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Multifamily Homes

Buying Rental Property – Single Family or Multifamily?

We’ve written about becoming a landlord in a previous series. Now we look at the pros and cons of single family homes versus multifamily rental property. What should you go for when buying rental property?

In the game of Monopoly, a popular winning strategy is to transform four little green houses into one large red hotel.

Real estate investing is similar – many new investors start out with single family homes and eventually move into small multifamily homes or apartment complexes.

Every type of investment has pros and cons. This article compares investing in a single family home to a multifamily home (duplex, triplex or quadplex) with the objective of helping a growing investor decide which type of investment is appropriate for them and their portfolio. Note that the comparisons are highly dependent on the chosen real estate market, the availability of multifamily homes, and the projected tenant pool.

Advantages Of Multifamily Property Investing

One of the greatest advantages of investing in multifamily homes is the ability to maximize mortgages. Fannie Mae and Freddie Mac, the two government-backed mortgage lenders, limit the number of mortgages an investor can have at one time to ten. Because most mortgage companies eventually sell investment mortgages to another company, they need to conform to Fannie and Freddie’s guidelines.

A multifamily home with four units or less is still a basic mortgage and only counts against one of those ten mortgage allotments. After ten traditional mortgages, the investor must get creative and look into private money loans or portfolio loans to continue to expand a leveraged portfolio. Buying multifamily homes enables you to rapidly build your portfolio. Mortgaging ten triplexes yields thirty units compared to mortgaging ten single family homes.

Buying multi family homes enables you to rapidly build your portfolio. Mortgaging ten triplexes yields thirty units compared to mortgaging ten single family homes.

With multifamily properties the cost per unit will always be cheaper than a single family home in the same area. The overall purchase price might be higher, but the price per unit will be less than a single family home. This again, will allow you to rapidly build your portfolio up with less upfront costs at closing.

Multifamily investment properties usually have higher cash flow and returns on investment than a single family home. This also provides a type of safety net – owning more units gives your cash flow a buffer when a unit is between tenants.

If you have four mortgages on four single family homes and one is vacant it might be tight to cover all your expenses. But if you have one mortgage on four units and one is vacant, your cash flow should still be positive.

Disadvantages Of Multifamily Property Investing

As with all investing, it’s important to understand the risks and pitfalls of your investment. A primary concern for multifamily properties is the quality of the tenant. Because the location of a multifamily property might be in a less affluent neighborhood, you may end up with lower income tenants.

This may lead to more vacancies or problems with multifamily renters compared to single family renters. Multifamily properties require more property management — instead of finding one tenant, you or your property manager will need to find multiple tenants. This also means you have more tenants to manage and possibly more headaches.

Some multifamily homes do not have utilities divided between all the units. This means it will be a service provided by the landlord. Now you have to pay water, gas, electric, trash, snow removal, etc., for your tenants. Ideally you should buy a multifamily home where each unit has its own utility meter.

When you eventually sell this property, it will most likely be to another investor as multifamily units are not as competitive in the home sales market for families looking to establish a home. This limits the pool of potential buyers and could make selling the property harder down the road. Also, multifamily properties historically do not appreciate in value as much as a single family home.

Economy Of Scale

Multifamily investments traditionally claim economy of scale as an advantage, but it can go either way in my opinion. A definition of economy of scale is an economic advantage due to size, output or scale with the cost per unit generally decreasing with increasing scale as fixed costs are spread out over more units of output.

An example is roof replacement. If you owned a triplex you have one roof over three units, so when it is time to replace your roof it will be cheaper than replacing the roofs on three separate single family homes.

Another example is if you want to rehab all three units you can send one plumber, painter, etc., to the property, do all the units at once and get one larger bill instead of getting several smaller bills if you had sent the same people to different properties. Conversely, multifamily properties have more HVACs, toilets, and appliances to maintain compared to a single family home.

Real Examples

Here are three different properties for sale right now, broken down by asking price, cost per unit, monthly rent, mortgage and tax liabilities, management, and overhead.

Property 1 – Single Family Home; 3 bedroom 1 bathroom

Asking Price
$76,360
Cost/Unit
$76,360
Total Rent/Month
$900
25% Down Payment & 5% Closing Costs
$22,908

Monthly Expenses

Mortgage Payment (30 year 5% fixed)
$307.44
Property Tax & Insurance
$115
Property Management (10%)
$90
Vacancy (5%)
$45
Repairs (5%)
$45
Misc (Utilities, HOA)
$0

Profit Potential

Monthly Cash Flow
$297.56
Cash on Cash Return (COCR)
15.59%
Cap Rate
9.51%

Property 2 – Duplex; 2 bedroom 1 bathroom and 1 bedroom 1 bathroom

Asking Price
$103,300
Cost/Unit
$51,650
Total Rent/Month
$1,300
25% Down Payment & 5% Closing Costs
$30,990

Monthly Expenses

Mortgage Payment (30 year 5% fixed)
$415.90
Property Tax & Insurance
$145.83
Property Management (10%)
$130
Vacancy (5%)
$65
Repairs (5%)
$65
Misc (Utilities, HOA)
$0

Profit Potential

Monthly Cash Flow  
$478.26
Cash on Cash Return (COCR)
18.52%
Cap Rate
10.39%

Property 3 – Triplex; all 2 bedroom 1 bathroom

Asking Price
$177,780
Cost/Unit
$59,260
Total Rent/Month
$2,400
25% Down Payment & 5% Closing Costs
$53,334

Monthly Expenses

Mortgage Payment (30 year 5% fixed)
$715.77
Property Tax & Insurance
$233.33
Property Management (10%)
$240
Vacancy (5%)
$120
Repairs (5%)
$120
Misc (Utilities, HOA)
$0

Profit Potential

Monthly Cash Flow
$970.90
Cash on Cash Return (COCR)
21.84%
Cap Rate
11.38%

Math notes:

  • Monthly Cash flow = Monthly income – monthly expenses
  • COCR = (Annual Cash Flow/Total Cash Needed to close) x 100 – Allows you to compare properties that are leveraged with mortgages
  • Cap Rate = (Annual cash flow without mortgage payment/purchase price) x100 -Cap rate allows you to compare properties as if you paid all cash

As you can see from the examples, moving up in size increases returns but you have to take into account all the advantages and disadvantages we talked about earlier to see what is right for you. Personally, I would select the duplex above for my first multifamily investment.

The cost per unit is the lowest, the cash needed to close on the property is a lot smaller than the triplex, the returns are very solid, and eventual resale of a duplex might be easier than the triplex.

Any of these properties could be a great investment for you; it all depends on your goals and the area of the country in which you are looking to invest. Good luck and see you in early retirement!

Featured Image Photo Credit: “Yellow and white military duplex at Fort Lawton, American flags, trees, yellow grasses, Discovery Park, Magnolia bluffs, Seattle, Washington, USA” by Wonderlane on Flickr

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