Real estate has become increasingly popular worldwide as the asset class continues to mature, offering stable and competitive returns. Average returns, or cap rates, for single-family rental (SFR) homes and multifamily properties nationwide are currently in the mid- to high-5-percent range. Therefore, diversifying your portfolio into either type of real estate can be a very lucrative proposition.
As both types of real estate continue to perform well – and should remain healthy in 2018 – which type of investment is right you: an SFR or multifamily investment? The short answer: It depends. It depends on what stage you’re at in your life, how much money you have to invest, and your ability to absorb risk.
“It really depends on what stage you’re in as an investor,” explains Steve Hovland, director of research for HomeUnion. “Based on my own personal investing experience, entry-level investors should look at single-family rentals because they are less expensive, and they need less capital to get started.”
After buying your first investment home, Hovland suggests utilizing a 1031 exchange “to buy up” into an apartment asset. (A 1031 exchange is a provision of the IRS code that allows an investor to defer capital gains taxes on any exchange of like-kind property.) He believes buying more multifamily assets throughout your life will help build wealth.
As retirement approaches, an investor might want to consider liquidating some of those real estate portfolio holdings for cash proceeds, and then trade back into SFRS using a 1031 exchange. “Distributing one’s portfolio from apartments to SFRs helps retirement-aged investors avoid major tax hits all at once, and eliminates some of the risk of that investment not being cash-flowing,” says Hovland. When an investor approaches retirement, it’s important to have passive, cash-flowing properties in their portfolio, especially if they have limited savings, pensions or 401ks to tap into.
Now, to dissect the benefits of investing in each asset class, no matter which stage you’re at in life. Let’s start with single-family real estate.
What are the 3 benefits of investing a single-family rental?
- Easier Financing, Faster Closing Times
- Appreciation Tied to Neighborhood Growth
- Inefficiencies, Lack of Regulation Benefit SFR Investors
SFRs: Conventional Financing, Faster Closing Times
For first-time real estate investors, buying an SFR couldn’t be easier. They can select from a number of financing sources, including conventional GSE loans (which feature historically low rates), a self-directed IRA, or all cash. At HomeUnion, an investor can even utilize our in-house lending service to do all of the legwork for you.
It’s standard to place a 25 percent initial investment down on an SFR, and the Q3 2017 median SFR price was $191,600. So, for about $48,000 down, a first-time investor to enter the real estate investment market. A multifamily property – which is a dwelling with 5 or more units – is more expensive than an SFR, at least up front. The average price per unit for an apartment property is approximately $72,200, which means a 5-unit building could cost $361,000, a significant sum for a first-time investor.
An e-commerce company like HomeUnion can close an investment home sale in under 15 to 20 days, but the average closing takes 30 days to complete, according to Chris Diaz, VP of HomeUnion Lending. Meanwhile, a multifamily sale can take anywhere between 60 and 90 days to complete.
SFRs: Neighborhood Quality Positively Impacts Values
Other houses in a neighborhood drive up or push down the value of your investment property, a commonly known fact in the real estate industry. Crime rates, schools, easy access to public transit or freeway systems, and proximity to employment centers impact neighborhood quality, and in turn, home values, according to a report by Realty Times. A number of websites, such as Zillow, Redfin and HomeUnion feature data on neighborhoods that can help investors select the right investment for them.
“It’s easier to control the exact location of your investment home purchase, than a multifamily purchase,” notes Hovland, “especially with tools like our Neighborhood Investment Rating.”
SFRs: Market Inefficiencies, Lack of Regulation Give You the Edge
Although SFRs continue to emerge as a viable asset class, market inefficiencies remain in place. A dearth of professional management and transparency due to less regulation than the apartment industry are examples of these inefficiencies. Investors can take advantage of these inefficiencies, which don’t exist in the more established multifamily sector,” says Hovland. “As a result, it’s possible to achieve returns that are disproportionately higher in the SFR sector because of the risk investors are taking when acquiring properties.”
