Hundreds of books and blog posts echo my sentiment- real estate investment is my ticket to freedom. Of that, I’m sure.
I’ve considered HUD properties and auctions, flipping and turn-key investment. I’ve consumed all the podcasts, audiobooks and bootcamps I can get my hands on. I’ve owned and operated single family homes, condos and small multifamily student rentals. The real estate investment game is rife with fuel for “shiny penny” syndrome, yet the most sage advice implores us to find a niche and specialize. Over the last 10 years as an investor, my opinion on what deserves my attention has changed. After all this learning, multifamily has my full, undivided attention, and I think it deserves your consideration too. Here’s why.
When I was new to the investing game, I became OBSESSED with my “freedom number” that I’d heard so many gurus talk about. Once I did the math, I realized it would take a cool 50 SFR at $200 cashflow to reach my goal. Wait. What?? 50??? Bonkers. At a rate of 1 or 2 per year, I should retire…. Around 65. Kind of defeats the whole purpose. Multifamily offers an opportunity to acquire all of those doors in one fail swoop- essentially killing 50 birds with one stone.
Another aspect of scale that is important is the concept of proportional costs, or economies of scale. Having one roof, one boiler system, one driveway (you get the picture) is easier to maintain than 50 of each. Beyond that, when rehabbing and designing units, I can be sure to use the same fixtures and paint, allowing my management staff to keep exactly what we need on hand.
2. Control of Valuation
My urban condo is nice. I bought in the path of progress, and got lucky. You’ll hear every seasoned investor say that appreciation should be considered “icing on the cake” and to really focus on cashflow. I totally agree. The interesting part of multifamily vs single family appreciation is how it’s measured.
Residential real estate (SFR, duplex, triplex and quadplex) values are all derived from comparisons vs other similar properties nearby. This comparable market analysis determines what the value of your property is. Said another way, residential real estate values are almost totally determined by what other properties are like.
Commercial real estate (5+ unit building) are valued in a completely different way. Apartment buildings are meant to be an investment, so they are valued like other investments- a function of net operating income (NOI) and prevailing capitalization rate. What this means to me as an investor- if I see a property that has lower than market rents, lots of vacancy, or is managed with unchecked spending- I can make changes to increase the NOI in a very straightforward way. What does this look like? Well, glad you asked.
Let’s say a 10 unit building rents for $400 per unit, and costs $300 per unit to manage. This means it had a net operating income of $12,000 per year.
($400-300)*10 units*12 months=$12,000
Value is calculated by taking this NOI divided by prevailing cap rate. Let’s say that’s 10% for our area. So what’s our value in this first $400 rent scenario?
$12,000/10% = $120,000
This asset is worth $120,000 in this scenario.
I realize rents in the area are $700 per month. My asset’s rents are way too low. If I bring them up to market rates, what does that mean for NOI?
($700-300)*10 units*12 months=$48,000
We’ve increased NOI up to $48,000 just by charging what every other rental charges! Now what does that mean for the value? Let’s assume same cap rate of 10%
$48,000/10% = $480,000
In this example we were able to drive value from $120,000 to $480,000 just by recognizing under market rents. If these were 10 single family homes, increasing rents wouldn’t change values at all. This control significantly buffers risk should we experience a correction.
3. Debt Instruments
I spent my 20s as a disciple of Dave Ramsey and Suze Orman. I never carried a credit card balance and got through college without debt. I’m pretty much the luckiest girl in the world. When I hit my mid-twenties I caught the real estate investment bug. I realized that leveraging hard assets would exponentially increase my returns and significantly lessen my financial freedom timeframe.
Those first few residential properties meant great Fannie/Freddie Mac financing. Then I learned about the property limits- I would hit a wall after I’d acquired 10 properties and be pushed into commercial lending. After a bunch of conversations with bank commercial lenders, I learned that I’d pay a higher interest rate, have a balloon payment due in 5 or 7 years and personally guarantee that loan. GULP. What if the market was back in a 2009 type correction in 5 years?
The very most interesting thing I’ve learned as I go down the rabbit hole of real estate investing is- the bigger you go, the easier it is. Sounds ridiculous. Sounds short sighted. Sounds risky. But it’s absolutely true! For example, Freddie Mac has a small balance program whereby they lock in a loan for up to 30 years of $1M-$6M non-recourse debt. Non-recourse… meaning, I don’t personally have to guarantee the loan. Check it out here: https://mf.freddiemac.com/small-loans/
Multifamily real estate offers significant advantages to single family, in my opinion. With a limited bandwidth, I choose to put my focus where I can get the most accomplished in the shortest time. I used to think multifamily was an advanced strategy that was outside of my scope; I now believe this perception is exactly why it deserves my attention.