How to Scale From Single Family Homes to Multifamily Apartment Communities
It’s a well-known fact that most of the wealthiest people in the world are real estate investors on a significant level. In fact, 90% of all millionaires are invested in real estate.
Real estate can help you fast-track your net worth, accelerate your retirement goals and provide you with extraordinary tax benefits. Real estate investing can also create a hedge against inflation and can help you to diversify your investment portfolio. It’s no wonder why the wealthiest among us are invested in real estate.
Most new investors start out in single-family investing to get their feet wet. I, like most investors, started rehabbing homes and selling them for a profit. I also began buying single-family homes and holding them to rent out for cash flow.
When to Transition
There comes a time in most real estate investors’ careers when they want to scale their real estate business or become a hands-off passive investor so that they can better live a life by design and reap the benefits of their efforts.
That is where investing in multi-family homes becomes a good fit either by actively investing in these assets if you still want to be hands-on or you can passively invest in these properties.
Before you make the leap, let’s discuss the pros and cons of real estate investment in each asset class and the various ways to help you make the transition.
Pros of Owning Single-Family Properties
– Low Barrier to Entry – Single family properties typically are pretty simple to acquire for new real estate investors. It is not unlike purchasing your primary residence, and you have the opportunity in some cases to buy below market if the property needs substantial rehab.
– Low Down Payment – You can purchase single-family real estate for very little down in some cases and can be a better option for those starting out. The most you would likely have to put down is 20% down, so it’s easy to build wealth through leverage.
– Financing is Readily Available – There are a number of ways to finance single family homes such as conventional loans, hard money loans, semi-hard loans. Or you could do a joint venture partnership where your partner would bring in the down payment and/or credit to acquire the loan.
– A Number of Exit Strategies – Single-family homes have myriad ways of making the owners money. You can, of course, simply sell the property for a profit. Or you could perform a lease option with a tenant-buyer. Or you could sell on seller financing if you owned the property outright. Or you could simply hold onto the property and rent it out for cash flow.
Cons of Owning Single-Family Properties
– In Economic Downturns People Downsize – When there are economic downturns, unlike investing in affordable multifamily housing communities that did very well in economic downturns, property owners who owned single-family rental properties got hit pretty hard in the 2008 Financial Crisis, for example. Now, to be fair, that was by and large a lending crisis that caused the housing crisis, however, when times get lean, people naturally downsize from single-family rentals to multifamily communities, mobile home parks, or they consolidate and move in with family or friends.
– Much Harder to Manage Many Single-Family Properties – Let’s say you have 100 single-family homes that you own and rent out. It’s obviously much more difficult to manage 100 properties that are spread out over a geographic area as opposed to 100 unit apartment complexes that are all managed under one roof.
– The Repairs and Maintenance are More Expensive Per Unit – Each individual single-family home has a roof, a furnace, a water heater, an electrical panel, a yard, a garage, etc. When repairs are needed on residential real estate, they can really rack up quickly and negate any cash flow you would be anticipating. Furthermore, additional expenses for each and every property are insurance, taxes, property manager fees, and accounting fees whereas with multifamily investments these costs are spread out over the entire community – not an individual unit.
Harder to Scale Single-Family Properties
– Harder to Scale – There are several reasons why it’s harder to scale with single-family properties that we have mentioned in part here, but the main reason is that you will be unable to obtain more than ten mortgages. Fannie Mae guidelines restrict real estate investors to a maximum of ten conventional mortgages, and lending gets more restrictive after the fourth mortgage. There are always other options, but it will mean having to be more creative.
– Valuations are Capped – With single-family homes, your valuation is capped based on comparables of like/kind properties that are in a close geographic area. You can obviously improve the property as much as you would like, but there are limits as to how much you can increase property values.
Pros of Owning Multifamily Properties
– You Control Your Valuation to a Larger Extent – As a multifamily investor, when you own a commercial property with apartment units your valuation is based on your net income, so if you can incorporate various ways to increase your rental income and various other revenue streams while reducing your expenses, then the property value will increase. You have much more flexibility in growing your wealth with a multi-family property in this way.
– Easier to Manage Properties Under One Roof – As we mentioned earlier when you have single-family properties spread out in various areas versus the same number of units under one roof you can capitalize on in-house maintenance and an in-house property management company if your property is large enough to warrant this – usually 100 units or more.
