It’s easy for investors to get comfortable with one property type and not consider deals outside their core focus. The danger of this mindset is that investors may miss out on opportunities that could 1) diversify real estate portfolios; 2) add a different type of income stream and 3) potentially improve returns and/or reduce risk. There is nothing that precludes an owner of apartment buildings from also investing in single-family home flips and veteran house flippers may be pleasantly surprised by the advantages of owning a multi-unit building. The key for investors venturing outside their comfort zone is preparation, which means carefully examining the risks and rewards associated with both types of properties. Here are several pros and cons of investing in multi-unit dwellings as compared to single-family homes.
The Pros of Multi-Unit Dwellings
Economies of scale are one of the big advantages of multi-unit dwellings. Time invested in identifying a property, crunching the numbers and performing due diligence is leveraged when multiple units are being acquired, each of which generates a separate cash flow, In a similar fashion, repairs costs can be leveraged by spreading costs over a larger asset base. While the cost of a new roof or other major repair is greater for an apartment building, it will be less than the costs associated with replacing the roofs of multiple single-family homes.
Another advantage of multi-unit dwellings is the simplicity of dealing with multiple tenants at one location versus lots of tenants spread across multiple properties. Landlords also gain better negotiating power with property managers and other service providers when multiple units are at the same site.
More reliable monthly income is another benefit of multi-unit dwellings. Instead of one rent payment there will be multiple rent payments coming in to offset monthly expenses. Risk is generally lower with multi-unit dwellings since odds are good that some apartments will be generating rent even if other units are vacant or under construction. It’s rare for a multi-unit building to ever be entirely empty.
More income per square foot is often possible with multi-unit buildings. A single-family home in a desirable LA neighborhood may fetch rents of $3,000 a month or higher, but a multi-unit building at the same location could easily command rents of $2,000 or more per unit. In this scenario, a six-unit apartment building could generate upwards of $12,000 in monthly rent.
Appreciation potential is usually greater for multi-unit dwellings. Regardless of upgrades that have been made, the value of most single-family homes is closely tied to surrounding properties. Different methods are used to value multi-unit dwellings and building owners also have more options for maximizing the value of the property. For example, a landlord could increase the value of an apartment building by making upgrades that support higher rents or adding revenue generators such as on-site dry cleaning or day care.
The Cons of Multi-Unit Dwellings
Tenant turnover is one of the biggest hassles of owning a multi-unit building. Tenants leave for all kinds of reasons and even properties that are well-managed and maintained experience turnover. There is also risk from tenants who stop paying and must be evicted. Some risk can be mitigated by good tenant screening, but landlords must plan for some tenant turnover in the building budget.
Acquisition prices are often higher for multi-unit buildings and purchaser usually must come up with a bigger down payment, sometimes as much as 25% of property value. Lenders often demand more cash upfront from landlords who don’t plan to live at the property. Renovation and maintenance costs also run higher as well, requiring landlords to maintain significant cash reserves. On the other hand, it is sometimes easier to secure financing on multi-unit apartment building since lenders usually attach more weight to the property’s cash flows and are less interested in the borrower’s credit history.
Bigger investments carry greater risks. Delays in completing renovations or difficulties in securing tenants can result in massive losses for apartment building landlords. Cash burn rates may also be higher due to more spending on debt servicing and maintenance.
The Pros of Single-Family Homes
Smaller cash outlays. The initial investment in a single-family home is generally smaller and renovation budgets and maintenance costs are also more modest. Instead of a 20% or higher down payment, many single-family homes can be purchased with a 10-15% down payment. Because cash requirements are smaller, it may be easier for investors to secure funding. In addition, finding a single buyer or renter is often easier than securing multiple tenants for an entire apartment building. Single-family homes can also be flipped more quickly. Multi-unit buildings usually require more complex marketing strategies.
Value may appreciate faster. Multi-unit dwellings are typically valued on the property’s rental income stream, but the value of a single-family home is more influenced by location and local supply and demand. A single-family home in a desirable, well-maintained neighborhood may appreciate more rapidly in value if many buyers are attracted to the area and there are only a few homes available for purchase.
The Cons of Single-Family Homes
One income source. The biggest drawback of investing in a single-family home is that it provides only a single source of income. If the property sits empty for any length of time, the home owner will have zero income to offset expenses. Another drawback is lost income opportunities. This happens if a landlord has inquiries from multiple tenants, but only one rentable property available.
How to Get Started With Multi-Family Property Investment
If you are contemplating an investment in a different type of property, our best advice is to start small. Fix-and-flip investors interested in becoming landlords should consider initially investing in a duplex or three-flat instead of a larger multi-unit apartment building. Starting small allows investors to learn the ropes while minimizing costly mistakes. Investors who enjoy being landlords can then gradually trade up to bigger rental properties.