Choose The Right Apartment

It reminds me of the old Miller Lite commercials; “Less Filling!” “Tastes great!,” the constant debate on what is a better investment, multifamily/small apartments or single family homes. So where is the best place to put your hard earned profits? I often think about where to put profits, and it is a big variable when analyzing when to sell an asset. I can get offered more than a property is worth and turn it down if I don’t have a good place to put the money. Knowing what you are going to do with your excess cash is essential to your overall objective. The way I process this is to compare alternatives against each other. Typically it is specific opportunities, but that all starts with a much broader view. I actually don’t land on one side or the other in the debate. I am usually the one asking questions that get the conversation going or gets people thinking. I think both are good, so let’s take a look at the positive aspects of each one when you compare to the other.

SMALL APARTMENTS

I am lumping all residential property that is more than one unit into this category. What is not included would be extended stay hotels or short term lease units. I have a handful of small apartments in my portfolio and here is why I like them.

One Roof: I use one roof only as an example. Multiple units offer economies of scale. Let’s assume we have a 20 unit building. If I replace one roof, I replaced the roof on 20 units at one time. Same will go for painting or any number of other maintenance or improvement items. When you do the math, the price per unit is significantly lower than that of single family homes.

Economies of scale are not limited to maintenance. You will get other savings as well, like marketing expense when you have a unit or two go vacant. You can create a prospect tenant list that you can tap into whenever a unit becomes available. In larger buildings, you will have units coming available each month so you can have a steady marketing campaign constantly running, saving you time and money. It is also likely you will get referrals from other tenants if a unit goes vacant. Insurance is another example of some cost savings per unit.

Easier to Manage: This is not always the case as we will discuss below, but at certain times small apartments can be easier to manage. Sometimes you will have onsite management which will put someone there all the time. They will keep the place clean and take the initial impact of any tenant problems. Even without an onsite manager, multifamily can be easier to manage because all the units are in one location so you are not driving all over town.

Better to Finance: Financing is always an important component when you are a real estate investor, and it becomes more challenging as you get more rentals. One easy way to accumulate more rentals without getting cutoff with your loans is to buy multiple units with one loan. Also, most multi-family loans are considered commercial loans, so there could be more flexibility with the number of loans you have, making it easier for some investors to finance. Commercial loans often times do not get reported to your personal credit, even if you personally guarantee them, which has its own benefits. As mentioned, the big benefit to financing multifamily is you can buy a lot more units. The downside is the loans have shorter terms (you cannot lock them in for 30 years very often) and they have higher interest rates.

Cash Flow: This is not always the case, but from the properties I have reviewed or purchased the cash flow is higher on small apartments, which is a big benefit.

SINGLE FAMILY HOMES

I am considering single family homes as anything where it is just one unit owned. This could be single family detached or attached. Although I am including them in this discussion, condos and town homes sometimes come with their own unique set of advantage and disadvantages.

Less Maintenance: It has been my experience that tenants that live in apartments are much harder on the property than those that live in houses. Often times the lower rent levels attract tenants that care less. There is also common space with small apartments that no one wants to take care of, so that will be additional maintenance for the manager.

No Tenant Fights: The problem I have run into with all of my small apartments is that eventually the tenants won’t get along. One might be loud or messy or not be courteous. When this happens it is common for the landlord to get a call complaining about the other tenant. The problem is… it is not the landlord’s problem. There is really nothing for the landlord to do. When I get a call like that will commit to sending a letter to the residents about following the rules and respecting their neighbors, but outside of that, there is not a lot to be done. I always suggest they call the police.

Can Be Easier to Finance: I say can be because financing is a tricky subject. The money you can get on single family is the best money out there. It is cheap, long term, and fixed. In a lot of cases, you can get higher loan to values and if you know how to use hard money as a bridge loan, you can potential buy homes with little or no money down. The big problem with financing single family is that you are limited on the number of loans you can get with Fannie Mae and Freddie Mac, and there is no flexibly with their guidelines. Either you fit into their box or you don’t.

Diversified Across Several Local or Non Local Markets: When you buy single family homes you are likely spreading your money out into different markets or neighborhoods. In Denver during the Great Recession, I owned houses in areas that dropped 50% but I also owned homes in other markets that did not take a price hit at all.

Liquidity: This is big to many investors that I know. Single family homes are much more liquid. Your buyer pool will consist of; first time home buyers, move up buyers, downsizing buyers, and investors. A larger pool of buyers makes something much easier to sell, which reduces risk.

I left off appreciation, but many will argue that you will see greater appreciation over time with single family homes. That may be true, but I cannot say that with confidence because there is also a larger decrease in value in a down market.

You can see that there are benefits to both, which is why I like to have both small apartments and single family homes in my portfolio. I really don’t believe one is better than the other and each offers its own set of benefits.