Small or Large Multifamily?

OK, so you’ve decided to invest in multifamily, now you have to decide if you’re going to stick with 2-4 units or go to 5+. There’s a big difference depending on how big you go, and you should make sure that what you choose aligns to your goals.

Bigger is Better, right?

Well, not necessarily. The other day, I asked an aspiring investor what kinds of properties he wanted to invest in, and he said large multifamily. I asked him why, and he said, “Because the returns are bigger.”

That answer is cringy for a few reasons, but most importantly, it didn’t align with his goals. Earlier in the conversation, I asked him why he was investing, and he said, “For financial freedom and to support my mom as she gets older.”

I love that reason! Being able to support someone you love can be an amazing driver. But if that’s what he wants, he should stay away from large multifamily.

What’s the big deal?

There’s a huge difference between investing in smaller deals and investing in really large deals:

Invest in large multifamily if you want to start a business in real estate.

Invest in single family and small multifamily if you want to have assets that pay for your expenses.

That’s it. If you read nothing else here, just take away those two lines and internalize them.

If you don’t want to build up a large system of processes, partnerships, complex legal entities, and form a deep database of investor connections, then stay away from large multifamily. If you just want to live financially free, then keep buying single family homes, duplexes, triplexes, and quads until you can live that dream.

But if you love the challenge of building a business, want to feel the pain of many defeats and frustrations, and build up your entrepreneurial mindset so that you can give your friends, family and acquaintances returns on their money that they’d never see in the stock market, then maybe large multifamily investing is for you.

Where is the line?

There is a fuzzy line between small and large multifamily assets and you might OK crossing it depending on the deal and your goals, but you should be informed before you do.

Lenders

Banks define residential as 1 to 4 units, and anything greater would need a commercial loan. That is typically handled by a different department, or possibly a different bank entirely. The purchasing process for 5+ unit properties is different, requires different documentation, and typically requires setting up some sort of legal entity. And that says nothing about how these properties are evaluated for price (more on that in a future post).

Investors

But when the rubber hits the road, there’s a lot of people out there who will buy larger properties with these commercial loans and treat them exactly the same as a small multifamily property. These investors are what people in the business call “Mom and Pops” owners. There’s nothing inherently wrong with being an owner like this because you can typically get away with it up to a certain amount of units. I see and hear about a lot of these style owners that do alright up to around 12 units. Beyond that, they usually don’t have enough systems in place and the properties deteriorate.

The Punchline

Don’t think that you should start buying large multifamily properties just because you hear big numbers and someone said “economies of scale” at a meetup. Make sure to invest in the right size investment for you. For most people, that means buying 1-4 unit buildings, and that’s OK! Lots of people become very wealthy buying the small stuff.