5 Ways Multifamily Real Estate Is Superior to Single-Family Homes

Which is a better investment — multi-family real estate or single-family homes?

You've probably seen a lot of TV and media covering single-family homes. It’s quite popular. But is there a better investment out there? In this blog post, I’m going to walk you through five reasons why you should consider investing in multi-family rather than single-family homes.

So let's get right into it. Here are five things to consider:

1. Cash Flow

There are several reasons why multi-family wins when it comes to cash flow.

When I first started investing in real estate — before I knew where I wanted to go and before I had a long-term plan — I was acquiring and buying single-family homes. And one of the things I found is cash flow — the rental yield is extremely tight. Why is that? Well, let's say you have a single unit or even a duplex or a triplex. If you have one tenant move out of a duplex for example, there goes 50 percent of your revenue. That absolutely kills your cash flow.

Then we have expense ratios. With multi-family, because we have more units, the expenses are spread out over a larger number of units so the ratio of expenses per unit goes down. This frees up cash flow.

Then we have management fees. With single-family homes, you can be paying 10 to 12 percent to have professional management or a professional property manager. With multifamily, not only do you have on-site staff in the leasing office and a maintenance staff, your management fees are significantly less, usually 3-4 percent. This improves your cash flow.

When I owned a single-family home (it was a duplex), we had a drain to the sewer go — a tree had gone through it — and it cost $9,000 to fix. That was basically two years of cash flow gone overnight with one repair. In multi-family, when you're dealing with larger properties with more units and more scale, the cash flow is there. It's a lot more cash flow positive, and cash flow is king in real estate. Without cash flow, the deal dies.

2. Stability

Multi-family is incredibly resilient and stable in economic downturns. CBRE once did a study where they looked at the past two recessions. They discovered that multi-family outperformed all the other types of commercial real estate.

There's a reason why lenders love lending for multi-family — it's incredibly stable. Why? People always need a place to live. Office spaces can shut down. Businesses and factories can close. But people still need a place to live. That is the last thing they will give up. The government will do everything they can to make sure people don't have to give up their home or place to live.

So multi-family is incredibly stable. We have the strong cash flow which definitely helps out in the deal. You have much lower default rates in multi-family real estate because the cash flow is so strong. You have more units and more scale. If you have a triplex and a tenant moves out, there goes 33.33 percent of your revenue. Most businesses can't absorb that type of loss.

But a multifamily can. Let's say you have 150-200 units having 5-10 units vacant. No big deal. That’s just the cost of doing business. The strong cash flow supports it. So during the choppy waters of an economic recession or downturn, multifamily comes out ahead. Generally speaking, multi-family has a shorter downturn in terms of rents dropping. And then it picks up a lot faster, surpassing the previous peak faster than office, industrial, and retail real estate.

3. Valuation

This really means control, the number one thing professional investors look for. When you're dealing with single-family homes, these homes are valued based on the comparable approach. This means, if you have a three-bedroom two-bath home on the street and three of them sell for $500,000, chances are your home is worth $500,000. The bank doesn't really care about what you're renting it for. It doesn't care about potential rents. It doesn't really care about any of that. They're looking at what the comparable properties are selling for on the street.

With multifamily and commercial real estate, it's valued using the income approach. This means, the more net operating income or the more free cash flow the property produces, the more the property is valued. So we can control the additional income streams we bring in, how we optimize expenses, and how we raise the rents. This gives us a great amount of control over the value of our property.

So rather than just waiting for Mr. and Mrs. Jones down the street to sell their house, we can really take an active role in forcing the appreciation of the asset. This is a huge thing that I wish I had when I first started investing in real estate when I started doing single-family homes. I had no control over how the bank and the lenders valued my property.

4. Debt

When you're investing in single-family homes, the lender looks at you first. You as the borrower. Your income and your assets have to speak for themselves. The bank doesn't really look at the property itself. They want to make sure it's there. But when they're doing their underwriting and figuring out if you can afford the debt that's going on the property, the buck stops with you. So if something goes wrong in the deal, they're coming after you and all your assets.

Your income has to qualify. So even if the property is producing strong income — let's say it's a triplex or a fourplex — the lender is still looking at you, the borrower, to qualify for that debt — not the property itself.

When I was trying to scale my single-family portfolio, this really held me back. The lenders have such a tight box they want you to fit in. But when we moved over to multifamily, the lender now looks at the property first and you as the borrower second. Sure the lender wants to make sure you've got an experienced property management team on site and you have your business plan and you know what you're doing.

First of all, they look at the property itself. Can the property support the debt? What is the property looking like? What's the business plan? That is the main focus and this gives you a huge advantage as you're scaling your multi-family portfolio. Plus with commercial real estate we also have non-recourse debt, which I didn't have access to with single family homes.

5. Tax Benefits

This is huge in real estate. Sure, we can use single-family homes and residential real estate. We can depreciate those and get some tax benefits. But we really put depreciation on steroids in larger multi-family real estate properties. And the reason is cost segregation. Basically what we're doing is we're taking 39 years worth of depreciation and we're front-loading it right to the very start. So it all comes down to the time value of money.

A dollar in your pocket today is worth far more than a dollar tomorrow or three years, five years, 10 years, 15 years, even 39 years from now. But why wait 39 years for the property to fully depreciate when you can front-load it and take advantage of the time value of money? Because of the scale and size of the properties, it makes sense to do a cost segregation study and take advantage of the tax code that basically gives us huge tax credits just for acquiring real estate.

The Bottom Line

I started off in my investing journey buying and acquiring single-family homes and duplexes. If I could go back in time, I would have started with multi-family right away. The scalability, cash flow, stability, valuation (control), the debt you can put on the property, and the tax benefits are all superior when you look at it.

If you're interested in learning more about multi-family real estate, join our free Facebook group. It's a great group of people! And if you are an accredited investor and you're interested in learning more about the deals I’m currently looking at, head on over to callseth.com and set up a free 20-minute phone call with me.