– Better Economies of Scale – With all of the multifamily units in one place in a multifamily community, with more units it’s easier to negotiate better rates with vendors and contractors as well as insurance. Also, your marketing costs are greatly reduced when you are marketing just one property as opposed to 100 different single-family properties. Additionally, for this reason, property management fees are less with multifamily rentals as a percentage of revenue compared to single family rentals, so you have a lower per-unit cost overall.
Capitalize on Better Tax Strategies
– You Can Capitalize on Better Tax Strategies – When you invest in multifamily apartment communities you are able to not only capitalize on depreciation as you would a single-family property, but you can potentially capitalize on a powerful tax benefit called cost segregation, which can dramatically reduce tax consequences for investors. This strategy is only available with commercial properties
– More Tenants Provide for Better Occupancy Rates and Better Cash Flow – it sort of goes back to the economies of scale argument but for a different reason. If you have a vacancy in your single-family rental property, you have a 100% vacancy rate on that property and those costs add up. In contrast, however, if you have a vacancy in your 100-unit multifamily community, you have a 1% vacancy rate and the other 99 units greatly offset those costs of the vacancy.
– Much Easier to Scale the Business and Grow Your Wealth Faster – Let’s face it buying one single-family home at a time can be excruciatingly time-consuming as opposed to buying a multifamily property, but being able to purchase a number of units at once can tip the scales exponentially faster when it comes to growing your net worth and legacy wealth for your children.
Cons of Owning Multifamily Properties
– There Are Limited Exit Strategies – Most of the sizable multifamily communities will only be able to be sold with a loan assumption (rare) or with a new commercial loan, so you have limited options as far as the disposition of the asset.
– Multifamily Assets Are Harder to Finance – Commercial assets that are purchased at a price point that in the 10’s of millions of dollars are acquired at a much higher price tag so will often need multiple people or partners to bring in the liquidity or net worth needed to qualify for the loan. Unlike a residential mortgage, you will likely need additional people to acquire these types of properties.
– You Will Likely Need to Have Partners – Again with smaller multifamily properties you can typically get away without having partners for the financing or the day-to-day operations, but it is virtually impossible to acquire large-scale apartment communities such as a 100 unit apartment building without having a team of experts in place to execute the business plan and properly take care of all of the daily functions that these communities require.
How to Transition from Single-Family Investing to Multifamily Investing
So with all of these compelling reasons to make the leap into multifamily investments, let’s explore the ways that you can invest in multifamily properties so that you can scale your business and increase your net worth.
- Build a Team to Acquire Apartment Communities – You could always start partnering with a general partner who knows the apartment space well, and determine what skills or value you can bring to the partnership team such as solid underwriting skills, or a sizable net worth so that you can be a Key Principal in an acquisition or you could put up the risk capital (earnest money, due diligence, up-front legal fees, etc.,) to get a portion of the General Partnership.
- You Could Invest Passively in Crowdfunding Opportunities – In most crowdfunding opportunities you do have to be an accredited investor, but you can start on a smaller scale without much money to see if multi-family properties are your jam. Crowdfunding platforms are everywhere these days – some more well-known shops are RealtyMogul, CrowdStreet, Fundrise, and Equity Multiple just to name a few.
Invest in Commercial Real Estate Syndications
- You Can Invest in Commercial Real Estate Syndications – A real estate syndication is simply a group investment with general partners (or the sponsor team) who have a deep understanding of the real estate market. They find the deal, help fund the deal, and conduct all of the day-to-day operations on behalf of the other investors. The other investors are the limited partners or the passive investors.
As a passive investor in a commercial real estate syndication, you get to leverage other people’s expertise and knowledge, and capital. You don’t have to do any day-to-day work; you don’t have to be entrenched with market and submarket knowledge.
With multifamily real estate syndications, you simply receive quarterly passive distribution checks AND a portion of the profits when the asset sells 3, 5, or 7 years later depending on the business plan and strategy. And if that’s not enough, one of the biggest benefit of these investment opportunities is that you also may be eligible for extraordinary tax advantages with syndications depending on your own financial situation.
At the end of the day, if you do decide to scale your real estate investment portfolio with multifamily homes, you have several options to explore. Affordable Multifamily communities are a great investment and are predicted to be in high demand for decades to come.
Ready to Learn More?
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