Multi-Family “Hype”

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Last week I wrote about The 5 Most Annoying Misconceptions Newbies Love. I left one out. Multi-families.

I use “hype” not suggestive that the publicity of the investment is wrong but that multi-family investing, like wholesaling, tends to be a popular claim by new investors who know nothing about what they are doing.

No doubt, multi-family properties (a.k.a. MFRs, for multi-family residences) can be amazing investment deals. The cash flow can be smooth and plentiful, individual residences are all under one roof (literally) which helps in lowering expenses and hassle, and the best is when you as the owner live in one of the units so you can potentially take out an owner-occupied loan at cheaper rates than if you didn’t live there (see New Investor Strategy: How to Buy Your First Multi-Family Investment Property & Live Rent Free for more information on this strategy.)

The reason I group multi-families into my “annoying” category has nothing to do with the quality of the investment but rather the assumption that multi-families are the best thing out there. Moreover, as I said last week, the annoyance really comes from real estate investing newbies who claim their only focus is on something so specific, like multi-families, before they’ve even really even learned to understand what makes a good real estate investment. If you have been investing in multi-families, and the majority of your portfolio is multi-families, awesome! Claim it, shout it from the rooftop, and call yourself a multi-family investor all you want. There is no hype in that. If you’ve never bought a multi-family before, don’t call yourself a multi-family investor. For a couple reasons.

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1. Tunnel Vision

To become a successful real estate investor, you should always be interested in the best deals. When you are choosing a focus, you should first select what type of investing you want to do: rental properties/buy and holds, flips, wholesaling, land, tax liens, commercial, etc. High-level categories.

Under each of those categories, there are several more options that you can focus on. Let’s pick rental properties. What constitutes a rental property? A property in which a tenant pays you as the owner for the right to use it as their own, usually in the form of a monthly rent payment. Owning rental properties deems you a ‘buy and hold’ investor because you buy the property, whatever type it may be, and you hold onto your ownership of that property for some amount of time with the goal being to collect the cash flow it produces from the tenant. That’s it. There are no requirements past that in terms of what kind of property it must be. It can be single-family properties, multi-family properties (including properties as small as duplexes and ranging up to large apartment buildings), office spaces, and even mobile homes.

So you’re a buy and hold investor. Great! What is your goal? To earn the most amount of money you can in relation to the cost of buying. If that is your goal (it is, isn’t?), then how smart are you to only focus on one possibility of potential property types you can buy? What if you are so gung-ho to buy multi-families, all the while single-families are bringing in higher cash flow in relation to how much they cost? Doesn’t that mean then you aren’t making the most amount of money you could be?

Having tunnel vision can cause you to lose out on insanely profitable deals. If the best deals you find are multi-families, then great, buy them up! But only after you know for sure those are the best deals, meaning they will put the most amount of money in your pocket for the least amount of time, money, and effort you have to put into them. If you are claiming, before you’ve bought anything, that you are a multi-family investor, you have tunnel vision and may miss out on a huge cash cow elsewhere.

2. The Fine Print

Another fault of the new investor is to not assume there are actually disadvantages to buying multi-family properties over single-family proprties. Learning the downsides of any investment type really does come a lot with experience, but there are so many upsides to a multi-family property that it is easy to not even notice the aspects that are less appealing. In comparing a multi-family property to a single-family property, let’s look at the obvious advantages, but also the disadvantages.

Obvious Upsides

  • Lower price per unit
  • Less maintenance costs per unit because of the common areas
  • All units in one location
  • All units can be managed by one person or company
  • One set of paperwork for the whole building versus individual houses
  • Rent from one unit can make up for the cost of a vacancy in another, leaving less chance of having to pay any expenses out of pocket

Less Obvious Downsides

  • Tenant turnover is notoriously higher in multi-family buildings. The American dream has always tended to lean towards homes, not apartments. Even if a family can’t own, they would usually prefer a house over an apartment if they have the money to do so. This isn’t always the case, but it does tend to cause longer-term tenancy in houses rather than apartments. Tenant turnover is one of the most costly expenses to an owner of investment properties, and statistically you will see way more turnover in the multi-families.
  • Tenant quality tends to be lower in apartments because most people who live in apartments only live there because it is all they can afford. Most everyone would take a house over an apartment if given the option, as already mentioned. Because you are dealing with a lower income bracket of tenant, you are automatically at a higher risk for less-than-pleasurable tenants. What is the one thing that can cost you considerably more in expenses than tenant turnover? Bad tenants. Not only do you have to pay for the turnover once they are gone, but you have the expense of lost rents, eviction costs, and likely higher repair costs during the turnover.
  • In terms of selling a multi-family property, you are really limited on who you can sell it to. Most likely you will sell to another investor. What do investors want? A deal. Good luck getting full value for your property! You also are limited to selling to investors who can afford the property. Unless you bought a really cheap multi-family that anyone could afford then you may not have a hard time selling it, but then I already know why you are selling it. See previous two Downsides! Compare that to a single-family home which now opens up the possibility of selling to a primary homebuyer. Gold! Primary homebuyers are everywhere and they are the most likely to give you a lot more money for your property.

