Help me understand the advantage of multi's

Eric James · 2018-01-31T08:53:40-08:00

I frequently hear/read that large multifamily properties (i.e., apartment complexes) produce better returns than SFH or small multifamily (2-4 units) properties. I just can't see it in the numbers, as I can figure them. When asking why large multis are better than SFH I've gotten responses such as 'economies of scale', meaning maintenance and property management are cheaper when done in large numbers and at a single location. However, if I'm not mistaken, cap rates take these expenses into account, and cap rates under 10% just don't look like good deals to me, in comparison to SFH returns (at least those I have access to). Please tell me if you think my analysis below is on track, or if it is mistaken somewhere. Let's say we look at every $100,000 of property value of a MFH compared to SFH. If an apartment complex is at a cap rate of 8%, this means net operating income (gross income - operating expenses) =$8000/year. This comes out to $667/month for every $100K of property value. Say the debt service is $550/month (80% LTV, 5.5% interest, 20 year amortization), that leaves net income of around $117/month. I also believe the calculation to this point does not include capital expenditures. This $117/month – capex isn't very impressive, compared to the return I'd expect from a $100K SFH purchase. A positive aspect of MFH can be forced appreciation, that is, renovating etc. to be able to raise rents and property value. Let's say rehab is done so as to allow a 25% increase in rents (e.g. from $800/mo to $1000/mo), so as to increase cash flow by $200/month, that takes you to $317/month - capex. That is an improvement, but still something achievable with a $100K SFH that you rehab (e.g. BRRR). The rehabbed MFH will now have a greater resale value (due to the increased rents), but so will the rehabbed SFH. One positive with the SFH route is that by using the BRRR strategy you can refinance and pull all your cash (or more) back out quickly, rather than having to wait for the time it takes to rehab an apartment complex before refinancing or selling (which is an opportunity cost). Some might say a benefit of purchasing an apartment complex is the time savings of being able to make a single purchase (for example) of $2M, rather than 20 purchase of $100K SFH. However, it seems to me that the process of finding, negotiating, doing due diligence etc. for a $2M apartment complex may not be much less than that of purchasing 20 SFH.Another advantage I've heard claimed about MFH is that if you have 40 apartments, one or two vacancies don't hurt your cash flow that much, compared to having a vacancy in a single SFH. In this case an appropriate comparison would actually be having one or two vacancies out of 20 SFH (or whatever number would equal the value of the MFH used in the example), which wouldn't be that bad. I can see there being an ego boost in buying an apartment complex, which could make someone feel like ‘one of the big boys’, but I just don’t see it in the numbers. I keep looking for the big advantage of large MFH, but haven’t been able to see it in the numbers. What am I missing?

Fred Heller

Real Estate Agent/Property Management · Houston, TX · Member since 2014 · 1k+ posts · 827 votes

8y

@Eric James Let me give you an example of why multi-families are better than single families.

I recently sold a 4-plex in Humble. Our offer was for $225K, but we negotiated down to $213K after the inspection uncovered some issues.

We got it so cheap because the seller was one of those absentee landlords who never raised the rents, and didn't really take good care of the property. All four units were renting for $550 when the market rent in that neighborhood is $900.

Even if we did absolutely nothing to increase rents, the monthly rents on this place were $2200 on an investment of $213K. It is very unlikely that you can get $2200/month on a $213K house in Houston. More likely, you're looking at $1500 to $1700 tops.

Fast forward to January. We increased the rents to $700/month plus a $25 pet rent for those who have pets. Three of the four tenants remain. We lost one, but the incoming tenant is going to pay the market rate of $900. So now we're getting $3050 for a property my clients paid $213K.

Once we get all units up to market rate, the rents will be $3600. There's no way you're going to get that kind of return on a single-family property.

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Eric James

OP

Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes

8y

Originally posted by @Fred Heller:

@Eric James Let me give you an example of why multi-families are better than single families.

I recently sold a 4-plex in Humble. Our offer was for $225K, but we negotiated down to $213K after the inspection uncovered some issues.

