There are both pros and cons to investing in single-family rentals (SFRs) as opposed to apartment buildings. One is not necessarily better than the other. Instead, the value of your investment is dependent upon your investment strategy. Each type of property lends itself to different approaches, which is good news for you because that’s more ways to make money!
What rental options are available to investors?
There’s more than just SFRs and apartments for you to invest in. The variety frees you up to add variation to your investment strategy. You can either swap out the properties you purchase for the purpose of accomplishing your investment goals or change your goals entirely because you’d like to invest in a particular type of property.
Single Family Home
One tenant lives in a single-family home. Such properties tend to have only one kitchen and one main entrance and exit. Its layout makes it suitable for just a single occupant.
Two Family Home
A two-Family home is suitable for two separate groups of tenants to rent. Both units are separated, on different floors, and have their own bathroom, bedrooms, kitchens, etc. Each unit also has its own entrance and exit. One space can be in the basement or top floor of a home. It’s common for the landlord to live in one of the two units.
Duplex
A duplex is just a two-family home where the apartments are side by side instead of one on top of the other.
Mixed-Use Building
These properties are mixes of residential and commercial rental units. You could have a doggy daycare on the ground floor and then rental units above. It’s that sort of mix.
Traditional Apartment Building
This type of real estate is entirely comprised of rental units. There could be one or more units per floor depending on the size and layout of the property.
What are pros of investing in single-family rentals
There’s a lot of good reasons to invest in SFRs. That means SFRs can fit into a variety of investment strategies. And this is more than just opinion; these are positions backed by data!
Affordability
Single family rentals are less money and require less money upfront. In parts of the US, the Midwest and South, for example, you can find properties for under $100,000, but a small multifamily home(MFH) could easily start at over a million! For a single family home, loans tend to require at least a 20% down payment. That’s $20,000 for a property valued at $100,00. For a multi-family property with over four units, though, you’ll probably have to get a commercial real estate loan, which tends to require a 25 to 30% down payment. That’s at least $250,000 for a property worth over $1 million.
Similarly, lenders tend to want investors to have at least six months of payments for an SFR, but between six and a year for MFRs. The loans you’d get for an MFR also tend to be 2 to 2.5% greater and other less favorable terms. There’s also less lenders in general because the secondary market of institutions who may buy the loans is smaller.
Since the risk is greater for the lender when issuing a commercial real estate loan they really do their due diligence. They’ll require information about your income, business tax returns the property’s operating statement for the previous two years, and the rent roll. Lenders also tend to expect that you have property management experience already.
Ability to scale your rental portfolio slowly
When you’re investing in SFRs you can build your portfolio at a more gradual pace. That’s because SFRs are smaller investments relative to an apartment building. You’re not diving in deep right away, and can work at a pace that suits your lifestyle. You can space out the purchase of your properties over years and diversify as opposed to getting all your rental units at once.
Diversification
Because SFRs are easier to invest in they can add diversity to your portfolio, which will make you a more resilient investor. If you have multiple properties it will be easier for you to weather regionally based economic downturns. Or you can just cut and run easier if need be because SFRs require less effort to sell.
Leverage and liquidity
Given that SFRs are easier to sell, you have access to cash that you can use however you need, whether it be for other investments, emergencies, or big purchases like your child’s college education. You can also just sell one of your properties if you have multiple ones and not entirely empty your portfolio.
If you need money but don’t want to sell your property, SFRs are also easier to leverage into a loan. That’s because the lower costs mean you can build equity faster. You can also refinance to get more favorable terms, and therefore free up more cash. Or do a cash out refinance where your new mortgage is for a sum greater than the remaining balance of your current mortgage so that you can use that money as deemed necessary.
Greater resale opportunities
SFR’s are easier to sell. In addition to generally requiring less money and having a lower barrier to entry, you can sell SFRs to both real estate investors and homebuyers. That’s more potential buyers than duplexed or mixed-use real estate.
As reported by CNBC in July, 2019, SFRs are the fastest-growing type of property available in the U.S. real estate. Faster even than buying single-family homes! One reason is the student loans, credit card debt, and stagnating wages have precluded many people from becoming home buyers. Additionally, millennials are entering the age range when having a child is common, which also increases the demand for something larger in size than an apartment for one or two or a situation with roommates.
Lower tenant turnover
SFRs experience less turnover than other types of properties. This is a big deal! Not only do vacancies cost you money because your income flow has dried up, but you or your property manager have to sink resources into finding a new tenant and making the new space presentable, which may include deep cleaning, re-painting, repairs, etc. So, not only does consistency in income save you money, but you can also re-invest into your business or spend however you deem fit.
According to MarketWatch, most SFR occupants stay for three years, which is about twice as much as the typical apartment tenant’s stay. And as National Real Estate Investor points out, it’s not unheard of for a tenant to stay for five or six years! Many SFR renters may be unable to purchase a home but want to, and this attitude leads them to treat their space as if it were their home. And SFR renters aren’t just individuals or couples, they can also be families that don’t want to disrupt their children’s childhood with a move. As reported by John Burns Real Estate, 52% of SFR renters are families vs only 30% of MFR renters, who actually tend to be over 65 or under 35.