One note about these downsides- I’m really talking more about apartments and not so much about condos. Condos are a different story in terms of property and tenant quality, as well as tenant turnover, but the numbers on condos don’t usually work out favorably for investors due to the monthly condo fees breaking too far into the profits. So for the purpose of this discussion, I’m really just looking at apartments. Obviously there is a big difference between a duplex and a 300-unit apartment building but just throwing generalizations out.

Do I Buy Multi-Families?

I haven’t yet, but I certainly plan to. There is no argument multi-family properties can be stupidly good deals. They have mega advantages and they can put a nice pretty penny in your pocket. I know I plan to buy them at some point. I want to buy them for the same reason anyone does and especially now because I don’t qualify for a mortgage since I left my corporate job, so I’d love to take advantage of commercial financing.

However.

A couple years ago when I started buying real estate, I of course saw the glam in multi-families as does anyone. I wanted to pursue them. I got sidetracked though because at the time, single-families were wopping multi-families in terms of returns. It would have cost me less to buy 100 single-family properties and get 25-30%+ cash-on-cash returns for each than it would have to buy a 100-unit apartment building for probably closer to 10-15% returns. So I’d have to put up more money, accept lower returns, and have the potential for more tenant expenses and fewer options for an exit strategy if I were to need one. Why would I do that, other than to be able to have all the units under one roof?

I evaluated the two options- buy single-families or multi-families- and it only made sense, as the best investment, to buy single-families. That will not always be the case, especially now since housing prices are back on the rise, but do you see the point? Focus on the best investment. The best investment is always changing. It may not always be multi-families.

Why do you think Warren Buffet said he’d buy all single-family houses and not multi-families? At the time he said that, the profit was in the single-families.

You will never hear me claim to be anything more specific than an investor who buys rental properties. Why? Because who knows which type of rental property will be the best at any one time, so who knows what type of rental property I’ll be buying at any one time.

What’s the term, pigeon-hole? Don’t put yourself in one!

About Author

Ali Boone

Ali Boone(G+) left her corporate job as an Aeronautical Engineer to work full-time in Real Estate Investing. She began as an investor in 2011 and managed to buy 5 properties in her first 18 months using only creative financing methods. Her focus is on rental properties, specifically turnkey rental properties, and has also invested out of the country in Nicaragua.

22 Comments

  1. Matt DeVincenzo on

    Great post Ali! I would add one more benefit to multi’s for newbies, assuming you’re going conventional your 10 mortgage “bullets” gets your more total doors. And one more disadvantage is they usually require a higher down payment for NOO.

    But you’re absolutely right on the money with this post. I myself have been looking to buy a 2-4 multi for the last 6 months, and in that time I bought 2 more SFR’s because the multi numbers are too out of whack with regards to the return on a SFR at least in the market I’m buying in right now.

  2. Fabulous advice!

    Best to learn something about all the buying possibilities so, when one shows itself, you’re ready to buy no matter which strategy it needs.

    We started with single family because (1) we were more familiar (having lived in them) and (2) repair costs would be lower (I’d much rather replace a HVAC unit or roof on a single family than multi!). Also, I suppose, (3) control. To buy larger units usually requires a pool of investors and I maintain 100% control (and, yes, responsibility) with a single family.

    Be prepared/educated so you can “Take the lead as it comes!”

    Great post, Ali.

    • I understand your perspective. I currently own all single families, but am looking at apartments. If I get an 8 or 12 unit apartment building, I only have to worry about one roof and one buildings siding or AC. It would be more expensive overall, but less on a per unit basis. If I could find or build a nice building with a townhome or condo feel, I’m thinking I could have the best of all worlds. Higher than average rents, more responsible tenants, and fewer building components to worry about.

  3. I think you highlighted an excellent point that constant evaluations need to be made. I also feel that something that might have been missed is the time horizon that is taken into consideration when choosing an investment strategy. For a buy and hold investor a duplex or triplex will give that more homeownership feel compared to an apartment complex and maintain lots of the benefits of a single family home while still garnering some of the benefits of larger multifamilies. I can sell to another investor or convert back to a single family if it makes sense or even sell the duplex to an owner occupant that wants to tip toe into investing.

    I do own a single family rental but my bread and butter is duplexes at this time. I do not see single family homes as a long term play as it will come to a point where it will be a better use of equity to sell as opposed to continue to rent. At the end of the day I guess it all depends on one’s comfort level.

      • Ali – very opinionated and quite good…

        With all due respect to Both you and Jeff, there is a poem by an old German philosopher – sorry, the name escapes me at the moment:

        Be lonely rather than be in the wrong company
        Go hungry rather than eat the wrong thing

        Just because the market is giving you something, doesn’t mean you should take it – if it’s not what you are comfortable with or deem “good”. Markets reflect the tendencies of the majority, which are often misguided 🙂

        Good work on this one Ali

  4. Greta post as usual Ali. i began with that same newbie mnistake of telling myself I was going to be a multi-family guy. But judging by the market my area is prime for SFR. Even though I haven’t threw my hate in the ring, as you said it was a bad call to limit myself without knowing the facts!