We got it so cheap because the seller was one of those absentee landlords who never raised the rents, and didn't really take good care of the property. All four units were renting for $550 when the market rent in that neighborhood is $900.

Even if we did absolutely nothing to increase rents, the monthly rents on this place were $2200 on an investment of $213K. It is very unlikely that you can get $2200/month on a $213K house in Houston. More likely, you're looking at $1500 to $1700 tops.

Fast forward to January. We increased the rents to $700/month plus a $25 pet rent for those who have pets. Three of the four tenants remain. We lost one, but the incoming tenant is going to pay the market rate of $900. So now we're getting $3050 for a property my clients paid $213K.

Once we get all units up to market rate, the rents will be $3600. There's no way you're going to get that kind of return on a single-family property.

You don't think it is possible to get that kind of return on a SFH? You purchased it for $213K. It sounds like you had to put some money into it (inspection uncovered some issues, absentee landlord, probably deferred maintenance). What are you all in for, $250K or more? If total rents are $3600/month this is 1.44% of total investment (est $250K). That is definitely possible with SFH. I can believe that your ongoing expenses will be less than for a SFH, but not by an order of magnitude. Another factor that sometimes gets left out of these discussions is that SFH have somewhat less tenant turnover than MFH.

Your general point seems to me to indicate an advantage of purchasing small properties, whether they are small MFH or SFH.....because there the seller's aren't pros and will sell at a discount. I doubt there are very many owners of large MFH that will sell at a large discount just because they are tired of the headache, but I could be wrong.

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Eric James

OP

Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes

8y

Originally posted by @Todd Dexheimer:

It's about growth/scale. Unless you can buy 100+ SF's in a small 5-10 mile radius it is hard to grow and scale. Think about buying 1000 units in Multi-family. That would be 5-200 unit buildings or 10 - 100 unit buildings. Try doing that with SF's.

The other thing is the numbers that most people use on singles is not realistic. Most people don't account for all the little expenses, like you do in a MF deal. I have owned nearly 100 SF's at one time and understand the difficulty of that and have seen that as you obtain more units, spread out your cash flow/building actually goes down.

I look at return, but I also look at the best business model. For me the time and effort it takes to make $200-$400/mo on a house is not worth it, even though I can get a 15%+ CoC. I'd rather make $20k/mo on an apartment at only 9-12% CoC

If someone has the goal of growing to the point that they would own 1,000 SFH, that would seem unwieldy, and large MFH would be a better option. That is a good point that I can definitely agree with. The same would probably go for someone who has several million $ to invest.

I can understand choosing a simpler, more easily managed business model in exchange for a few percent lower return. However, I don't know as I would choose a 9-12% CoC return over the BRRR model, where you end up with essentially no money left in the deal once rehab is completed.

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Eric James

OP

Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes

8y

Originally posted by @Michael Le:

Originally posted by @Eric James:

But that's part of my point: with the kind of capital it takes to buy large multis you can do a LOT of anything.

Maybe that one reason is good enough for you then. Finding investor capital for MFH is much easier. Instead of getting capped at 10 houses by your bank or chasing down private and hard money lenders with 10-15% interest rates, you can raise capital to buy MFH.

I'm not capped at 10 houses by my bank, but I agree that using hard money at 10%+ isn't something appealing to me.

Regarding raising capital, I've never seen much of an advantage in getting together a number of partners/investors and sharing proportionally in the return. What I would be making on my money would still more or less be the general rate of return on MFH.

What I could see being a huge advantage is if the return is not proportional. For example, the other day I was listening to a podcast talking about a General Partner/Syndicator getting 70-80% of the returns, due to their experience, knowledge, and work on the project. Do I understand that correctly? If so, I could see that being a huge advantage for the person with that experience and knowledge of large MFH.

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Eric James

OP

Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes

8y

I can agree with this. The only thing I would quibble with is that lower cap rates are 'better' investments. I would say they are 'safer' investments. For someone willing to accept somewhat greater risk for a higher return, perhaps they aren't a 'better' investment.

