Let's play devil's advocate

7 Replies

I've been recently looking for smaller apartment complexes in my area (DFW). 

I understand the market is hot (some would say stupid-hot) but I can't shake the feeling I'm missing something. 

So I'd like to play devils advocate against myself here and see if you could help me see the light or where my logic is flawed. 

Option #1: smaller Multifamily with 30 units.

Let's assume that purchase price is about 1.5M and I can get $250 cashflow per door per month. That's a total of $7,500 per month or $90,000 annual which places our cap rate at 6% (market cap rates are 5-7 for B/C class these days)

Option #2: Four single family properties:

Simple math says that in order to get $7,500 / month I need singles that cashflows $1,875 /  month. Let's use the 50% rule and get to $3,750

Use the 1% rule and we get to a purchase price of $375,000 each.

Now the simple multiplication of $375,000 X 4 = 1.5M

Soooo, head ache and paint of 30 lower end (B/C class) tenants or 4 higher end tenants ($375K in DFW are very nice houses in good neighborhoods)?

I know I skipped some of the math such as vacancies, turnover maint, appreciation etc but I wasn't sold on these being the major decision factor (please DO correct me if I'm wrong here)

What am I missing? 

Does apartment complexes only make sense at larger units numbers?

What tips the scale either way?

Those smaller things tip the scales, the devil is in the details. Rentability would be the biggest in my opinion. It would be a lot easier to rent out a  B/C apartment than an A house. Most people do 2-3x rent as qualification for renting a unit. So for your house, the tenant would have to make $7500 - $11,000 a month (90k-135k per year). Your apartment tenant would have to make $1000-$1500 a month (up to 18k per year). So it would depend on your market: are there more people who make 120k a year who don't want to (or can't) buy a house or people who make $9/hr who can't buy a house.

Another aspect is the ability to add value to an apartment complex from raising rent, adding coin-op laundry (debatable on the profitability), rental storage, soda/vending machines not to mention the natural appreciation. Those houses can only appreciate with the market.

Someone else should comment on the ability to get a loan on a 30-unit vs 4 houses.

I might have misunderstood the underlying assumptions of the model, but a net cash flow of $1875 on a single-family home seems very high.  Remember that both the 50% rule and the 1% are just rules of thumb (by the way, the 50% rule does include maintenance and vacancy), and the 1% rule is what you want to get, not what you should expect to get on any given property. The better the neighborhood, the lower that percentage is. You are basically accepting a lower ROI in exchange for the peace of mind of having good tenants with good neighbors.

The thing you might be missing is this: Can you actually rent a $375,000 single family home for $3750 in your market? In my market, a $375,000 single family in an A neighborhood will rent for about $2000-2500 max. The low end of that would barely cover all the expenses after mortgage, tax, insurance, and maintenance - nevermind vacancy. That's why I invest in multi-family homes a few towns away from where I live: it's where my ROI is best. If you can really achieve the 1% rule on such an expensive single family, then go for it, but the apartment cashflow sounds more realistic to me.

Ahhhh I realized where I misunderstood, and now have a much better answer to the question: the 50% rule does not include the mortgage, so you have to take that out of your $1875, too.  If you're putting 25% down and paying 5% on the loan, that's still going to end up being $1500 or so, knocking your actual return to $375 a month, much more in line with $100 per door "rule," even if you can get that six-figure-income tenant to pay $3750 a month for a $375,000 house.

 @Joseph Gozlan :

I recently had to answer this same question for myself. Do I buy 4 SFR or go multifamily? I had planned going class c so the hassle factor didn't play into my decision. It seems to be a concern of yours. Is that why you're thinking of those higher end rentals?

I feel higher end renters while they take better care of the place they also tend to expect more. Not sure how that plays into your thinking. I wanted to throw it out there just in case. 

Trying to hold high end rentals will need deep pockets. A single vacancy will drain funds quickly. In comparison vacancies in multifamily are easier to absorb due to its scale.

A 30 unit multifamily @ 1.5 mil implies you’re buying at 50K a door. Buying at that price point is a challenge in the current market. It can be found but it’s going to take time to find and even more time to turn around. Recently I was looking at a 21 unit @ 30K a door. On paper it was making $50 per door monthly. The reality is it was losing $30 per door monthly. It would lose even more during the first year.

Smaller multifamily owners are looking to 1031 into larger investments. Since finding deals are tough they are just staying put.

I chose multifamily. The ability to increase value in multifamily puts me in control of my investment. I just have to invest in the right deals.

Best of luck with whatever you decide. 

I just want to know where you think you are going to buy a $375k house that will cash flow, assuming you're using anything close to a standard financing arrangement  (~20% down).  Your mtg payment, insurance, maintenance and vacancy reserves are only the tip of the iceberg. You're likely looking at property taxes pushing  $8k a year or higher. 

Thanks everybody for the responses. 

A couple of things:

1) the title says "let's play devil's advocate" this should've implied that I already subscribe to the idea of "multi-family is better"

2) I should really not post things like that at midnight :-D

@Matt Slakey dealing with the lower end tenants is a concern. Although I will have PM in place to handle the property, the turnaround, the evictions and the refreshing you HAVE to do every time a tenant leaves are a headache and a cost that comes more often with C class tenants.

@Kevin Siedlecki you actually nailed it on the head. In my calculation above i included the mortgage in the costs of the multi but not in the costs of the singles. The math should have indicated higher cashflow for the multi units since I was assuming cash payment of the 1.5M to simplify the scenario.

Did I mentioned I shouldn't be posting these things at midnight?

@Alberto Camacho This is a theoretical discussion. The question of where/if I can find such a unicorn of a house that sells for $375K and cashflows is not the subject of the discussion. As for the mortgage costs, the main assumption was paying cash (see my answer to Kevin above). If we were to do a full technical analysis we would have to compare commercial loans to 30 years conventional and factor in risk and expected rate changes on the 5/10/15 year terms the commercial loans carry. I was trying to keep it simpler.

Once again, thanks everyone and keep the comments/responses coming. I find this discussion very useful!

If the devil is in the details, then where is his advocate??

The difference between a newbie and a pro, is their understanding of all these "details" that you only learn from experience - which means they can possibly play closer to the "edge". Still no excuse to buy stupid


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