will definitely lean toward the right side. You are responsible for identifying what to purchase, if the numbers make sense, getting a loan, the list goes on. That's not taking into account the volume of work after the purchase, especially if you decide to self manage. Discussed often in the industry are the "3 T's" - tenants, termites, and toilets. You must contemplate becoming a landlord and if the amount of work involved is worth your time.
Unless you are deciding to start your own company as a multifamily operator or syndicator (for which I commend you!), all of the things mentioned above go away. You simply place your capital in a deal, receive distributions, and file the K-1 tax form that your sponsor provides once per year.
The 5 categories above are not exhaustive, but are some of the fundamental differences to consider between single family and multifamily investments. For my audience, who tends to be mostly working professionals, the most important to consider is #5. If your sights are set on raising kids, focusing on a career, and traveling, then passivity in your wealth building journey needs to be top priority. Let's setup a call and discuss whether or not multifamily syndications make sense in helping you achieve your financial goals.