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Anthony GaydenPro Member

Rental Property Investor · Omaha, NE · Member since 2014 · 2k+ posts · 3k+ votes

8y

@Eric James

Let's not forget about the other costs associated with purchasing multiple 1-4 unit properties. The closing costs and the costs for inspections are going to be far higher for multiple single family homes purchased with bank financing. Also it will take more time and effort to locate and purchase a large number of single family homes.

I believe that single family homes are the future of rental real estate. The US is becoming more of a rental nation, but I do not believe that people with families will choose to live in apartment complexes over single family homes. People want space and privacy.

The big investors will overlook single family homes because it is more difficult to scale, but that means that smaller investors such as ourselves will have the opportunity to jump in there and make some real money.

Lately I have seen multifamily deals that were pure garbage. C class duplexes selling for two and a half times as much as a single family home in the same neighborhood. To me that is just idiotic. For that reason I am looking primarily at single family.

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Eric James

OP

Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes

8y

Originally posted by @Anthony Gayden:

@Eric James

Let's not forget about the other costs associated with purchasing multiple 1-4 unit properties. The closing costs and the costs for inspections are going to be far higher for multiple single family homes purchased with bank financing. Also it will take more time and effort to locate and purchase a large number of single family homes.

I believe that single family homes are the future of rental real estate. The US is becoming more of a rental nation, but I do not believe that people with families will choose to live in apartment complexes over single family homes. People want space and privacy.

The big investors will overlook single family homes because it is more difficult to scale, but that means that smaller investors such as ourselves will have the opportunity to jump in there and make some real money.

Lately I have seen multifamily deals that were pure garbage. C class duplexes selling for two and a half times as much as a single family home in the same neighborhood. To me that is just idiotic. For that reason I am looking primarily at single family.

Multiple closing costs and inspections may be greater when purchasing multiple SFH. I don't really know what they are for large MFH, as I've never purchased one. I've heard it said before that it takes more time and effort to locate and purchase a large number of SFH, but I'm not sure if that is accurate. From what I have heard, it sounds common for it to take someone over a year and a lot of time/effort to find and purchase a large MFH. With the same amount of capital needed to purchase a large MFH, I think someone could also purchase a lot of SFH in a year.

I see the same thing in my area regarding small MFH (2-4 unit) being overpriced, compared to SFH. I can see there being some cost savings to purchasing a duplex, compared to a SFH, but not nearly enough to justify the higher prices.

I agree with you that a SFH is most people's first choice for living. In large cities I can see there being a large number of young professionals and others who want to rent. But apart from that I think people's first choice is to live in a SFH. Where I own SFH rentals, and even a triplex, I don't really consider large MFH complexes to be direct competitors. They offer something completely different than a SFH. Even in the triplex I own, I get renters who are tired of living in a complex and are willing to pay more in rent for a similar size apartment that isn't in a complex.

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Anthony GaydenPro Member

Rental Property Investor · Omaha, NE · Member since 2014 · 2k+ posts · 3k+ votes

8y

@Eric James

I think one of the best benefits of 1-4 units is the ability for almost anyone to get started investing. I do not come from wealth and my full-time career is not high paying. Still I was able to relatively easily scale up to multiple small properties.

Overcoming the first steps in investing are already hard. Trying to do that when properties are costing $1,000,000+ and you need down payments in the hundreds of thousands of dollars can seem impossible to a newbie coming from an average middle class job. Smaller properties offer the opportunity for a lot more people.

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Michael Le

Developer · Houston, TX · Member since 2015 · 1k+ posts · 1k+ votes

8y

Originally posted by @Eric James:

You keep saying that but I have never seen that to be true. It is true that there are some investors doing 100 houses a year but they usually run a business with multiple people doing acquisitions and then many large crews of workers doing the rehab work. But they are by far the outliers. Whereas it is not uncommon at all for MFH investors to buy hundreds, even thousands, of units a year. And that doesn't usually require them having their own employees to accomplish.

