When considering real estate investment opportunities, there are a lot of options. Investors can focus on single-family rentals, multifamily, or a wide variety of triple-net commercial properties. For residential real estate investors, however, multifamily assets have a variety of advantages and are ultimately a more effective growth strategy than single-family homes. Apartment investments are more efficient, offer better returns and easy scalability—but that isn’t to say that single-family rentals don’t offer upside. So, let’s take a look at the pros and cons of apartments and single-family rental investments.
Before we catalog these benefits, remember to compare apples-to-apples. Not all investment properties are created equal, and market and asset quality will play a significant role in the viability of an investment.
Three factors contribute to the internal rate of return (IRR) for multifamily: up front capital costs, cash flow from operations, and the sales price. Although purchasing a multifamily property is more expensive overall, the cost per unit in many markets is generally lower than a single-family residence. Even in the most expensive markets in the country where SFR investors have been priced out, small apartment buildings are still affordable on a price-per unit basis.
The income for an apartment building is also more attractive. A well-maintained multifamily property will generally have a lower vacancy rate and more per-unit profitability, resulting in superior cash flow. With lower per-unit property management and carry costs, multifamily properties will generally outperform a portfolio of single-family properties.
Lower Cost Structures
Multifamily properties benefit from economies of scale, including lower costs for repairs and improvements. Everything from a roof replacement to property insurance and marketing costs will enjoy a per-unit discount when you invest in multifamily properties. This lower cost also applies to administrative responsibilities, like oversight and management. A collection of SFR properties require more time and attention than a single apartment building.
Vacancies Are Spread Out
More tenants per property also means less vacancy risk. Think about it this way: if a single-family home becomes vacant, the owner has 100% vacancy and is responsible for the full mortgage until the property is re-leased. If a unit in an apartment building becomes vacant, only a fraction of the property is vacant and only a portion of the income is lost. In most cases, apartment owners have leases starting and terminating at different times during the year, decreasing the opportunity for multiple vacancies at one time.
Better Financing Scenarios
Traditional financing is generally available for the first four single-family properties you buy, assuming you have plenty of up-front cash and great credit. Beyond that, you’ll be cobbling together a variety of loans in order to scale up your business. For multifamily investment, you may be better able to prove the potential and creditworthiness of your property and show more consistent cash flow, making your multifamily property more attractive to lenders. Additionally, government-backed agencies like Freddie Mac and Fannie Mae continue to be active in the small loan category.
In order to build a significant SFR portfolio, it will probably be necessary for you to own properties in a variety of markets—perhaps even distant secondary markets in other states. This means a variety of market and property analyses, property management services of varying effectiveness, and a host of local and state laws to follow. By contrast, one multifamily property can provide the same ROI with significantly less time and money spent on management and far greater risk mitigation.
For independent investors, single-family portfolios have a limit at which point they become challenging to scale. SFR portfolios have several mortgages, financing options, property taxes, governmental entities, and property management services. Multifamily properties build in scale by maximizing appreciation, cash flow, and diversification.
In investing, there is always a downside. It’s important to think through the potential drawbacks that can come with apartment ownership.
More tenants can also mean more conflict. Conflicts between tenants can cause difficulty with tenant retention and lead to unnecessary vacancies. For this reason, it’s important to ensure that your property management company is responsive and able to smooth over small grievances in order to keep tenants happy.
Single-family homes typically sell faster than apartment buildings because both homeowners and investors are potential buyers. If you know that you want to keep a percentage of your investment portfolio available for quick liquidity, it might make sense to diversify and maintain a percentage of investment properties that are smaller and easier to sell. By and large, however, a long-term hold position will always produce better returns.
For new investors, a single-family home can seem like a more manageable proposition than investing in multifamily, and it is often more affordable, as well. However, you can start small in the multifamily arena. The right multifamily investment can allow you to earn a significant return from day one.
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