Single Family & Multifamily Investment Overview
Residential real estate is the foundation for many investors looking to add real estate to their portfolio. There are many avenues available to investing in residential properties, but the most common is purchasing either Single Family Residences/Houses (SFR/SFH) or Multifamily properties (ownership of an entire apartment complex). Both are excellent opportunities that have their own unique place in investment portfolios and the capital markets. Both Single Family and Multifamily properties have different strengths and weaknesses.
To understand these two types of residential properties, single family and multifamily, we must first define them. Single family homes are essentially single unit properties that are meant to house one family. Single Family residences range from townhouses, condos, conventional houses – the picket fence nuclear family household dream that many speak of. Multifamily is defined as properties that have more than one unit and can house multiple families such as; duplexes, triplexes, fourplexes, a 5-unit, 10-unit, 150-unit and so forth.
Multifamily investments have additional factors to consider, such as the division of financing between the 2-4-unit properties and their 5+ unit counterparts. Multifamily properties in the two to four-unit range (duplex, triplex, and fourplex) allow for a residential loan, and their 5+ unit counterparts require commercial loans. With 2-4-unit properties, an owner has the option to utilize a lower down payment if they occupy one of the units. 5+ unit properties require a commercial loan, bringing up the complication of the Debt Service Coverage Ratio (DSCR), financials of the building, and experience level of the buyer. The DSCR is a metric the lenders use to determine whether or not the income of the property is able to cover the debt service (mortgage) on the property. A DSCR of 1.0 indicates that the property’s cash flow covers the debt service, but most lenders in a normal market require a 1.20-1.25x debt service. The DSCR relays to lenders that the interest from the investment (which is what lenders are most interested in) will be consistently paid, giving them further confidence to fund the loan.
Single Family & Multifamily Investment Property Similarities
- Historically good long-term return on investment
- Larger market of buyers and renters than commercial property
- More consistent during an Economic Crisis
- 4 benefits to real estate investment & beyond.
Some investors prefer to purchase single family properties in bulk and diversify the markets that they invest in.
Single Family Investment Highlights
- Affordability
o Lower up front cost to purchase and much easier flip.
o Lower insurance rates because there is only one unit being covered.
o Utility expenses are fairly manageable as a lot of agreements require the tenants to pay for a higher portion of the utility expenses.
- Appreciation
o More demand for a single family home since there is a greater buyer pool.
o Single-family homes are more subject to supply and demand factors from individuals who want to purchase the property and inhabit it.
o Demand is seldom lacking so home values in primary markets tend to follow a linear appreciation schedule.
- Long Term Tenants
o There is a tendency for single family tenants to view the property as their own in comparison to living in an apartment unit.
o There is less turnover with single family properties, and many SFR tenants look to stay long term and occasionally negotiate a rent-to-own exit.
Multifamily investment allow for multiple residential tenants to pay for rent. In the event there are a couple vacancies, the landlord is not under a ton of stress in comparison to a single family vacancy.
Multifamily Investment Highlights
- Rental Incomes
o Because there are more units, multifamily properties are able to generate higher monthly rental income in comparison to their SFR counterparts.
o An investor can increase their rental income through methods such as renovation, changing the property management team, vending machines, parking spot fees, pet fees, laundry, fitness centers, common area amenities, or RUBS (Ratio Utility Billing Systems).
- Vacancy
o Less vacancy issues. Even if one of the units are vacant for a month or two, the other units are able to supplement the vacancy and pay the debt service (mortgage).
o When an SFR property has a vacancy, the investor still needs to pay the mortgage. This can be out of pocket and last for months on end depending on the location as well as the expectation of the investor. Some investors are unwilling to accept a changing market, and will sit with an overpriced vacancy, further increasing their cash burn.
- Controlling Value - Forced Appreciation
o Because multi-family assets’ values are determined by the income that it produces, the investor is able to force appreciation on the property. This is accomplished through repositioning the asset (also known as rehabbing) or changing out underperforming tenants for market rate ones.
o The forced appreciation strategy allows one to BRRRR apartments (Buy, Rehab, Rent, Refinance, Repeat).
o While SFR properties can get renovated and slightly increase in value, a small rental increase on a multifamily property by $50-$100 a month or a reduction in expenses by 3-5% can unlock tens to hundreds of thousands of dollars in equity upon refinancing.
Additional Considerations
It is critical to consider the marginal costs and benefits to Single Family and Multifamily properties prior to investing. Many Single-Family and 2-4 Unit Multifamily investment properties in the San Francisco Bay Area yield sub 2-3% Capitalization Rates (or simply put, Year 1 return if purchased all cash). Cap rates allow one to quickly determine a property’s return potential, value, and whether or not the property will benefit from financing. High cap rates tend to indicate riskier but greater cash flowing investments, while low cap rate investments indicate stability but are challenging to derive additional value from. Many local investors target Multifamily versus SFR purely off of the increased return. While SFRs have historically performed in the 2-3% range, it isn’t uncommon to see 1.5-3x the rental return with a similarly priced Multifamily property.
Many of the advertised rental numbers on the MLS or the offering memorandums (OMs) for multifamily properties require additional due diligence. An individual skilled in real estate investment advisory should be able to walk someone through the strengths and weaknesses of different properties, identify discrepancies, value-add potential, and present them side-by-side with comparable investments.
Ron E. Cruz