“Cap rates were 20 basis points higher at the end of 2017 for SFRs than multifamily assets, and they’re even higher in riskier, smaller markets such as Cleveland,” Hovland says. In 2016, cap rates hovered in the 10-percent range in the Cleveland metro, 410 basis points higher than the national average for SFRs.
It’s a well-known fact that “there’s a lot more legislation surrounding multifamily properties so investors looking into that space need to have a property management company. Multifamily properties are difficult to manage on your own. In California, for instance, you are required by law to have a property manager on site if your complex has more than 15 units.”
SFRs aren’t encumbered by many of the affordable housing laws, low-income housing tax credits (LIHTCs), Sec. 8 mandates, and other regulation that drive acquisition and operating prices up. A slew of regulations at the Federal, state, county and municipal level also add to the complexity of owning apartments.
Now, to analyze apartment properties and their advantages. What are the 3 benefits to investing in multifamily real estate?
- Financing Based on Property’s Performance
- Cheaper Management, All Under One Roof
- Economies of Scale Can Mean Higher Profits
Multifamily: Non-Recourse Loans Are Available
Buying a house as an investment typically requires mortgage financing. And that mortgage financing for any type of home is called conventional financing, and is loaned to the borrower based on their creditworthiness and personal income levels. If an investor defaults on that conventional loan, it could be detrimental to their financial future. For apartment leverage, the borrower typically utilizes a non-recourse loan to finance the asset, and the property’s historical operating performance determines the loan terms. Generally speaking, an investor can find lower interest, non-recourse financing for a property with the following attributes:
- The apartment is in good physical condition, or was recently rehabbed.
- The asset is located in an area with mid to high median income levels.
- The property has historically high occupancy.
Multifamily: Ease of Management
As any CEO knows, it’s easy to manage your employees when they’re located under one roof. But when they’re scattered across the country, managing your staff becomes a bigger challenge. Similarly, it’s easier to manage a single multifamily property in one location than multiple rental properties scattered across the country. “Apartments are cheaper to manage because they’re all under one roof. In fact, you only have to replace one roof if necessary,” Hovland shares. “Furthermore, operating expenses decline and management is less intensive on one site – in an apartment building – than it would be with rental units located in different cities or states.”
Property managers charge a higher rate for managing scattered houses because it’s harder to monitor unruly tenants, or illegal activities that violate the terms of a lease, such as having a pet on premises or more occupants than the lease terms dictate, etc. Maintenance requests, additionally, can be handled easily in one location rather than from various locations. However, there is one company in the U.S., HomeUnion, that handles all of an owner’s property management services remotely from one location – their headquarters in Irvine, Calif. In this rare case, HomeUnion levels the management playing field for multifamily and SFR owners. “Nationwide, the availability of professional and effective property management for apartments is higher because multifamily is a more mature asset class,” says Hovland.
Multifamily: Economies of Scale Present Better Opportunities
As a general rule, economies of scale – buying more dwellings in one transaction – result in fewer expenditures for multifamily investors. For example, a multifamily investor only needs to replace one roof for 40 units, versus 40 roofs for 40 separate single-family rentals located in various places, presenting an incredible cost savings to a multifamily investor over the long term.
Apartment managers can save on their operating expenses by implementing a Ratio Utility Billing System (RUBS), which effectively passes on the property’s utility bill to the residents based on an occupant factor, square footage factor, or a combination of both. Each tenant is billed for a portion of the water, trash, sewer and pest control charges out of the total master bill that the owner receives.
Ask for Help Before Investing
“If you conduct your due diligence, an SFR or a multifamily asset can be an excellent investment, especially when that investment is a diversification play,” shares Hovland.
In the end, it’s all about your own personal preferences and financial goals, and the best advice is to talk to a real estate investment and management expert. Schedule a consultation with one of our Solutions experts or contact us today at firstname.lastname@example.org.