The reason I wanted to write this blog post is to share my experience in investing in both single-family homes, small multi-family, and large multi-family. I started my real estate journey with a single-family home in Anaheim, California, which appreciated over time. I was able to access the equity from that to then invest in my primary residence condo here in Honolulu, Hawaii.
Around the same time, I bought a three-unit in Indianapolis with a partner that led to another partnership where we bought a single-family home, another single-family home, a ten unit and a four-unit in Pittsburgh. Since then we have sold the Indianapolis three-unit and the first single-family home in Pittsburgh. Next, I partnered with another group to invest in a 52 unit in Saginaw, Michigan. Around the same time, I invested in three apartment syndications as a limited partner, 814 unit in Atlanta, Georgia, a 192 unit in Lago, Texas, and a 310 unit in El Paso, Texas. This gave me the experience to sponsor four apartment syndications as a general partner, three ended up in El Paso, Texas, and one in Salem, Virginia, since then one of my limited partners deal exited producing over a 2X equity multiple in two and a half years.
Having gone through the various types of real estate investments, I strongly believe that investing in apartments is superior to single-family houses for the following 10 reasons.
Reason #1: Resilience in Tough Times
Multi-family has been resilient throughout the COVID-19 pandemic of 2020. Generally, multi-family is better protected against economic cycles, particularly because the need for shelter is an essential need. A multi-family has been shown to be an evergreen business model. In tough times, people tend to move to apartments from single-family houses. This is even more evident as people downsize when income drops. Looking back at the 20 worst quarters over the recent past for a portfolio consisting of 60% stocks and 40% bonds, real estate was up for 17 of those quarters.
Multi-family real estate generally has better cash flow potential than single-family real estate investments. For example, in a multi-unit apartment complex, there are multiple streams of rental income coming in compared to just a single monthly rent payment with a single-family home.
Having numerous units also keeps cash flow more consistent. If a single-family home becomes vacant, investors lose a hundred percent of that rental income until the home is rented again. Whereas an apartment building will really be completely vacant. Besides for the rent, apartments tend to have other sources of income, such as laundry, vending machines, covered parking, rubs, which is the ratio utility bill back and more.
Reason #2: Tax benefits
There are simple tax benefits to multifamily real estate investing: consult your tax professional to see if you might benefit from any of these multi-family real estate tax advantages, real estate depreciation deduction multi-family real estate investors can claim a depreciation deduction on their investment. DRS sets the useful life of a multifamily property at 27 and a half years to calculate the deduction, divide the value of the property by the number of years, this is the amount that you can deduct from your taxes.
Reason #3: Cost Segregation
Cost segregation allows investors to take advantage of the different links of useful life. Either five, seven, or 15 years for various property-related costs, breaking them down into categories, such as electrical systems, plumbing, sidewalk, construction, light fixtures, and more getting a cost segregation analysis is not cheap, but it could potentially pay for itself. And then so through higher tax deductions, this allows for accelerated depreciation at a faster rate than the standard 27 and a half years bonus depreciation. The 2017 tax cuts and jobs act increased the allowable first-year bonus depreciation from 50 to a hundred percent. This means that in the first year of owning a multi-family property, investors can deduct up to a hundred percent of qualified expenses. These qualified expenses are limited to assets with a useful life of less than 20 years. So they do not include the value of the multi-family property itself.
However, it can be applied to certain expenses when using cost segregation. Not that the current a hundred percent bonus depreciation rate is scheduled to start phasing down in 2023 to 80% and then dropping 20% each year until it is phased out completely in 2027, the appreciation recapture it is important to note that when you sell your multifamily investment, the sale will be subject to depreciation. Recapture why a portion of the gains will be taxed at the long-term capital gains rate. The appreciation deductions will be taxed at your higher personal tax rate. A 10 31 exchange allows investors to roll their capital gains from the sale of one property into the purchase of another one tax break long-term capital gains tax. In most cases, gains from multi-family real estate investments are taxed at the long-term capital gains tax rate, which is lower than a standard individual tax rate.
Reason #4: Less Risk
Investing in apartments is considered to carry less risk than other types of real estate. One reason for this is the fairly consistent rental demand while the demand for single-family homes, offices, and retail properties testify during economic downturns, leading to higher vacancy rates, the demand for residential rental properties typically stays strong or even increases as more rental households increase. When someone moves out of an apartment that only creates a vacancy in one of the units in the property. Whereas when someone moves out of a single-family house, the vacancy rate then becomes a hundred percent. This means a smaller risk of periods with no cash flow. Also, multi-family real estate includes a variety of property types, including large apartment buildings, duplexes, and communities geared towards retirees. This diversity can further lower the risk of investing in multi-family real estate. Easier to manage while managing apartments can be complex.
