Multifamily vs Single Family

8 Reasons Why Multifamily Is Superior To Single Family For The Passive Investor

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Background

Recently I was speaking to a friend and passive investor when our conversation wandered into the pros and cons of single family vs multifamily investing. We had such a great discussion that it made me realize that I needed to write about it.  So here are some thoughts on multifamily vs single family based on years of investing in both asset classes.  I approach this discussion from the perspective of a passive investor.  I assume you are trying to invest a sum of money for a period of 5 to 7 years.

The Case for Single Family

Advantages to passive investments in single family have a theme of fewer barriers to entry:

  1. Easier to understand—Our journey in real estate investing started shortly after my wife and I purchased our first home. We  had just navigated the home buying process successfully. There was a lot of excitement about owning property.  We thought that buying another house when we had the funds, would allow us to steadily build a portfolio over time.  The concept was easy to wrap our head around. This is true for anyone who has acquired their personal residence.

In contrast multifamily investing seems more daunting. You simply require more knowledge to start. First, you need to know a deal sponsor or syndicator. You need to understand how the transaction is structured. You then need to analyze the property itself to determine how realistic the return projections are. Frankly, we did not know we had the option to participate in multifamily investments at the time. It was not something that we even considered mostly due to lack of knowledge.

  1. Less Money To Participate—Typically a lot less money is required for the down payment of a single family vs multifamily. In many parts of the country you can still find decent investment single family houses that cost less than $150,000.  The median home price in America hit record highs of about $350,000+ in successive months in the summer of 2021.  This makes it increasingly more expensive to invest.  However, most single family investors actually buy houses at lower price points than $150,000.  The amount of down payment depends on your lender but a typical range is 5% to 20% minimum. This means that on that $150,000 home you will need $30,000 on the high end to get in.  By comparison, most syndicators require a minimum of about $50,000 to participate in their investment. Many  have higher minimum requirements.
  1. Fewer Things To Fix—Single family homes in good condition usually do not have a lot that needs fixing.  By good condition we assume a sound roof, decent bathrooms, functional kitchen and with a responsible tenant. Tenants who live in single family homes are usually resourceful enough to change their own light bulbs, air filters and will often “project manage” little repairs as they want things to be done on their schedule.  I have even had arrangements with good tenants to mow their own lawn and shovel their own snow.  In contrast apartment dwellers often display less “ownership”. Plus there are typically common areas, grounds, and sometimes a pool or fitness center, to maintain which tend to result in higher costs per unit overall.

The Case for Multifamily

In my humble opinion there are significantly more reasons why multifamily is superior to single family as a passive investment.  Advantages of multifamily tend to stem from greater scale efficiencies and higher diversification of risk.

  1. Overall Efficiency—Owning more units in one place is simply more cost effective during the acquisition, hold period and disposition of the asset. During the acquisition and disposition the legal costs, diligence costs, lender fees, and other expenses are spread over more units in one single transaction.  This makes it less expensive overall. During the hold period a higher sophistication is typical in the people, processes and technology that are employed to manage a hundred unit building than a single family home. This is simply due to economies of scale and scope.  This means that the investor’s dollar goes further in achieving the goal across more units vs single family homes.
  1. Professional Property Management—To build on the point above having unit concentration and scale makes it more practical to engage a professional property management firm to manage a multifamily property. The property manager is a key partner in ensuring successful execution of the investment business plan. They are your partner in making your investment work whether it is upgrading units or implementing rental increases. It is usually much more expensive per unit to hire a professional property manager for your single family home and the quality of property management tends to be lower the fewer units they manage.
  1. More Efficient Maintenance–Having unit concentration makes it less expensive to hire maintenance labor. Simply put, you can afford to hire a good maintenance employee for a hundred units rather than pay a third party company hourly service fees. There are also fewer roofs, parking lots, mechanical systems per resident and upgrading any one of these affects many tenants at once. Similarly, with many units the owner is in a position to get some discounts as they have the purchasing power with vendors.  Instead of buying one set of appliances, floors, or paint you can plan ahead and purchase items in bulk which is less expensive. This advantage often extends to third party services provided as well.
  1. Sophisticated Systems and Processes—The multifamily property allows the manager to use more sophisticated systems which allow for more efficient property operations, provide better visibility of key performance indicators and improve the tenant experience. There are systems for accounting, to process electronic rent payments from tenants, to submit work orders for repairs, and for upcoming maintenance notifications. Such systems would be impractical for a single family investment.

The scale provided by the property often allows a savvy operator to consider water and electricity conservation efforts which may be too expensive to implement in a single family home. Tenant communications can be optimized as you don’t have to customize the message to each individual single family address. There is someone overseeing the investment whose job it is to ensure operational efficiency.  This is almost never the case with single family house investments.