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JD MartinBusiness Member

Moderator

Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 17k+ votes

8y

As soon as I hear someone speak in absolutes like "better" my ears more or less turn off. There's no such thing as better or worse on a macro scale, like the entire US, the North American continent, the world, the State of California. The only thing that matters is what is more or less profitable, and achievable, for the individual within the market that he/she wants to invest. Some areas MFH is far better than SFH. Other areas it is reversed. Both have their advantages and disadvantages. You can holler about being able to scale, but you can also lop off 1/4 of a SFH portfolio just to back off a little bit, rather than sell the entire apartment complex. You can sell a SFH to a family. You can lose a SFH for whatever reason with no risk to the rest of the portfolio.

There's no right answer. There's only the answer that works in the market that you are in. If you want to own 10,000 units, then you have to realize that's very difficult to do when you are doing it one house at a time. But you also have to look at what you are trying to achieve - lots of markets you can achieve double the cash flow on SFHs as you can on apartments.

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Eric James

OP

Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes

8y

Originally posted by @Michael Le:

Originally posted by @Eric James:

You keep saying that but I have never seen that to be true. It is true that there are some investors doing 100 houses a year but they usually run a business with multiple people doing acquisitions and then many large crews of workers doing the rehab work. But they are by far the outliers. Whereas it is not uncommon at all for MFH investors to buy hundreds, even thousands, of units a year. And that doesn't usually require them having their own employees to accomplish.

If we're talking about 100s of units every year, absolutely.

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Eric James

OP

Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes

8y

Originally posted by @JD Martin:

As soon as I hear someone speak in absolutes like "better" my ears more or less turn off. There's no such thing as better or worse on a macro scale, like the entire US, the North American continent, the world, the State of California. The only thing that matters is what is more or less profitable, and achievable, for the individual within the market that he/she wants to invest. Some areas MFH is far better than SFH. Other areas it is reversed. Both have their advantages and disadvantages. You can holler about being able to scale, but you can also lop off 1/4 of a SFH portfolio just to back off a little bit, rather than sell the entire apartment complex. You can sell a SFH to a family. You can lose a SFH for whatever reason with no risk to the rest of the portfolio.

There's no right answer. There's only the answer that works in the market that you are in. If you want to own 10,000 units, then you have to realize that's very difficult to do when you are doing it one house at a time. But you also have to look at what you are trying to achieve - lots of markets you can achieve double the cash flow on SFHs as you can on apartments.

Thanks JD. Great points!

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Shawn L.

Rental Property Investor · Natick, MA · Member since 2015 · 128 posts · 188 votes

8y

Originally posted by @Michael Swan:

Hi @Eric James,

.... I am not at the mercy of comps. With single family (1-4 units), I am 100% at the mercy of comps.....

Maybe I'm taking this out of context, but are you not at the mercy of the market cap rate? Everyone knows cap rates have compressed in recent years, are they somehow immune to market forces that would push them back up?

I am looking to move up to larger buildings in order to scale more efficiently, but I recognize that the market does still have some effect on asset values. Curious what everyone's thoughts are on this.

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Rick S.

Investor · Oceanside, CA · Member since 2017 · 61 posts · 22 votes

8y

I have yet to purchase multi-family, however, at the moment I am considering it. If interest rates continue to rise in the future, is there any reason that Cap Rates wouldn't follow and rise as well?

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Michael Le

Developer · Houston, TX · Member since 2015 · 1k+ posts · 1k+ votes

8y

Originally posted by @Rick S.:

It likely would but it could stay the same or even (although unlikely) still compress. The cap rate is a function of demand of the asset. Higher interest rates could blunt that demand but if investors still decide there are no other better alternatives then the demand for MFH will stay high and keep the cap rates down.

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Immanuel Sibero

Carrollton, TX · Member since 2015 · 415 posts · 371 votes

8y

@Shawn L.

Agree with you.

Everyone is at the mercy of the MARKET. Those who play the residential game are at the mercy of the market by way of direct sales "comps". Those who play the multifamily apartment game are also at the mercy of the market by way of cap rate "comps". We are all at the mercy of "comps". So essentially, "comps" IS the market.