Bundling numerous units together in one place actually makes it easier than managing a portfolio of single-family homes. But one thing, even if an apartment building has 50 units, there’s only one bank loan compared to these two separate loans for each single family property. A single insurance policy will also cover the individual units. And if you need to replace an old roof doing so would effectively replace the roof for 50 different streams of rental income, all the multi-family properties also make hiring a property manager, a cost-effective way to make managing the property easier. Some single-family homes often don’t bring in enough income to make hiring a property manager worth it, leaving you stuck managing the properties yourself, the larger the property. The more you can afford full-time staff, which makes it easier to manage from an asset management perspective.
Reason #5: Under-supply of Housing
Under supply of housing, the combination of a housing shortage and a more conservative lending environment will make it more difficult for prospective buyers to purchase a home. This means more rental demand and there are limited options in the market. The demographic trends show that the US is shifting towards a renter nation. The increase in the supply of labor hasn’t addressed the sectors with the most pressing needs in the mid to lower-income levels. The majority of properties under construction require prospective renters with a higher annual income. Given that most renters are less than $75,000. The current supply does not address the needs of the largest sector of renters. The increased demand of baby boomers, downsizing to apartments, and younger generations staying in apartments longer than previous generations has led to the large gap between affordable housing supply and demand. Most of the new construction, this space has been class a or newer stock, which is mostly unaffordable for many, also a declining trend in homeownership and increasingly difficult lending standards means that workforce housing will be in high demand for the foreseeable future and your household permission.
This ticket has averaged 1.04 million while housing production has averaged 880,000 units. The resulting annual housing undersupply of 160,000 units has been a major contributor to rising housing costs. Over the past seven years, single-family sales prices increased by about 7% each year, much higher than the average wage growth of 2.5%. Multi-families 3.1% annual rent growth. Also outpaced the average wage increase.
Reason #6: Flight to Safety
Global investors are seeking safety. In essence, like multi-family, as they consider the risk of their paper assets, foreign investors are continually flocking to us multi-family as it provides better yield and stability. One key part of the yield component is current income in the form of cash flow from day one defined to be income leftover after deducting operating expenses and debt service from the collective rent yield comes from the net income after expenses, the yields available in other asset classes, such as dividend-paying stocks and bonds tend to be a lot lower than that of multi-family real estate compared with single-family houses. There’s a lot higher demand from larger, more institutional investors looking to park capital.
Reason #7: Control
Apartments tend to allow owners to exercise more control than single-family houses prepared owners can wait out a down market because of solid cashflow reserves and favorable loan terms. When demand dips, the asset can be held longer when demand jumps, the asset can be sold for profit in our deals. We believe in the buyer watch model. This is where we continually assess the market for refinancing or sale opportunities. We seek financing terms that allow for maximizing profit for us and our investors.
Reason #8: Scalability as a Limited Partner
Being a passive investor allows one to scale as quickly as funds are available to invest. Typical barriers like personal debt to income ratios in qualifying for an investment loan are not present. Moreover, the limited partner is not constrained by the time required to operate deals and can participate in as many deals as desired with single-family houses.
You can only get loans for 10 houses with your personal name. This makes it a lot harder to scale along with the management headaches of having your properties scattered throughout, as opposed to concentrated at one address, apartments are a lot more scalable because the loans are commercial and are qualified for based on track record and the performance of the property.
Reason #9: Principal Pay Down and Leverage
Real estate is one of the safest tools to create wealth because the rent that residents pay goes towards paying down the principal of the mortgage. This means the equity position in the project increases independent of market conditions. This only applies to leveraged assets, but it’s one of the best benefits of a conservative loan to value investment. In multifamily. This concept is amplified even more because the scale is much larger than in single-family homes. Generally real estate allows for much better leverage than other asset classes like stocks and bonds.
However, there are some differences in the type of leverage you can get for multi-family versus single-family homes. Multi family allows the passive investor the opportunity of leveraging the sponsor’s skill, experience, and network to participate in quality investments that normally would not be available to an individual investor. The project can use leverage from banks or agency lenders to further amplify returns. This has the added benefit of asset protection. Since the lender assumes the majority of the risk. In most cases for single-family houses, you will be on your own to qualify for financing and building your own team to handle all the details of management and repairs.
Reason #10: Forced Appreciation
While single-family homes often have the potential to appreciate and value more than multi-family properties. Multi-family real estate tends to be more resilient to down markets offering a slow but steady increase in value over the long term.
While bringing in impressive monthly cash flow, one of the downsides of smaller properties, which are four units and under and single-family homes is that the value is based on comparable properties, which is at the mercy of market conditions at the time of sale or refinance. Before we get into the reason why apartments are better.
Let’s define some terms:
Net Operating Income (NOI) is the income minus expenses without debt.
Cap Rate is the market return without debt.
Value is the NOI divided by cap rate because the value is based on the net operating income divided by the cap rate, investors can benefit from the increased value due to either increasing income or decreasing expenses.
Therefore, the savvy investor has some control over the value at exit by increasing the NOI through more efficient operations.
All right, that’s going to do it for the top 10 reasons for investing in apartments versus single-family homes.
If you have any questions about passive investing in apartments, drop a comment below. Thank you so much for reading and check back for more updates.