So, you’re considering real estate investing and don’t know whether multi-family residence (MFR) is more attractive than single family residence (SFR). You’ve come to the right place, where we’ll break down the advantages and disadvantages of MFR.
Before we dive into that, let’s take a look at five reasons why real estate investing is one of the smartest ways you can build wealth and achieve financial freedom, if not THE smartest; after all, while statistics vary, most say that 90% of the world’s millionaires achieved that status primarily through real estate:
1) Cash flow – simply put, debt service aside, rental revenue minus expenses puts money in your pocket every month. It’s an asset that pays you monthly.
2) Appreciation – as you hold the asset, it is very likely to go up in value over time. If you decide to sell, you pocket the capital gain.
3) Tax breaks – the expenses you pay out of pocket, as well as the “paper” loss of depreciation, will help to reduce your taxable income (though there are limits on each tax return as to how much you can claim, unless you can claim “real estate professional” status).
4) Leverage – as you build equity in a property, pay down any debt service, and enjoy potential appreciation, the more opportunity you have to borrow against the property’s equity to then buy more property, all without ever selling the original property or liquidating it into cash (you essentially are pulling cash out of the property without giving it up as an asset).
5) Inflation hedge – while official statistics often put annual inflation around 1-3%, essential goods are much more sensitive to inflationary pressure. So, things like food, gas, and lodging – items that cannot be eliminated from a person’s budget – can be highly susceptible to inflation, outpacing the average amount.
Now that we’ve established why real estate is a great way to build wealth and establish financial freedom, let’s take a look at the pros and cons of MFR real estate investing.
PROS:
There are distinct advantages that come with investing in MFR properties. One of the most obvious is the fact that you instantly establish multiple streams of rental income, from the collection of units under one roof. From a cash flow perspective, you’d have to assemble a SFR portfolio of an equivalent number of units to match the same amount of revenue – a tall order, depending on how many units are in the MFR.
Building on that point, MFR properties will allow you to scale your portfolio much faster from a time perspective. Think about it this way: let’s say your goal was to accumulate 10 units (or “doors” as some people like to call each unit) that are cash flowing monthly. From a MFR versus SFR perspective, here are the two scenarios you’d be facing:
? Locate one 10-unit MFR property, conduct one inspection, close the one contract, hire one property management firm, manage one building; or,
? Locate 10 different SFR homes, conduct 10 separate inspections, close 10 contracts all at separate times/places, hopefully hire one property management firm (but could be more if your properties are not geographically clustered), track 10 sets of maintenance issues
Another big advantage of MFR is the fact that maintenance issues and costs are consolidated under one roof. An improvement to the property benefits all units, both from a monthly cash flow perspective (you can eventually raise rents assuming the improvement is substantial enough) and from an appreciation perspective. Continuing the example from above (one MFR vs. 10 SFRs), you’re responsible for one roof versus 10, one central heating system versus 10, and so on.
Vacancies are the bane of a real estate investor’s existence. Vacancies can be so costly it sometimes makes more sense to allow even partial rent-paying tenants a break versus evicting them. When you throw in rehab costs and marketing, on top of a potential eviction, it gets very costly and can wipe out your profitability for the year. However, multi-unit portfolios absorb vacancy expenses, since the cost gets distributed across all of the units. An advantage of MFRs is you automatically have a “portfolio” once you own even one MFR property. If you have nine MFR units paying rent and one that isn’t, you effectively have 90% revenue-generating capacity still in place to handle maintenance, property management fees, property taxes, etc. and thus share the load.
Another great strategy for enhancing the value of your MFR (an option not available to you with SFRs), is to make common area improvements, and leverage those to charge higher rents and enjoy greater appreciation down the road. For example, you could install or improve an existing laundry service, provide Wi-Fi throughout the building, upgrade the great room or business center, and then add an extra charge for those amenities to the rent.
CONS:
Probably the biggest hurdle you’ll face when buying a MFR property is securing financing. Obviously, MFR properties are more expensive than individual SFRs, so you’ll need a solid strategy for putting together the deal from a financing perspective. Consider the following:
? If the MFR is 5 units or more, you’ll have to get a commercial real estate loan, which almost certainly will command a higher down payment, usually on the order of 25-30% down. This adds up quickly on a $1M MFR property, for example.
? You may need to show a track record in successful real estate investing to give the bank confidence you know what you’re doing. If you’re just starting out, this can be a difficult one to get around.
? Many banks will also look for you to show 6-12 months of cash reserves to cover maintenance costs, unexpected repairs or expenses, etc. Add that to the down payment and you could be looking at a large cash requirement to have a shot at financing.
From a risk perspective, as convenient and cash flow favorable as it can be to have all your units under one roof, it can also present a downside given that a systemic problem (or worse) with the building jeopardizes all units simultaneously. Ironically, a 10 SFR portfolio, while harder to assemble, leaves the investor with a diffuse set of risks, where one house being compromised has no effect on the others. This may be an issue in places more prone to natural disasters (hurricanes, earthquakes, etc.).
From a market dynamic perspective, MFRs bring unique challenges. Consider the following:
? It’s often harder to exit a MFR property versus a SFR since there’s a greater pool of buyers for SFRs, which are attractive to both homebuyers looking to live in the house as well as rental real estate investors. MFRs will likely only be appealing to investors.
? SFR rentals are growing in demand since the national trend is towards renting versus buying. The “sharing economy” has resonated with younger generations who don’t see the need, nor have the ability, to put large down payments into houses they own – they’d rather rent instead.
? SFR tenant lifespan is, on average, 3 years in the property, whereas MFR tenants usually only stay about 1.5 years; given how vacancies can affect a portfolio, this higher rate of turnover can quickly impact profitability.
Lastly, a challenge with MFRs that will almost never be a problem for you with SFRs is the lack of inventory. It’s simply harder to locate deals on the MFR side, especially when investors are holding them as assets for cash flow purposes and tax reduction, versus looking to flip them over for appreciation-based capital gains.
SUMMARY:
In summary, whether you pursue MFR, SFR, or both, the key is to assess your risk appetite, your personal financial goals, and your time horizon for expecting the desired results from your investments. Once you’ve done that, you can confidently narrow down the type of deals you’re seeking. I think that once you’ve taken a close look at it and compared it to other types of investments, you’ll agree that real estate is the preferred way to build wealth, achieve financial freedom and fast-track your retirement.
