Just the other day, I had lunch with my investor buddy, who worked for years as a CPA, watching his clients make money from numerous commercial real estate deals. Eventually, he decided to enter the world of multi-unit apartment investing himself, and he’s been very successful. In recent years, he has bought and sold more than 1,000 apartment units valued at over $30 million.
It seems clear, though, that my friend’s prior experience helped him immensely, especially when it came to understanding the commercial side of real estate investing. Most new investors don’t have that level of experience or access to capital right out of the gate, so they start out in real estate by investing in single-family residences (SFRs) in order to learn the basics.
It may also be the case that investing in SFRs aligns better with the investor’s goals. After all, no one said that you have to transition into multi-unit apartment investing. It’s not always the right move for everyone nor is it the best strategy for every situation.
So, what are the differences between these two strategies? How do you determine which is right for you? Let’s take a look.
Investing in Multi-Unit Apartments: Pros & Cons
With multi-unit apartments, especially those over four units, many of the advantages have to do with scalability and growth potential.
Pro #1: Easier to Raise Rents All At Once
By adding amenities or making improvements to your complex, you can raise the rent on all of your units. Appraisals and future values are also based on net operating income, as opposed to comps nearby, which is a common consideration when valuing residential properties.
If you were looking to raise rent on all of your SFRs, you would have to drive out and make improvements to each property separately.
Pro #2: On-Site Property Management & Maintenance
A rule of thumb is that if you own at least 100 units, it may be more affordable to hire a property manager and on-site maintenance. This would free up some of your time as well, allowing you to focus more on the growth of your portfolio.
Pro #3: Possibility of Non-Recourse, More Flexible Financing
If you have a certain number of units (i.e. greater than 70-100 units), you may even qualify for a non-recourse loan, which would not require you as the owner to personally sign.
Financing can be flexible in some ways. For example, the buyer’s lender may allow the seller to carry a second mortgage. You may also raise private equity or borrow private money to fund the deal.
Con #1: Rates & Terms Sometimes Less Favorable
Commercial financing can also, at times, be more strict than residential. Not only is a larger percentage of capital needed to fund the deal, but the term is typically shorter, interest rates are sometimes higher, and there’s the possibility that the loan will be recast in 5-7 years.
Con #2: More at Risk
Operating on a larger scale and purchasing more expensive, multi-unit properties, whether you’re using OPM (other people’s money) or not, may require a higher level of risk-tolerance. There’s more at stake, and your risk is not spread out amongst cheaper properties.
Investing in Single Family Residences: Pros & Cons
When compared to multi-unit apartments, a portfolio of SFRs has less economy of scale, but it isn’t without its benefits.
Pro #1: Less Expensive with Better Financing Options
Of course, SFRs are often less expensive than multi-unit apartment complexes, but another big advantage of this investment type is the eligibility for more favorable financing.
For example, there are several programs with very low down payments for first-time homebuyers, which may be perfect for you if you’re just starting out. Owner-occupants also receive more favorable terms, allowing investors to build their portfolios by buying intentionally and living in each property for at least a year and a day. Of course, the bank may cut you off once you own a certain amount of properties in your name.
Pro #2: Fewer Expenses
Another advantage is that you may also have fewer expenses, as tenants in SFRs typically cover more utilities and stay longer than they do in apartments, resulting in a lower vacancy rate. There are usually fewer common areas, so you would likely save on maintenance costs as well.
Con #1: Property Management Spread Out Over a Wider Area
In a portfolio of multiple SFRs, maintenance work is usually spread out among multiple properties in different locations.
Which Do I Prefer?
When I started out, I invested primarily in SFRs, but today I invest in both.
At my stage of the game, I’ve had enough aggravation when it comes to managing properties, and I’m looking for something more passive with less management and maintenance.
If I’m looking to invest in less than 100 units, I would just do SFR deals, as the tenant would be more involved in the upkeep of the property, and I wouldn’t need to pay for on-site property management or maintenance.
When it comes to multi-unit buildings, my focus would be on purchasing those that have at least 100 units, as this makes property management and maintenance more affordable. Plus, I would likely be eligible for a non-recourse loan, where I wouldn’t need to personally sign.
So, both of these strategies align with my goal of investing more passively. That said, my goals have definitely shifted over the years, and what’s right for me now may not have been right 30 years ago.