By Russell Barneson
By Russell Barneson
A big question when starting out in real estate investing is which property type to invest in:
Each of these property types have their own distinct advantages and disadvantages and require different strategies for obtaining the highest ROI.
Figuring out which type of property to invest in depends on many personal factors such as your financial situation, experience level and time commitment.
In this article, we compare and contrast the benefits of investing in these different property types to help you determine the right investment choice.
Conversely, multi-family and apartment buildings have a higher barrier to entry, easily exceeding a seven figure purchase price.
Single family home owners are likely to be less knowledgable about the local market and therefore create great buying opportunities well below market value.
This gives you instant equity and a big advantage ensuring a strong ROI.
Multi-family and apartment complexes are usually pursued more aggressively by savvy, knowledgeable and more experienced real estate investors, making it difficult to find a bargain.
If you start off by living in the property there are FHA mortgages available requiring as little as 3.5% down for a 30 year fixed mortgage.
This is obviously a big advantage if you are low on cash.
Multi-family properties require a down payment of 10%-20% for a 30 year term and up to 6 months of cash reserves.
Loans for commercial apartment buildings usually require 25% to 30% down, 6 to 12 months of cash reserves, 2% to 2.5% higher interest rates and a shorter term of only 20 years.
They also commonly have interest rate increases every 5 years and a possible balloon payment after 10 to 15 years.
In addition, commercial lenders will want to examine your income statements for the last several years and require you to have previous property management experience.
Clearly these loans are riskier as it's much more difficult to predict your future cashflow, the state of interest rates and future economic conditions.
Nationwide there is almost always a greater supply and demand of single-family homes.
Whereas multi-family and commercial apartment buildings only appeal to a wealthy niche investor class.
This means there are more exit strategies available for single-family homes.
These tenants stay for an average of 3 years and often longer if they have children who are attending the local schools.
On the other hand, multi-family and commercial apartment building tenants stay an average of 1.5 years.
This results in a more varied tenant, and more managerial work from a higher turnover, increased maintenance expenses, and more wear and tear.
Unlike individual homes, commercial apartment buildings have features that are shared or common throughout the building, which can make maintenance cheaper on a per-unit basis.
For instance, it would cost much less to fix the roof or repair the plumbing for one building with 5 units than doing the same for 5 separate houses.
Contractors offer better rates for apartment buildings where all of the units are similar.
In addition, with all of the units are in one location, you would only need one insurance policy for the one building, and the property management fees would be lower when calculated for each unit (savings of 3-6% of revenue according to Roofstock).
Trying to manage 10 individual single-family homes spread across a city is a much more costly and time consuming than having everything under one roof.
Although multi-family properties require more cash upfront, their per-unit costs tend to be lower than single-family units due to economies of scale, which are the efficiencies that accompany having more units.
Every real estate transaction is a complex undertaking that includes due diligence, negotiation, legal work, financing, and more.
If you wanted to add 10 units to your portfolio, then it may take many years of accumulating various transaction costs to go through this process for 10 separate single-family properties.
With apartment buildings, you may only need to close one deal to add those 10 units.
For experienced investors with deep pockets, buying multi-family units allows them to scale their business and generate a large amount of cash flow quicker.
Cash flow is more stable in both commercial apartment buildings and multi-family.
Having one unit vacant in a 4 unit apartment complex is not as detrimental to the bottom line as having a vacancy in a single-family unit.
If you encounter a vacancy in a 4-plex, you still have 3 other units to rely on for income.
Apartment buildings suffer from having high mortgage expenses and therefore do not generally cash flow as well as multi-family complexes.
Choosing an investment property, whether single-family, multi-family or commercial apartment building will largely come down to a combination of expertise, wealth and preference.
From our analysis, for a beginner to intermediate real estate investor, single family and multi-family units are the best fit.
For investors with vast knowledge and resources, large apartment complex buildings come out on top because of scalability.
Many seasoned investors love multi-family because you get the benefits of both the single family and commercial apartment complexes.
It's best to specialize in one property type, ideally in one area.
If you have success investing in single family homes, don't feel obligated to jump into a commercial building.
Disclaimer: Crescent Lenders, DBA CrescentLenders.com ("CL") is a California licensed broker under California Bureau of Real Estate License No. #01792267. Regardless of this license, CL considers itself a “finder” for purposes of applicable laws and regulations (California Business & Professions Code § 10130, et. seq.).