Last week I wrote about The 5 Most Annoying Misconceptions Newbies Love. I left one out. Multi-families.
I use “hype” not suggestive that the publicity of the investment is wrong but that multi-family investing, like wholesaling, tends to be a popular claim by new investors who know nothing about what they are doing.
No doubt, multi-family properties (a.k.a. MFRs, for multi-family residences) can be amazing investment deals. The cash flow can be smooth and plentiful, individual residences are all under one roof (literally) which helps in lowering expenses and hassle, and the best is when you as the owner live in one of the units so you can potentially take out an owner-occupied loan at cheaper rates than if you didn’t live there (see New Investor Strategy: How to Buy Your First Multi-Family Investment Property & Live Rent Free for more information on this strategy.)
The reason I group multi-families into my “annoying” category has nothing to do with the quality of the investment but rather the assumption that multi-families are the best thing out there. Moreover, as I said last week, the annoyance really comes from real estate investing newbies who claim their only focus is on something so specific, like multi-families, before they’ve even really even learned to understand what makes a good real estate investment. If you have been investing in multi-families, and the majority of your portfolio is multi-families, awesome! Claim it, shout it from the rooftop, and call yourself a multi-family investor all you want. There is no hype in that. If you’ve never bought a multi-family before, don’t call yourself a multi-family investor. For a couple reasons.
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1. Tunnel Vision
To become a successful real estate investor, you should always be interested in the best deals. When you are choosing a focus, you should first select what type of investing you want to do: rental properties/buy and holds, flips, wholesaling, land, tax liens, commercial, etc. High-level categories.
Under each of those categories, there are several more options that you can focus on. Let’s pick rental properties. What constitutes a rental property? A property in which a tenant pays you as the owner for the right to use it as their own, usually in the form of a monthly rent payment. Owning rental properties deems you a ‘buy and hold’ investor because you buy the property, whatever type it may be, and you hold onto your ownership of that property for some amount of time with the goal being to collect the cash flow it produces from the tenant. That’s it. There are no requirements past that in terms of what kind of property it must be. It can be single-family properties, multi-family properties (including properties as small as duplexes and ranging up to large apartment buildings), office spaces, and even mobile homes.
So you’re a buy and hold investor. Great! What is your goal? To earn the most amount of money you can in relation to the cost of buying. If that is your goal (it is, isn’t?), then how smart are you to only focus on one possibility of potential property types you can buy? What if you are so gung-ho to buy multi-families, all the while single-families are bringing in higher cash flow in relation to how much they cost? Doesn’t that mean then you aren’t making the most amount of money you could be?
Having tunnel vision can cause you to lose out on insanely profitable deals. If the best deals you find are multi-families, then great, buy them up! But only after you know for sure those are the best deals, meaning they will put the most amount of money in your pocket for the least amount of time, money, and effort you have to put into them. If you are claiming, before you’ve bought anything, that you are a multi-family investor, you have tunnel vision and may miss out on a huge cash cow elsewhere.
2. The Fine Print
Another fault of the new investor is to not assume there are actually disadvantages to buying multi-family properties over single-family proprties. Learning the downsides of any investment type really does come a lot with experience, but there are so many upsides to a multi-family property that it is easy to not even notice the aspects that are less appealing. In comparing a multi-family property to a single-family property, let’s look at the obvious advantages, but also the disadvantages.
- Lower price per unit
- Less maintenance costs per unit because of the common areas
- All units in one location
- All units can be managed by one person or company
- One set of paperwork for the whole building versus individual houses
- Rent from one unit can make up for the cost of a vacancy in another, leaving less chance of having to pay any expenses out of pocket
Less Obvious Downsides
- Tenant turnover is notoriously higher in multi-family buildings. The American dream has always tended to lean towards homes, not apartments. Even if a family can’t own, they would usually prefer a house over an apartment if they have the money to do so. This isn’t always the case, but it does tend to cause longer-term tenancy in houses rather than apartments. Tenant turnover is one of the most costly expenses to an owner of investment properties, and statistically you will see way more turnover in the multi-families.
- Tenant quality tends to be lower in apartments because most people who live in apartments only live there because it is all they can afford. Most everyone would take a house over an apartment if given the option, as already mentioned. Because you are dealing with a lower income bracket of tenant, you are automatically at a higher risk for less-than-pleasurable tenants. What is the one thing that can cost you considerably more in expenses than tenant turnover? Bad tenants. Not only do you have to pay for the turnover once they are gone, but you have the expense of lost rents, eviction costs, and likely higher repair costs during the turnover.
- In terms of selling a multi-family property, you are really limited on who you can sell it to. Most likely you will sell to another investor. What do investors want? A deal. Good luck getting full value for your property! You also are limited to selling to investors who can afford the property. Unless you bought a really cheap multi-family that anyone could afford then you may not have a hard time selling it, but then I already know why you are selling it. See previous two Downsides! Compare that to a single-family home which now opens up the possibility of selling to a primary homebuyer. Gold! Primary homebuyers are everywhere and they are the most likely to give you a lot more money for your property.
One note about these downsides- I’m really talking more about apartments and not so much about condos. Condos are a different story in terms of property and tenant quality, as well as tenant turnover, but the numbers on condos don’t usually work out favorably for investors due to the monthly condo fees breaking too far into the profits. So for the purpose of this discussion, I’m really just looking at apartments. Obviously there is a big difference between a duplex and a 300-unit apartment building but just throwing generalizations out.
Do I Buy Multi-Families?
I haven’t yet, but I certainly plan to. There is no argument multi-family properties can be stupidly good deals. They have mega advantages and they can put a nice pretty penny in your pocket. I know I plan to buy them at some point. I want to buy them for the same reason anyone does and especially now because I don’t qualify for a mortgage since I left my corporate job, so I’d love to take advantage of commercial financing.
A couple years ago when I started buying real estate, I of course saw the glam in multi-families as does anyone. I wanted to pursue them. I got sidetracked though because at the time, single-families were wopping multi-families in terms of returns. It would have cost me less to buy 100 single-family properties and get 25-30%+ cash-on-cash returns for each than it would have to buy a 100-unit apartment building for probably closer to 10-15% returns. So I’d have to put up more money, accept lower returns, and have the potential for more tenant expenses and fewer options for an exit strategy if I were to need one. Why would I do that, other than to be able to have all the units under one roof?
I evaluated the two options- buy single-families or multi-families- and it only made sense, as the best investment, to buy single-families. That will not always be the case, especially now since housing prices are back on the rise, but do you see the point? Focus on the best investment. The best investment is always changing. It may not always be multi-families.
Why do you think Warren Buffet said he’d buy all single-family houses and not multi-families? At the time he said that, the profit was in the single-families.
You will never hear me claim to be anything more specific than an investor who buys rental properties. Why? Because who knows which type of rental property will be the best at any one time, so who knows what type of rental property I’ll be buying at any one time.
What’s the term, pigeon-hole? Don’t put yourself in one!