The suggestion that only single family house valuation method makes use of "COMPS" is incorrect because multifamily apartment valuation method also uses "COMPS". So one method uses "sales amount" comps while the other uses "cap rate" comps.

Well at least this is what I understand from reading BP forums... comments welcome!

Cheers... Immanuel

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Andrew SyriosPro Member

Moderator

Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes

8y

Forced appreciation is a big advantage as well as its easier to manage because it's all in one place. But probably the biggest advantage is just economies of scale. It's much easier to buy a 100 unit apartment than 100 houses (although we have tended to do that latter).

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Michael Swan

Rental Property Investor · San Diego, CA · Member since 2014 · 1k+ posts · 2k+ votes

8y

My properties that I am picking up, latest 34 units at $33,825 a unit. The cap rate for this Blue Collar neighborhood is about 8.5. I am picking up properties $6,000-$8,000 under market. I find complexes that are at least $80.00-$100.00 under market rents. I force appreciation. If the housing market crashes for some reason in NE Ohio, it is already low and if people start losing there houses again, due to overextending themselves again etc... they have to move somewhere. Why not my little 2br 1b that rents for $695-$720 a month or 1br 1ba that rents for $595-$620.00. If they lose there house, they have to live somewhere. Why not an affordable apartment complex in a safe neighborhood.

Swanny

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Jonathan R McLaughlin

Rental Property Investor · Boston, Massachusetts (MA) · Member since 2016 · 2k+ posts · 2k+ votes

8y

Fun thread, thanks @Eric James !

I think you have a couple of different points mixed in about SF's v. MFs. We are in both and I'd agree with the general points that

MF's are usually more cash flow overall and benefit from efficiencies, economies of scale and ability to add value.

But I'd also add that you can benefit more from a MF if you pick the right location than an SF--more chips on the slot if you will--and the paydown starts to get significant, too.

And things start to turn into really separate beasts the larger the dollar amounts. A $1M house is usually capped in income, liquidity and market potential much more than a $1M MF of which you could have all types, not to mention $10M houses, there are only so many Taylor Swifts to buy those things, and its a pretty specialized field. Tons of options in multis there..... and 1% of 10M is 100,000 while 1% of 100,000 isn't worth much time.

Going a little overboard to make a point :)

I agree that its hard to see the value at 5-7% in lots of properties --people are paying more and more for the same size of income stream. Just because thats what people will pay that doesn't mean its the best idea and cheap money and investment size hedging bets (i.e a safe place for cash) are creating a lot of the downward pressure on cap rates. Especially foreign investors are willing to take nearly negative returns just for perceived safety. Not sure I'd want to walk that path.

We don't feel we can make reliable money unless things are over 8% (for real, with actual vacancy, turnover repairs, pm, taxes and reserve) and income stream can be increased and expenses reduced. We finance, so our margin doesn't have tons of room. I think you can still do that with decent places in lots of secondary and tertiary markets (25K-100K population around the US median income, not glamorous but solid) that haven't felt quite the squeeze the big metros have.

Hope I'm right enough :)

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Eric James

OP

Investor · Malakoff, TX · Member since 2017 · 2k+ posts · 2k+ votes

8y

Originally posted by @Michael Swan:

My properties that I am picking up, latest 34 units at $33,825 a unit. The cap rate for this Blue Collar neighborhood is about 8.5. I am picking up properties $6,000-$8,000 under market. I find complexes that are at least $80.00-$100.00 under market rents. I force appreciation. If the housing market crashes for some reason in NE Ohio, it is already low and if people start losing there houses again, due to overextending themselves again etc... they have to move somewhere. Why not my little 2br 1b that rents for $695-$720 a month or 1br 1ba that rents for $595-$620.00. If they lose there house, they have to live somewhere. Why not an affordable apartment complex in a safe neighborhood.

Swanny

What happened back around 2009 in one small Southwestern city I visited is that rather than sell their SFH for a loss, a number of people rented them out for almost what apartments were renting for. As you can imagine, this depressed the whole rental market. I suspect this wasn't an isolated phenomenon. I think that is a risk for rental owners in a downturn.