What are the cons of investing in single-family rentals
Many of the advantages of SFRs also end up being their downsides. The question, then, is, how will your strategy mitigate these cons. Sometimes in discovering our weakest part, we take the first steps toward creating our greatest strengths. This may be the place!
Management
Property managers are great for real estate investors because they do the bulk of the work that you may not want to do. Dealing with tenants, property maintenance, repairs, etc. The problem is that when you’re renting only a single-family home that a property manager may not make financial sense. They tend to charge 6 to 12% of the collected rent, and that may just eat up too much of your income.
What should you expect as the property manager? Everything you already know the property manager does! Plus, you may also have 2 AM emergencies and tenant disputes. This can all be resource-demanding and emotionally draining, especially on top of your full-time job if you have one. Just imagine having more than one property with the same needs–in places that may not be a driving distance apart!
Vacancy
Vacancies are so big of a deal that when you’re putting together your operating budget you just need to assume a portion of your income will be lost to vacancies. If you have just one or two units that you’re renting, then an empty space will significantly cut into your income. And don’t forget all the work you have to put into prepping your unit for a new tenant and then finding your new tenant. It’s a lot of work!
Some factors about your property may also make it harder to rent. Some tenants want a live-in super, which is commonplace in apartment buildings. Others may find a top-floor space prohibitive because they have small children, are elderly, or have health problems. After all, a set of stairs can be an obstacle!
Mortgage limitations
Fannie Mae has capped the maximum number of units financed by one person at 10. That means you’re going either need to get creative or turn to commercial loans.
Property expenses
If you own several properties then the cost of simply owning those properties goes up! Property taxes, insurance, maintenance, and upgrades; it’s a lot! And if an emergency or just wear and tear demands that property be replaced, then that could eat up a year’s worth of profits right away!
What are pros of investing in apartment buildings
Economies of scale benefit apartment buildings so much that it merits exploring the specifics with more clarity just to get a taste.
Economies of scale
Economies of scale are when fixed costs are distributed amongst a greater number of units.
Because all of the units are under one roof, for example, you only have one roof to fix! You also need only one insurance policy and just one property manager. And since you have a greater monthly cash flow a property manager is something you can afford! That higher monthly cash flow can also be used to improve the building, which can justify a rent increase that’s done all at once! No driving around town telling different people the same news if you own multiple properties.
Higher monthly cash flow
Rather than gradually build up to multiple units, multiple units is where you start! As a result, within a single day, you’re able to collect rent from multiple units. This increases your monthly income stream!
Vacancy
With more units, you become a more resilient investor. Now if 10% of your units are vacant you still have 90% covering expenses like property taxes and maintenance.
Ability to owner occupy too
Economies of scale benefit you if you live within your apartment building as well. One roof, one property manager, and improvements? All that helps you too. But living within your own building can also help you finance your property using loans from the Federal Housing Association (FHA) and the Department of Veteran Affairs (VA) because home occupancy is a prerequisite for receiving these benefits.
If you’re an active service member, veteran, or surviving spouse then you can get a loan with no money down and low interest rates so long as you spend at least one year living in your building. After the end of the year ends you can, if you want, move out. This applies to rental properties with as many as four units, duplexes, and triplexes, or even a room or apartment within your home that has its own entrance. You can move in and out multiple times until you reach a cap known as the entitlement limit. VA Mortgages also let you get a loan before you even have tenants! Instead, it’s your property’s potential for getting a loan that makes it great
If you can’t benefit from the VA, there’s still the FHA. Again, you must occupy a space within the building. The FHA will then ensure the loan made by the private lender. This allows the lender to offer a loan to someone with a less than ideal credit score, a smaller down payment size, and without even real estate experience. For a building with one to four units, the FHA will offer a down payment as low as 3.5% (as opposed to a standard loan that may charge between 20% for a two-unit property or 25% for a property with three to four units). Someone with a credit score as low as 500 can even get a loan!
The FHA also lets cash gifts and municipal grants count toward down payments, so you could technically get a rental property without using any of your own dollars. And if you find yourself low on money due to illness or bankruptcy, then the FHA will give you an allowance to keep making payments!
What are the cons of investing in apartment buildings?
The downsides of investing in apartment buildings are just implications of owning an expensive property. However, these are not necessarily barriers as much as they are guides to what you need to do to invest in a pricier property.
Affordability
The more units in the building the more you have to pay for that building. This makes financing challenging.
Management
More units mean more work, particularly when it comes to tenant relations. Apartment unit occupants tend to have higher turnover rates, and there’s also the risk of tenants not getting along.
How to find cash flow investment properties?
More units mean more work, particularly when it comes to tenant relations. Apartment unit occupants tend to have higher turnover rates, and there’s also the risk of tenants not getting along. The upside, though, is that it’d take more than one vacancy to put you into negative cash flow!
Bottom line
One is not better than the other. Rather, it’s your life situation that determines whether you should invest in SFRs or apartments. How risk-averse you are, for example, will make certain aspects appear more appealing than others, while those who feel less risk-averse will take greater chances. No matter what, don’t close yourself off to unforeseen opportunities because as your situation changes so too may your investment strategies.
