Why Multifamily Investing Makes Sense to Me
“Know what you own, and know why you own it.” – Peter Lynch
There is always debate on what is the best type of real estate investment – single family or multifamily. I have not been in the business long enough nor am I smart enough to know the answer to this question. What I do know is what is right for me.
Yes, I confess, I lean towards the multifamily side. It doesn’t mean that I won’t consider a single family, residential flip, but my heart lies in multifamily. Here are some reasons why:
Risk Sharing
Let’s face it, with the single-family house your income is dependent upon the tenant’s ability to pay. If the tenant is a good tenant then this can work out well, but if the tenant is not so good – this can be a headache and a money pit. With single family units, all the risk is dependent upon the quality of the one tenant.
In multifamily investments, the risk is shared proportionality based upon the number of units. The greater the number of units, the more the risk is shared. If you complete your analysis correctly and allow for a certain amount of vacancy for your “break even” point (we usually are around 80%), then one tenant is only going to cause a small headache and cash flow will still continue. In theory, with the way we structure our budget, we would need 20% vacancy or non-paying tenants in order to break even. The risk is dispersed among all the units and this provides a greater level of confidence and comfort for me.
Work vs. Reward
If you haven’t figured this out yet, real estate investing takes a great deal of time and work in securing deals. We recently acquired an 82-unit apartment complex in Jacksonville, Florida. It took a significant amount of time to work out every aspect of the deal, up to the minute we closed. However, all this work went into one deal. As I think about it, it would take significantly more time to find 82 single family homes and get them under contract.
Property management also comes into the equation since we tend to invest out of state. For our 82-unit property we were able to retain a quality property manager who will significantly reduce our workload. If you haven’t experienced this yet, it is very difficult to find quality property management for 82 single family residences with 82 different tenants. For the 82-unit, property management provides us with weekly reports on one property and all the common area problems are contained within the same property. For a portfolio, there would be 82 different reports with potentially 82 different properties. Also, if something happens to property management, the portfolio would be much more difficulty to temporarily management and replace as compared to the 82-unit complex.
Forced Appreciation
Forced appreciation is where you increase the value of your property through capital improvements and renovations. Forced appreciation can occur in the single-family market if you decide to buy and flip a home. This can bring about instantaneous profits, but they are one-shot deals where you have to immediately begin the process all over again.
What I have experienced in the multifamily market is that capital improvements and renovations are sustained over time. What do I mean? These improvements generally lead to an increase in rents resulting in a higher NOI (net operating income) after we have rehabbed apartment complexes. Unlike the single-family home which is dependent upon the market sales price, multifamily properties continually generate increased value when the rents increase. Additionally, when the time comes to sell, the increased value (NOI) can generate long term wealth for investors. As an investor, I am looking for a combination of cash-flow and wealth which I believe can be realized easier in multifamily properties.
Depreciation and Taxes
Now while I realize with the proposed tax laws things can change, but from what I understand the rules regarding depreciation are not to change too much. Basically, depreciation allows investors to take specific tax deductions on every eligible project or item for each unit. Going back to our example again, we would have 82-units on which we can have our accountant analyze and create a depreciation table on which we can take a deduction for 27.5 years under the current tax codes. Typically, the larger the property, the greater the ability to offset tax liability with depreciation.
With single-family properties, the amount of depreciation would be significantly less which could impact my tax liability.
Ability to Scale to Larger Investments
I have personally seen leverage at work in scaling my investments from smaller multifamily to larger units. Over the 18 months my participation started with an 8 unit, to a 17 unit, and our latest acquisition, the 82-unit. In multifamily investing we are able to leverage smaller properties to obtain larger properties of increased value.
Emotional Payoff
I admit, there is a big plus for some in saying that they own this particular house or that particular house, and for some investors this is very important. Some investors like to serve as the landlord for their properties and form personal connections with their tenants. There is an emotional reward in doing this for sure.
This emotional payoff is not that important to me. I don’t need to get to know my tenants, my on-site property manager does this very well. My emotional payoff comes from scaling to larger properties and seeing the potential for growth increase exponentially.
Peter Lynch stated that we have to know what we own and why we own it. So why do I believe in multifamily investing? It is the ability to increase income and wealth with less work and shared risk that makes sense to me.
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