New investors...Should you start out small vs larger when investing in Multi-Family?

Question

I've seen this question often here on BP. When you're first starting out as an investor and you want it to be in MF properties, is it better to start with a 2-4 unit or go with something larger such as a 10-12 unit? Imo...a lack of experience is going to come into play. If you're new to investing and want to start in MF, a 2-4 unit is where you're likely to find more success with financing. I can't speak for other lenders, but I don't know any willing to lend on a 10-12 unit property for a new or inexperienced investor (we're not...unless you have a strong sponsor on the deal with you).  Get your first 2-4 unit in your portfolio and manage it efficiently. Add another four unit property and do the same. Now you have a more favorable chance of getting financing for that 5-12 unit property.

Erik W. · Answer

It depends on....1) How developed is your ability to deal with difficult people?2) Do you already know your state's landlord/tenant laws?3) Do you have a list of reliable, honest, hard-working, reasonably priced contractors at least 3 persons "deep"?4) Do you have a lease ready?5) Have you established house rules for things like quiet hours, who parks where, whether or not pets are allowed, etc?6) Do you want fixed rate (smaller units) or variable rate financing (bigger units)?7) How do you plan to handle pest control?8) Does your city/municipality have any special laws or regulations that apply to certain number of units insofar as registration, having a business license, etc?9) What's your pain level? When one tenant calls, eh, not too bad... when 3-4 of them are calling, it gets more interesting.10) What is your time availability to deal with issues? On that note: are you going to self-manage or hire out management?There's probably at least another dozen, but that's enough to make this one most critical point: when you go big... you go big or you go home... and there's little time or space to make mistakes. Bigger deals also compound issues. When the tornado rips the roof off your 10-plex, now you have 10 dislocated tenants and need Mr. Big Contractor. If you have a duplex, your handyman can probably cobble something together temporarily.

Larger units also require things like professional lawn care, a cleaning crew, and a part-time/contractor maintenance crew. You and your spouse/significant other won't be able to keep up.

If it were me in your shoes, I'd start small. That's what I did: I started out with one small SFH. Then another. Then a duplex. Then two more duplexes. Then a four plex. Fast forward 18 years... we now own 25 residential units and 29 commercial units. I still self-manage, but I have a contractor team, nice software, and a bundle of knowledge accumulated over 18 years in the trenches.

That said, some folks dive right in and get 300 units. They're impressive. That would kill me. As a wise man said, "Know thyself."

Matthew Masoud · Answer

My advice is always to do a 2-4 units first, even if you have the money and capital to go big. Closing your first deal teaches you so much. How to deal with tenants, contractors, and vendors.

After that move on to 5+ so you're in the commercial space. Operations are very similar but valuation is very different.

I spent way too much time doing 2-4 unit deals when I should have been in commercial mf 5+.

Stacy Conkey · Answer

Start small. But my reason is different than the one you'll usually hear.

The real line in this business isn't property size. It's residential financing versus commercial financing.

Up to a fourplex, you get a residential loan. Thirty year fixed. No balloon. Value set by what similar properties sold for.

At five units you're in commercial. Now it's a five or seven year term with a balloon at the end, a twenty five year payoff schedule, a coverage test, liquidity requirements, and often a prepayment penalty that will hurt you badly if you planned to refinance in year three and never read the loan documents in year one.

A fourplex is the biggest property you can buy on a thirty year fixed. That's the advantage. Not the training wheels.

Now the part the start-small crowd leaves out.

On a duplex or fourplex, your income doesn't move your value. Push rents $200 a unit and your cash flow goes up, but your appraisal doesn't move at all. The appraiser is looking at comparable sales, not at your operating statement.

On a twelve unit, income IS value. Add net operating income and you add value, and how much depends on cap rates in that market. Same work but with a very different payoff.

That's the reason to get to five plus eventually, but not the reason to skip 2-4 units now.

So what are you supposed to learn during the small phase?

Most people say tenant handling. I'd say something else. You're learning to build and verify a team you don't stand next to. You learn how to be a CEO of your business.

Interviewing five property managers instead of hiring the first one who answers.

Getting the inspection report into every contractor's hands before they bid, so their findings don't come back later as change orders on your dime.

Setting it up so nobody gets paid until somebody with no stake in that work confirms it's done.

Those habits scale your business and a duplex is a cheap place to build them.

What doesn't scale is being close to it. My anchor property is a duplex in Indianapolis. Listed at $35,000, I bought it at $29,750, then put $60,000 into a full renovation across both sides in eight weeks. Post refinance, the mortgage runs $700 a month against $1,400 in rents.

I never saw it. Never touched it.

Here's where I'd push back on the standard version of this advice.

Three duplexes doesn't automatically qualify you for a twelve unit. On the commercial side, the lender is analyzing the property's coverage ratio and your/the businesses liquidity first.

So once you can run one property remotely with a team and real verification in place, what's holding you back from five plus is cash and coverage.

New investors...Should you start out small vs larger when investing in Multi-Family?

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