LIVE WHERE YOU DESIRE AND INVEST IN REAL ESTATE WHERE IT MAKES SENSE.
UNDERSTAND THAT YOUR HOME IS ACTUALLY A LIABILITY AND NOT AN INVESTMENT, BECAUSE IT TAKES MONEY FROM YOUR POCKET – IF YOU MUST BUY A HOME, CONSIDER A DUPLEX, TRIPLEX, OR QUAD FAMILY OPTION.
— ISMAEL R.
If you want to live where you desire and invest in real estate where it makes sense, there’s a lot to learn. First, let’s start with a few basics. From a financing perspective, commercial multifamily property is defined as 5 units or more. On the other hand, one to four-unit properties are categorized as single-family. The distinction is important because how a property is categorized determines the types of loan products it potentially qualifies for.
Next, it’s important to understand that commercial properties such as those acquired through passive investments in syndications get their value from their net operating income, while single-family homes get their value from comparable sales.
SINGLE-FAMILY RENTAL INVESTING
HIGHER VOLUME OF AVAILABILITY
With over 5 million home sales in an average year, there’s a much higher inventory. This gives single-family rental property investors a higher probability of finding great deals. It also increases the probability of a larger number of transactions.
SINGLE-FAMILY FOR LESS CASH
Getting started is easier with single-family homes. Off the bat, the price of a home is likely much less than the price of an apartment complex. Of course, this also means that you’ll need less cash upfront to buy a house. For owner-occupied single-family properties, Federal Housing Administration loans for qualified buyers require only a 3.5% down payment. Furthermore, many U.S. veterans can take advantage of a Veteran’s Administration loan which does not require a down payment (owner-occupancy required). Again, it’s only an investment if it puts money in your pocket, so the idea is to rent out a room or two or buy a duplex, triplex, or quad.
Another wonderful thing about this process is that your realtors and loan officers help you through each step. That eliminates a great deal of stress for investors allowing for smoother transactions.
HIGHER VACANCY IMPACT
The financial impact of a vacancy for single-family rental investment is far greater than with a multifamily property because of the difference in the number of units. For instance, if you own 3a triplex and one unit is vacant (33% vacancy), your finances are going to feel that a great deal more than if you invest in an apartment complex with 30 units and 3 are vacant (10% vacancy).
PROPERTY MANAGEMENT FACTORS
Routine maintenance may be more complicated with residential rental properties because each house likely has different types of appliances and standardization is difficult due to size/dimension differences. They also have systems (such as plumbing, electrical, or HVAC) at different levels of wear. With those varying factors, it means unpredictable, costly, and time-consuming maintenance requirements.
Although there are building codes for homes, they are not as complicated as those for a multifamily complex. This is primarily because of the difference between residential and commercial coding requirements.
Also, evictions are not as numerous with single home investments, but they still require a thorough working knowledge of all governmental laws where tenant eviction may be required.
MULTIFAMILY INVESTING
LARGER SCALE OF OPERATION
Multifamily makes up the difference in available properties by the scale of the investment. Simply stated, you make more money faster. Think about it. If each transaction adds anywhere from 5 to 500 new units to your portfolio (rather than one), you must ask yourself if that’s a better fit for your desired passive investment goals. Besides, although it generally requires more money to invest in multifamily versus single-family, you can partner with other investors and own a percentage of the asset.
TIME AND COST EFFICIENCY
The time it takes to process and close 50 home loans vs. one loan for 50 apartment units speaks for itself. Even though it does take somewhat longer to process one multifamily loan than a single-family loan, the transaction also includes the expectation of a more beneficial ROI for your time.
Again, a commercial acquisition is a bit more difficult, but as with a single-family property, there are people along the way that help spell everything out for you. Moreover, the bank usually requires that you partner with an experienced investor. Multifamily investing is considered by many as a team sport.
LOWER VACANCY IMPACT
Another advantage of multifamily over is the simple fact that because there are a higher number of units, the vacancy rate has a lower impact on the investors. However, the disadvantage is that there is a higher turnover.
ECONOMY OF SCALE
If you’re new to this, the ‘economy of scale’ is the savings in costs from an increase in production level. For instance, you might see it in this context, “syndications may lead to economies of scale”. Or, “one of the benefits of multifamily investments is the economy of scale”.
What this refers to is the ability to do more for less. How this plays out is that first, apartment buildings cost less upfront per door.
