One question I frequently hear from investors is whether to invest in small multifamily properties versus single-family homes. To help answer that, I will compare the pros and cons of single-family vs. multi-family investments looking at six different factors. (For the purposes of this article, “multifamily” means 2 to 4 units, like duplexes, triplexes and fourplexes).
Six Pros & Cons of Single-Family vs. Small Multi-Family Investments
If there is any argument that can be made for multi-family compared to single family investments, it has to be the economies-of-scale they offer.
Per Fannie/Freddie guidelines, investors are allowed a maximum of 10 loans, and they are usable for properties from 1 to 4 units. If you use those 10 loans to buy 10 fourplexes for example, you will have 40 doors instead of just the 10 that you would have had if you’d bought single-family homes. Using those precious 10 loans to buy more doors maximizes your borrowing power.
Maintenance and Repairs
Going back to the fourplex example, with a fourplex you have one roof to replace every 20 years instead of four roofs; you have one sewer line leading to this main sewer in the street, not four. It’s also a lot easier for your property manager to manage four doors at one address vs. four houses spread-out all-over town.
2. CASH FLOW
Another advantage of multi-family investments over single-family is that they offer higher cash flow per-invested-dollar AND more consistent cash flow.
While a four-unit building will cost more than a single-family home in the same market, the cash-on-cash returns from the multifamily are almost always higher due to the economies-of-scale mentioned earlier.
Caveat: This is true within the same market i.e., if you bought $140,000 house in Cleveland or a $200,000 duplex in Cleveland, the duplex would have a higher cash-on-cash return. This does NOT mean that a single-family home in Cleveland (purchase price $140,000, rent $1,250 a month) cannot cash flow better than a duplex in San Francisco (purchase price $1 million, rent $6,000 a month). To compare apples to apples, you must compare multi-families vs single-family homes within the same market.
Additionally, not only is the cash flow higher, but the cash flow is more consistent: if you have a vacancy in one of the four units you still have cash flow from the other three o cover your expenses. With a single-family home, when you have a vacancy, your vacancy is 100% and there’s no cash flow coming in.
In general, single-family homes tend to appreciate better than multifamily properties. The prices of single-family homes are driven by comps, and most homes are sold to owner occupants who are going to live there. For an owner-occupant, the purchase of a home is an emotional decision: The family likes the neighborhood, likes the layout of the house, likes the school district and is willing to engage in bidding wars to get this particular house – the one they really want.
With multi-families on the other hand, the buyer is almost always an investor who is looking at the property solely in terms of dollars and cents. To an investor, the purchase is just a business decision – not an emotional one – and if the investor doesn’t get this property, he or she will just move onto the next deal.
Additionally, due to zoning regulations, multi-families tend to be in tenant neighborhoods in which everyone on the street is a tenant: small apartments, large apartments complexes, etc., Typically, tenants don’t take care of the house the same way a homeowner would. A homeowner has pride of ownership and will maintain his house, clear weeds from the lawns, won’t allow junk to pile up on the lawn etc. As a result, tenant neighborhoods increase the risk that the neighborhood will deteriorate more than single-family home neighborhoods. Those neighborhoods don’t appreciate as well as owner-occupant neighborhoods.
As a result of these factors, single-family homes offer more price appreciation and longer term equity growth.
Advantage: Single-family homes
4. TENANT TURNOVER
As a general rule, tenants in single-family homes tend to stay longer than tenants in 2-4 multi-family properties. SFHs attract more families with children, and those families tend to stay longer as they want roots in the community and enrolling children in new schools is a hassle. Tenants in multi-family units tend to be more singles or young couples starting out.
The reality is: No one really wants to live in a fourplex. If you’re going to rent, you want to rent a house where you have some sense of ownership and privacy, or you want to rent in a 100-unit apartment complex that offers amenities like a swimming pool. The fourplex offers the worst of both: The lack of privacy of the single-family home and the lack of amenities that an apartment complex offers. Most tenants in small multi-families view their apartment as a steppingstone to renting something better.
Bruce Norris – legendary Southern California investor – once told me why he doesn’t like small multi-families: “Why what I want to own a property in which the tenant’s only thought is to get out of there as soon as possible?”
Overall, single-family home tenants tend to stay for three or more years, whereas tenants in small multi-families average about two years. Confirm this with your property management company and see what their experience is in the market that you’re considering.
Advantage: Single-Family Homes
With multi-family compared to single-family properties, the owner/landlord is exposed to slightly more legal liability.
In a single-family home rental, the tenant is responsible for everything: mowing the lawn shoveling the snow, replacing the batteries in the smoke detectors etc.
In a multi-family rental, the owner is usually responsible for common areas like the hallways and laundry room, common area maintenance (CAM), lawn maintenance and snow removal. If there is ice on the walkway and someone slips on it, you may be liable. If the tenant’s kid stole a battery out of the smoke detector in the hallway, you may be liable.
As a result, while the owner of a single-family home rental may or may not choose to put the property in an LLC, the owner of a multifamily rental has much more motivation to do so. Check with your property management company and your attorney to scope the size of this risk and how best to manage it.
Advantage: Single-Family Homes
6. EXIT STRATEGY
When it comes to exit strategies, single-family homes offer many more options.
A single-family home is a bread-and-butter asset and there’s a huge demand for them. When you decide to sell, you could sell to an owner occupant who’s going to make it his home, you could sell to another investor, or you can even sell to your tenant. There are lots of exit strategies. With a multifamily though, your pool of available buyers is much smaller. Not many people want a duplex or a triplex. That type of property would appeal only to another investor.
Another wild card is rent control. Rent control initiatives are being proposed in many municipalities across the country. If you have a single-family home and rent control is imposed, you can always put the property on MLS, sell to an owner-occupant and get the full value of the property. However, if you have a fourplex and rent control is imposed, that can be a kiss of death. When investors hear “rent control” they head for the hills and you’d have a hard time selling it at all or, if you do, it’ll be at a lowball price.
Advantage: Single-Family Homes
We’ve discussed the pros and cons of single-family homes vs. small multi-families over six different criteria. To summarize, here are the pros and cons of each asset class:
Invest in Single-Family Homes if….
- Your primary goal is appreciation
- You want longer-term, stable tenants
- You want an asset that’s more liquid
Invest in Small Multi-Family Properties if…
- Your primary goal is cash flow
- You want to scale your portfolio quickly –
- You’re willing to contend with more turnover risk and liability risk
So, should small multi-family properties be part of your portfolio?
There’s no right or wrong answer: it all depends on your goals and your risk tolerance.
Many investors like to do a little of both: Own some single-family homes for appreciation, but also some multi-family properties for cash flow. It’s like having a balanced portfolio of stocks and bonds. Most investors start with single-family homes as a way of dipping their toes in the water and then scale-up to multi-families after they’ve gotten some experience.
To help decide if there’s a place for multi-families in your portfolio, become a member of RealWealth and schedule a call with your Investment Counselor.