Thinking About Buying a Multifamily? STOP! Wait Until You Read This!
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It’s no secret that I love multifamily properties.
I talk about them on the Podcast.
I talk about them in books.
I talk about them at local BiggerPockets meetups.
But are multifamily properties right for everyone?
Just because some guy on a blog/podcast/webinar says it’s great DOESN’T mean you should go out and buy one. There are pros and cons to multifamily investing over single family.
Therefore, today I thought I’d give you a quick summary of the pros/cons of multifamily investing to help you decide if it’s the right path for you. But first…
What is Multifamily Property Investing?
Multifamily properties are buildings with more than one unit.
A multifamily could be as small as two units in a duplex or as big as thousands of units in a large apartment complex. Few people ever buy a multifamily to live in (though I do love the strategy of “house hacking,” where an individual lives in one unit and rents the other units out), but instead, most multifamily properties are owned by real estate investors who rent the properties out to those who can’t — or won’t — buy a single-family home of their own.
Multifamily classification is generally split into two categories: small and large.
- Small multifamily properties are any properties that contain two, three, or four units.
- Large multifamily properties, therefore, are those with five or more units.
This is an important distinction because of the way these properties are valued and financed. Smaller multifamily properties are considered “residential” to most lenders and are thus seen as no different from an SFR. Large multifamily, however, is considered commercial real estate, and the rules change drastically.
While the value of a residential property (single family or small multifamily) is determined by what the similar house down the street sold for, value on commercial property is largely determined by comparing the ROI one would achieve with that of other commercial properties down the street. More technically, it is based on the ROI an investor would achieve if they did not use a loan. This is known as a "cap rate,” and every location has a different normal cap rate to compare different properties against.
Let’s talk about the pros and cons of investing in multifamily properties.
Pros of Multifamily Investing
More Cash Flow Possibilities
If purchased right, multifamily properties have a likelihood of producing positive cash flow from day one. In addition, rents can be increased a small amount for each unit or expenses decreased and the ripple effect of those changes can cause huge increases in cash flow.
One Loan, Multiple Units
Trying to get a loan is a long, arduous process that no one enjoys. But it is a necessary evil for most real estate investors. This is a huge benefit of investing in multifamily properties: there are fewer loans to obtain! If you were to go out and buy 20 SFRs in the next few years, that's 20 loan applications you'd need to fill out, 20 financial statements you need to prepare, 20 "yeses" you need to hear from the underwriting department. Exhausting, isn't it? Instead, you can buy a 20-unit apartment building and get just one loanâone application, one set of financials, only one yes.
One Insurance Policy
I hate insurance. I understand the importance of it, but the insurance world is just so cumbersome and frustrating. A good amount of my wife’s administrative time is spent just dealing with insurance. We have boxes and boxes of paperwork with nothing but insurance documents. When you invest in a multifamily property, you have one insurance policy on it. It’s so much easier to keep track of and manage!
Math Over Emotion
When investing in multifamily units, I am able to separate emotion from the transaction much more easily than with a single-family home. Multifamily is all about the math, the numbers!
Business, Not Hobby
Furthermore, it’s much easier to treat multifamily investments as a business rather than a hobby because of the nature of the beast. Multifamily properties are designed for investors to own and management companies to run; thus, the cost of hiring such a management company is often figured into the cost of owning the property, leading to less hands-on-management by you.
As I mentioned earlier, multifamily units with more than five units are not valued the same way as SFRs. If I were to sell you my single-family home, the appraiser would look at a few other single-family homes that were similar and base their appraisal on the selling price of those other homes. Commercial properties, on the other hand, are valued based on the ROI they give their owners. After all, it’s not easy to compare a 24-unit apartment building with another 24-unit apartment building with the exact same returns because you’ll never find that exact similar property. Commercial investments are just too different from one another.
Instead, we rely on the cap rate to base value on. If these three properties that recently sold gave the owner a 10% ROI, then this one should also. So why is this income valuation so important? Because the value can be changed internally, rather than relying on others, by simply lowering expenses or raising the income. Small changes to the income can make drastic swings to the value of the property, and a savvy investor can use this to their advantage to supercharge the wealth building process.
Less Competition From Homeowners
When shopping for a single-family home, an investor is competing against tens of thousands of others looking for a home. Most of this competition is in the form of non-investors who buy property for way too much money because the front porch is “so cute” or the backyard is “perfect for Fido!” This can make competition much more difficult, because you are playing the game with a different objective! Instead, when you buy multifamily properties, you are competing with other investors, which means there is far less competition.
Okay, multifamily properties sound pretty terrific. So what’s the downside? Let’s find out.
Cons of Multifamily Investing
First, multifamily properties typically cost much more to buy than a single-family house. This can be a barrier to entry for many people trying to get started, so multifamily is often not considered until much later in one’s investment career. That said, smaller multifamily properties have some lower down payment financing options, and larger multifamily properties often include raising money from other people.
More Management Intensive
I’ll be the first to admit it, multifamily tenants cause more headaches than single-family tenants. They are generally more “transitional” and thus have much more drama in their lives. Tenants stay for shorter periods of time, which can add significant expense to your bottom line. They call and complain for more petty reasons, have more difficulty paying the rent on time, and tend to be harder on units because they don’t always feel like the place is their real “home.” That said, as I mentioned earlier, multifamily properties are often managed by third parties, so the owner doesn’t need to be very involved in the management drama.
More Savvy Competition
Although there is less competition from homeowners when investing in multifamily properties, the folks you are competing against are far more sophisticated than the average homeowner. They can spot a deal just like you can and generally have a lot more capital with which to buy those deals.
Most people can easily wrap their heads around a single-family investment property, but the more units in a property (and the more expensive that property is), the more complicated it all becomes. Suddenly, you are dealing with 20 moving parts rather than just two or three.
Fewer to Choose From
Depending on where you live, there may be a lack of available multifamily properties from which to choose. While single-family homes are plentiful across the world, multifamily properties may be more sparse in your location.
Finally, when you invest in multifamily properties and raise money from others to fund it, you enter a whole new world of government regulations that dictate what you can and cannot do while raising that money. If you do it wrong, you might end up wearing an orange jumpsuit and earning $1.38 an hour serving soup to other white-collar inmates.
So, Should You Invest in Multifamily?
Should you invest in multifamily? Or stick with single family? Or commercial? Or raw land? Or something else?
I wish it were that simple.
I’m not going to be the guy who says, “This is the right path” or “This is the only way to invest!”
There is never one right path, but there may be a right path for you.
My goal is to help you see the pros and cons of each choice and allow you to weigh the options and make the best decision for you and your family. Furthermore, although I believe that focusing on one niche is helpful, it is possible to try to invest in either single family or multifamily and just see which comes up first.
As long as you are willing to do the work and learn to run the numbers on either one, you can pursue both and buy whatever crosses your radar first.
Are you? Let me know in the comments below this post! Why do you want to invest in multifamily? Or why not?
Remember, your comments will help others who read, so let’s hear your thoughts!