If you invest in multifamily through syndications, you have an asset (project) manager that does everything for you including dealing directly with the property managers of the complex. While no investment is completely passive, this is definitely much more so than the typical single-family investor.
Moreover, when there are common area improvements to your investment property, it adds up to improvements to all units, thereby adding value to all units.
For instance, there is a new laundry room that now raises the value of all units in the complex. The same goes for the installation of a new swimming pool – one swimming pool installation increases the value of every unit.
INVESTMENT CONTROL
Multifamily syndications get their value from their net income; single-family homes get their value from comparable sales. This means investors have more control over their income.
The control comes into play when investors add value to a multifamily complex by installing laundry rooms, internet services, a swimming pool, and more.
Again, just one new amenity adds value to the entire complex. In other words, amenities add value and value demands higher rent prices and that increases the income of the investor.
Investors can also add value by reducing costs.
MULTIFAMILY PROPERTY MANAGEMENT FACTORS
Routine maintenance is less-complicated because, by design, apartments most often have similar systems, equipment, and appliances in every unit. This naturally makes maintenance streamlined and therefore less costly.
Larger multifamily properties likely have onsite property management and maintenance personnel which focus solely on that property, improving the speed of lease-up. Having onsite eyes and ears also means that they can identify and fix tenant/property issues before they become major headaches.
Property managers of multifamily units have tracking systems in place to keep on top of the leasing status of the properties under their management. When syndication managers need a status report for their investors, a professional property manager will have data at their fingertips for leasing status, current occupancy rates, and additional information.
When it comes to building codes and legislation for commercial properties, project managers must oversee and adhere to a strict set of guidelines. Along with this, the proper operating and inspection permits are equally important. This is a high priority task for property managers of multifamily units.
Lastly, due to the volume involved with multifamily units, evictions are more frequent and require expert handling by property managers to ensure all current local laws for evictions are met.
MULTIFAMILY NON-RECOURSE DEBT
While many multifamily loan products are non-recourse, almost all single-family loans are recourse. A recourse loan is one in which the loan is secured by the investor. Conversely, a non-recourse loan is secured by the property itself. In terms of multifamily investing, this means that as an investor, you will not be held personally liable in the case of default.
However, a multifamily non-recourse loan is not a “get out of jail free” card. Rather, there are stipulations in every non-recourse loan to protect the lender. Specifically, the lender has recourse in the event of fraudulent or criminal activity. This also includes negligence on the part of the investors.
Because of the burden of liability on the lender, the underwriting is stricter and requires excellent credit. It also requires a sufficient net worth and enough cash on hand for mandatory services as they arise. This is helpful when services amount to more than the current incoming cash flow.
TAX ADVANTAGES FOR REAL ESTATE INVESTING
As many of you know, one of the best benefits of real estate investing is the tax advantages that await you. While many of the tax benefits listed below are the same for single-family or multifamily, there are a couple of significant differences. Talk to a tax specialist for the qualifying details.
DEPRECIATION TAX DEDUCTIONS
- An investment property depreciation refers to an allowable asset with a determined value that lowers with age.
- The depreciation often zeros out the taxes so the investor pays low or no taxes. (However, at the time of sale, they still owe tax on the proceeds.)
COST SEGREGATION • ACCELERATED DEPRECIATION
- This process is highly expensive, however, it should be cost-effective for most multifamily investing.
- The goal is to accelerate the depreciation of deductions and deferment of income taxes for the investors.
- Not only can the depreciation be accelerated significantly, but like with single-family, there are ways to reset it.
LONG-TERM CAPITAL GAINS
- Apply to property investments held for more than one year.
- Are at a significantly lower tax rate than for short-term capital gains.
- Owner-occupied single-family properties lived in for two years (two out of the last five) do not pay capital gains tax.
DEATH TAX BENEFIT
Rather than taxing your heirs for the value of the property plus the capital gains, taxes are based on the property. So, the capital gains literally vanish and the tax base resets at the value of the property. An example:
- The fair market value of your property at your death is $6,000,000.
- Your heirs will get the $6,000,000 piece of property without the $4,138,640 tax basis or the capital gain of $1,861,360.
- The capital gains vanish, and the tax basis resets to $6,000,000 for your heirs.
For additional information about the Tax Advantages that Await You Through Multifamily Investments, please read more here.
I hope this has given you some insight into which direction to turn for your investments. As always, I am available for questions or comments.