RESIDENTIAL VS. COMMERCIAL INVESTMENT? ADVANTAGES AND DISADVANTAGES

What鈥檚 better – single family rentals or multifamily properties

Even in times like these, as commercial real estate is heating up and it鈥檚 more difficult to find good deals, investors who have SFH rentals are making killer returns, with cash on cash returns of 20% and more.

This is true even in hot markets like San Francisco or Washington, DC. That鈥檚 because you can acquire townhouses or single family houses for a relatively good price, but rent them out such that, after all expenses, you can net $400 鈥 $600 per month.

They鈥檙e more affordable.

Buying SFHs is much more affordable than buying apartment buildings. Many people have the cash themselves to slowly accumulate SFH properties over time.

They鈥檙e great for slow but steady growth.

This makes SFH investments perfect for the individual who wants to use his own financial resources to buy, say, one house per year, every year. If you can buy one rental per year for 10 years, it could set you up very nicely for an early retirement.

Cons
They鈥檙e difficult to scale quickly.

Let鈥檚 say your goal is to acquire 20 rentals in a year. To achieve that goal, you鈥檇 have to find and buy 20 houses. Regardless of how good you are, that鈥檚 going to take a ton of work.

Therefore, the SFH rental strategy becomes highly transactional: for each 鈥渦nit鈥 you want to add to your portfolio, you鈥檒l have to buy one house.

They鈥檙e harder and more expensive to manage.

A professional property management company will usually charge around 10% of the collected rent to manage a single family rental. Compare that with 4% 鈥 7% for apartment buildings.

Because of the increased expense, many landlords manage their own rentals, at least until they reach a certain size. If you don鈥檛 want to manage your own houses, then SFH investing may not be for you.

They鈥檙e more difficult to sell.

Compared to selling 50 apartment building units all under one roof, selling a similar portfolio of SFH rentals is much more difficult for two reasons:

(1) It takes a certain buyer to buy a portfolio of SFHs, which means the buyer pool is going to be smaller and (2) it is likely going to be more difficult to find financing for such a portfolio. Alternatively, you鈥檇 have to sell off each property separately, which will take time.

Their values are market-dependent.

The values of SFH rentals are driven by other residential sales comparables. The income normally doesn鈥檛 factor into the price of SFH rentals.

This means that the value of your portfolio is tied to the residential real estate market in general, which could be good or bad. But either way, it鈥檚 very difficult for you to influence the value of your SFH rentals because the market, not its income, will dictate its value.

Their vacancy equates to a 100% economic loss.

If one of your rental houses is vacant, then you have a total economic loss during the time of the vacancy. Unless you can offset the loss from other income, this can become a real problem.

Multifamily Apartment Building Properties

Pros

They allow you to scale more quickly.

Back to our original example with SFHs: Let鈥檚 say you want to acquire 20 units in the next 12 months.

With SFH rentals you鈥檇 have to find and buy 20 individual houses 鈥 20 separate transactions. With multifamily investments, you could get 20 units just by buying one building, in just one transaction. Multifamilies give you the opportunity to scale more quickly which gives you economies of scale.

They鈥檙e easier and cheaper to manage.

The nice thing about multifamily apartment buildings is that 鈥渘ormally鈥 the cost of a professional management company is built into the business model. Professional managers will generally do a better job than you can. And it allows you to be more hands-off, so that you can spend your time finding other deals or doing whatever it is you want to do.

If you鈥檙e looking for a more passive kind of investment, professionally-managed commercial property is the way to go.

You have more control over value.

Commercial real estate is as not as dependent on comparable sales as SFH rentals. That鈥檚 because it鈥檚 normally valued as a multiple of income. The higher the income, the higher the value. It鈥檚 therefore possible for you to pay 鈥渇air market value鈥 for a mis-managed property, make renovations, increase the rents and decrease the expenses.

Within 2-5 years, you鈥檝e increased the overall income and with that, the value of the property. Frequently, even a $50 per month per unit increase in operating income can increase the value of the building by several hundred thousand dollars. This means you have much more control over the value of your real estate.

There鈥檚 more upside.

Because you鈥檙e acquiring more units quicker than with a SFH strategy and you can create so much additional value by optimizing the performance of your property, the upside of apartment buildings can be significantly higher than with SFHs.

Cons

They鈥檙e more expensive to buy.

Unless you鈥檙e buying smaller properties, apartment buildings normally will cost more because, well, they鈥檙e bigger and more expensive to buy than a single family house. This seemingly puts apartment buildings out of reach of most investors. I say 鈥渟eemingly鈥 because some investors are of the impression that they can only use their own money or credit to invest with.

However, the solution to this problem is to raise money from other people. Even if it takes you a whole year to raise $500,000 to buy your first apartment building, it will still accelerate your real estate investing career.

It鈥檚 harder to find good deals right now.

It鈥檚 true: it鈥檚 darn hard to find good apartment building deals right now 鈥 all across the country. A lot of commercial real estate investors are being patient with their buying. Some have changed their strategy to SFH rentals because of these challenges.

Conclusion

SFH rentals are a good strategy because they鈥檙e easier to find and self-fund. But if you want to scale up and are looking for a more leveraged use of your time, then raising money to buy multifamily apartment buildings is the way to go.

Is it harder? Sure. But is it more worth while in the long run? Absolutely.