  5. Ali, your skills and knowledge is showing. Property types are consistent with location-i.e. multi family in multi areas or SFR in SFR areas. The area you’re buying in determines what type to invest in. Where I buy, is usually under 30,000 in population, so naturally SFR are more profitable with a larger pool to sell to down the road. Small towns don’t support large apartments and SFR are not cost effected in the bigger cities. Become a farmer and buy what you can afford, a herd of cash cows isn’t to bad!

  6. Great info. Just buy rental “income” properties, period. Be it SFHs or MFRs. The key being income and a property that cash flows.
    Additionally, what may help an investor decide beside the usual COC and/or ROI is the cash flow amount itself. Some investors criteria may required 200 or more cash flow per month, some 300 or more, 500 or more, etc. In general, MFRs will yield a higher cash flow though not necessarily higher returns.

  7. The advice I was given (but sometimes not taken) from my early mentor was to buy an investment when everyone was selling it, or when every one hates it.

    His advice also included selling the same investment when everyone wanted it, this part was harder to obey.
    He looked at REI in a much different way then anyone at my local DIG chapter, buying low and no matter what selling on the way up. In sometimes following his advice I have bought the same 3 unit building twice in the last 10 years.
    Initially purchasing the property in 2001 for $18k later in 2005 selling for $80k, and in 2010 buying back after foreclosure for $49k. The nice thing about the buying and selling this one particular building was along the way the new owner borrowed $125k to cash out and renovated the building to a high degree which saved me quite a bit of time and money.

    My worry in my present market is these (artificially) low interest rates causing a warped over supply of rentals and new single family homes, all of which will be underwater if the interest rates go up even a few percent. These homes will in the future either be foreclosed or enter the rental market further diluting the market and prices.

    I am selling all my highly leveraged properties in this market I will be using the proceeds to pay down the debt of my core long term holdings.
    In the past when rents needed to be trimmed (for competition sake) is was much easier to do so in my properties that were free and clear.

    In low income cash flow REI of which 90% is what I own having free and clear properties, I can financially hold on for neighborhood anomalies to pass. A recent anomaly; a local tavern business was sold, the new owner added all manner of drug sales to the menu. This attracted some very seedy young people who use violence as a means of daily life (sad to say).
    Out of 15 rental units on that one block I had 6 vacancies for one solid year, with other tenants promising to vacate at their first opportunity.

    As with all neighborhood anomalies they work themselves out, the bar is now gone forever the District Attorney seized and sold the liquor license. The tavern is now being converted to a coffee shop for some kind of AA group. The owner of the building after spending tens of thousands in legal fees to rescue the deed from the criminal legal system, has renovated the place and removed all of the druggies.
    Peace has come back, all of my rents have increased and I have no vacancies.

    • Cool comment, Dennis. It made me really think and understand everything which is awesome. I love that you bought the same property 3 times! Haha.

      Great thoughts and info for other investors.

  8. Great post, Ali. A person has to stay adaptable and be ready to tweak their plan as the market changes. Case in point – we had two rentals, a duplex and a SFH, that we picked up in 2010. The duplex kicks butt, the SFH is just ok. So this go around, we naturally wanted to pick up another duplex and duplicate what we had done with the first. Unfortunately the market has changed, and deals like the one we got on the first duplex don’t really exist any more. Prices are considerably higher and competition for the duplexes that at least kind of make sense is fierce. After lots of looking and several unsuccessful offers, we concluded that we would be on the sidelines indefinitely if we kept holding out for the kind of returns that we have gotten on our first duplex. However, after several late nights on realtor.com, we found that there were a fair number of SFHs on the market that DID meet our criteria. So we talked about it, and decided to shift gears, and we ended up purchasing a SFH. Competition for SFHs that work well as rentals is also fierce, but there is enough volume in the market, that you at least get plenty of tries. It is surprising how few small multis are available at a given time even in a large market like DFW. The compromise in this was that I invested less money but still burned one of my fannie mae bullets, however it seems that the alternative was to either overpay or do nothing. I do like duplexes though, and if the market changes I would love to pick up more.
    -Harry

  9. Hey Ali –

    Great info. I think in time you will find as an individual what you really like to invest in, and I do believe this is key for your success.

    I know one man that “has no boundaries”; he will buy anything that is a good deal. But he also has decades of solid experience. He knows how to properly conduct a due diligence process on multi-million dollar properties and he has the resources needed for this type of business.

    I also think that your comfort level grows over time right alongside your knowledge. As you grow personally, so will your confidence and usually your resources. It is then you will typically branch out and buy bigger properties and feel comfortable taking on bigger challenges and risks.

    Great read.
    Sharon

    • Totally agreed, Sharon. I feel like that for me actually. I’ve played in SFR world, and because of that experience I feel ready to move to the bigger boys. Not duplexes or tris, but apartments or commercial. I feel like I really got a solid foundation starting in the singles and with less risk. I recommend it for all.

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