  1. Improved Tax Treatment—The larger the property the more depreciation it generates. Further, savvy multifamily operators often employ cost segregation analysis to accelerate the depreciation treatment of the property. This allows a higher depreciation write-off during the years of ownership. This makes it highly likely that you will have a more favorable tax treatment of your investment. Often it will mean paying no tax despite having received a cash distribution during the year.  Single family investments on the other hand do not justify performing a cost segregation study.  Tax planning in such an investment is largely based on straight line depreciation.
  1. Valued As A Business—Most of us remember the Great Recession of 2005-2008. Many people lost their homes. The resulting havoc that ensued had a dampening effect on the economy. This tragedy happened in part because single family homes were valued based on what the houses next to them were selling for. This method is call “comparable sales” and was used egregiously without regard for the underlying intrinsic value of the properties. The default rate of single family mortgages during this period was almost 5% while that of multifamily properties was less than 1%. In other words there is a lot less risk in multifamily vs single family investing.

Multifamily properties are primarily valued based on the net operating income that they generate, a proxy for profit. Significant consideration is given to how much money the asset throws off.  In this sense it is valued like a business rather than like a fashion accessory. In other words single family homes are at the whim of buyer sentiment much more so than multifamily investments.  This makes multifamily investments a better intrinsic store of value.

  1. Forced Appreciation—Because multifamily assets are valued based on the cash that they generate it follows logically that the owner is in some control of driving that value. You will often hear properties described as “value add” deals. This is because the operator can do a number of things to generate a higher net operating income. Higher net operating income in turn translates to a higher value of the building. This is a big reason why I favor multifamily vs single family.

Initiatives which improve revenue can take many forms.  Performing unit upgrades, specifically to kitchens and bathrooms, usually results in higher rents. Replacing carpets in high traffic areas with vinyl plank flooring is another one. It reduces turnover expenses when tenants leave and increases property appeal. Improving the exterior of the property to attract better tenants, adding new amenities to the property, such as a clubhouse or a pool, all drive revenue.

The operator can also focus on instituting discipline when it comes to expenses. Cost cutting initiatives may include negotiating a lower priced cable bill for the property.  Alternatively, they make take the form of implementing water and electricity conservative initiatives to make the building more green.  Over time increasing revenue and paying attention to costs significantly grows the net operating income. This in turn results in significant appreciation in the property value.

You can execute similar initiatives in a single family setting. They may result in slightly higher rents. But they seldom translate to a higher valuation when you go to sell the single family home.

  1. Diversification Of Risk—In the first single family investment house we bought we were fortunate to have a great and responsible tenant. We never heard from them. They planted nice flowers in the yard.  The rent checks arrived in the mail like clockwork on the 25th of every month before the next month started. They stayed for the first few years. But then they moved out. After the new tenant moved in all of a sudden the house became a headache. I was getting requests to fix something new almost every week.  Soon rent payments started arriving late. Then they stopped.

It took several months before we finally got this tenant to leave.  Then it took a month to clean the house, do minor repairs and throw on a new coat of paint. We were now being cautiously selective with who we would allow to rent the house.  All this took time.  Throughout this period we had to absorb all these costs on top of all our regular expenses.  With no renter in a single family home there is no income coming in. The burden of paying the mortgage rests solely on the shoulders of the owner. While it may be bearable financially, for as long as this is happening you are technically 100% vacant.  The longer this period lasts the easier it is to wipe out any profits you may have benefited from while the house was occupied.

In contrast it is highly unlikely that your multifamily investment will ever become 100% vacant. This is why the default rate for multifamily was 5 times lower than for single family during the Great Recession.  Tenant diversification is key.

Different tenants will experience ups and downs at different times. If you screened the tenants well, not all of them will experience hardship at the same time. You are diversifying your risk among many individuals and their moral character.  Further, you are diversifying among tenants’ ability to pay the rent (your mortgage) and the economic viability of the many companies that they work for.  If you have tens or  hundreds of tenants in one or multiple buildings you diversify even more.  If you are invested in multiple areas and with multiple operators you are limiting the risk that any one factor would adversely affect your investments.  This is one of the most important factors why I prefer multifamily vs single family. More details and charts here.

Conclusion

In summary, there are many reasons to invest in single family and multifamily housing.  The primary demand driver is population growth. More accurately household formation drives demand for housing more than raw population.  But they are closely related.  People do need a place to live. For this reason there is more consistency in the residential housing market. It has less volatility than other real estate sectors. Demand in sectors such as retail, hospitality and office space fluctuates more.   The investment is generally easy to understand. There are ups and downs in real estate investing as with all markets. Real estate is often counter cyclical to other asset classes.  This is exactly what you want in your portfolio. For all these reasons residential housing is a good vehicle for the passive investor.

I prefer multifamily vs single family. I outline the reasons above.  If you are looking to invest a sizable sum of money passively in real estate multifamily is the answer.  It offers a better risk-adjusted return over time than a single family investment does. It is up to you to get comfortable with which makes more sense for you.

At Cape Sierra Capital we focus on providing investors with passive income by investing in multifamily real estate.  The multifamily asset class has high returns, relatively low risk and even less volatility as outlined in the arguments above. To learn more about how cash flow works download a free copy of The Personal Cash Flow Formula.  To hear about our upcoming investment opportunities join our Exclusive Investor Network.

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