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Michael Swan

Rental Property Investor · San Diego, CA · Member since 2014 · 1k+ posts · 2k+ votes

8y

Hi all,

This has been a great discussion and to each his own guys. The thread was based on helping Eric understand the True Multifamily (5 units or more benefits) and the rationale behind going in to True Multifamily.

Great job everyone contributing. Feel free to reach out to me and message me. I leave available every Mon, Tues, Thurs, and Fri from 3:15-6:15 pm. pst to talk Real Estate. It is much better on the phone. I live in San Diego.

Take care,

Swanny

2 Reply

Andrew Johnson

Real Estate Investor · Encinitas, CA · Member since 2016 · 3k+ posts · 3k+ votes

8y

@Eric James So a few thoughts:

1.) There are a lot of my pluses revolve around the large cap-ex items. With apartments you have less roof sq ft per unit. Less exterior brick/siding/etc. per unit. Sometimes you have less parking per unit (concrete or asphalt). If I'm stretching out ownership over decades, this all starts to matter.

2.) If you're an out-of-state investor like it, it's easier to have 3 buildings to think/worry about than it is to visit 30+ SFRs. Logistically, it's just more of a pain, more questions for a PM, etc. And if you don't want to depend on "dirt" appreciation, I can nudge rents up over the long-term and force appreciation in a way that I can't with an SFR.

3.) This isn't scientific but I think you get a better area/tenant/etc. when you buy a $50K/unit apartment building than you do with a $50K SFR. So I can get in to a better area at a lower-cost-per-unit.

But that's just me. If I was looking at areas where I'd bank on appreciation of dirt I don't know that I'd go the apartment route. In a lot of cases, dirt appreciation accelerates faster than rent increases. Consequently, just because I like apartments doesn't mean that I'd avoid SFRs if I wasn't investing where I invest.

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Juan Sebastian Martinez

Flipper · Tampa, FL · Member since 2017 · 9 posts · 3 votes

8y

@John Nachtigall I think you bring up a very good point. One of the main reasons multifamily is popular right now is because it's a good way to mitigate risk on your investment.

A good example on this is renovations. On a Single Family Home if any sort of repairs or renovations take place that might halt income on a property for a specific period of time. But in Multifamily you will see property owners constantly take units on/off line to be able to make these changes without it hurting property performance.

Economies of scale!

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Chase Gochnauer

Investor · Des Moines, IA · Member since 2015 · 380 posts · 201 votes

8y

I have 135 or so units. 71 in a recently acquired apartment complex, 12 plex, 8 Plex, and remainder are duplex or SFH. I have about 30-40 SFH in there I've BRRRd the last 2 years. The main advantage I see for the large multi family is scalability. Its much easier to grow quickly in larger multifamily. Someone mentioned above that buying and doing due diligence on a complex like this 71 unit would be equal to BRRRing 30 units in a year. Not at all, maybe equal to the time spent BRRRing 2 properties. I love the SFH, I think they're more stable and rent faster but it's much harder/time consuming to really grow your units with SFH. There are portfolios of SFH available but every one of those I looked at were not good deals. If you think it would be time consuming to do diligence on a 50 unit complex imagine trying to do it on 50 SFH, it's a nightmare! Not to mention you'll run into a lot of "lipstick on a pig" remodels that are overpriced in that bundle just because of its cap rate. I will always continue purchasing SFH just because I enjoy it. The thrill of getting a great deal and watching it be transformed from a dump to a nice home and renting it out is something that's hard to replace in multifamily.

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Chase Gochnauer

Investor · Des Moines, IA · Member since 2015 · 380 posts · 201 votes

8y

Also when the OP talks about anticipating a $100k SFH making more than a $100k MFH I do believe that has to do with PM fees as others have mentioned. You'll be hard pressed to find a turn key SFH that's going to realistically make you much over an 8 cap with a PM factored in.

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Help me understand the advantage of multi's

Help me understand the advantage of multi's

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