My First Property: 4 Unit or 10+ Units?

Question

Hi Everyone,

I'm very new to Real Estate Investing, (but not investing in general) and I'm looking to acquire my first investment property!

A few things to note:

1) I live in NYC but am looking at Allentown, PA. (1.5hrs away)

2) I am not able to make PA my primary residence due to the high-intensity of my work.

3) I have about $50k total for down payment + closing costs

With that said, I am weighing my options for my first investment. Many have recommended a smaller, 4 Unit purchase. (More within reach financially) However, I am more tempted to shoot for economies of scale and go for 10 - 16 units if I can.

I may be a little short on the cash but I'm sure I can come up with it somehow.

My question revolves around the advantages vs advantages of getting into a bigger property as opposed to a smaller one for my first investment. Am I in over my head? Is managing a 4 Unit easier than 10 Units or is it actually more efficient due to unit economics? Are there things I'm not foreseeing?

Would appreciate very much any insight and/or thoughts!

Best,

JH

John Henry · Answer

I see that!

After doing some additional research and contemplating, I've decided to go for the FHA loan and make it my primary residence for a while. Even if it means commuting an extra 1.5hrs each way in the morning, it's really going to free up my capital reserve and allow me to take things slowly until I can ramp up.

Will keep you posted!

Thanks so much for the comments everyone... super helpful. :)

JH

Kiersten Vance · Answer

@Ann Bellamy @John Henry @Allen Hayes I agree with Allen in regards to making mistakes on a bigger unit. You have to do the same research and run the same numbers to figure out whether it is a good deal or not. So John, If you find a 10-16 or even larger complex where all your numbers work out and it cash flows with enough extra for cap ex, then go for it. I would suggest running your numbers by an experience professional to make sure something wasn't forgotten accidentally. Ann is right that if you don't do your research, a larger unit will hurt more if it fails. But it shouldn't fail if you do the prep work and find a good deal. Also don't count on economies of scale making bad numbers work for a larger unit complex. There aren't that good of economies of scale. It's just kinda like an added benefit. Good luck!

Ann Bellamy · Answer

My take is that it's not economy of scale to start with, it's the cost of learning.  It's easier to learn on a small property, and your mistakes will be X 4 instead of X 20.

But Kiersten is right about her comments.  So I'd do a smaller one for the first, at least less than 10 units, and then when you've got your feet wet, go for it.

If you're a VC, I'll "venture" to guess that your first deal was not an 80 million dollar project in Dubai, it was maybe smaller and closer to home?

Allen Hayes · Answer

For me it's 1) free cash flow, 2) capital requirements, 3) other relevant ratios.

Real estate investing is basically buying your next job, so make sure the job is worth it income wise. Free cash flow also has most of your assumptions baked in, stuff like mortgage, interest, taxes, maintenance, vacancies etc.  I consider expected improvements as a discounted bonus because I can't count on cashing checks for rent increases I haven't passed yet.

If the free cash flow looks good I'll worry about capital requirements, basically is the deal too big for me to handle. Being short cash and credit when an AC goes out is a giant problem that forces you to make very bad decisions (hard money lender? pay day lender? let the tenant sweat?)

If the deal isn't going to swamp my cash and credit lines and will earn me enough every month to make it worth doing the job, I'll worry about other relevant ratios. Looking at the other ratios will also tell me what other investors are willing to pay. On my 20 unit deal I knew investors were way lower due to CAP rate, so I went in at full price but with an MLO that got her a steady cash flow, no tax penalties for sale, and she got me much better financing than I could ever have come up with anywhere else.  Everyone was happy in the end.

Kiersten Vance · Answer

FHA is a great option for the 4-plex. I love the tiny downpayment and living in the complex is a good way to learn. I lived in mine for a couple years on and off in the beginning.

Ann Bellamy · Answer

Good points, @Kiersten Vance, but if you mess up with tenant screening on 20 units, and have bad tenants, non-paying tenants, and have good ones leaving,  it's going to hurt way more than 4.    @John Henry, there are a lot of "you don't know what you don't know" in this business..

Allen Hayes · Answer

@Kiersten Vance, I like that you were able to get them like that.  I've been thinking of what it would take to build units here and I think that if I do build it'll be in 4 plexes like that just to make selling them off easier to regular people instead of deep pocketed investors.  I agree about the scale thing, my 4 plex is just about as much work as the 20 plex as far as landscaping goes.  The 20 plex is just more work keeping track of rents and fixing 5 times as many issues.

@Ann Bellamy, I've never understood the X 20 vs X 4 mistakes thing.  I'm only upgrading units when the tenant moves out so if I don't like how one unit looks afterward I just do the next one different.  I do expect to spend more time doing turns at the 20 plex just because there's 5 times as many people living there but if I were doing what @John Henry is talking about with regards to a maintenance company it wouldn't be a big deal, more turn on more units that make more money sorta thing.

Having said that, I do spend a lot more time at the 20plex because of issues from deferred maintenance that I'm still resolving.  I have to say that the 20plex seems to be the biggest pain in regards to collecting rents.  Keeping track of who's paid, who's late, who have I spoken to is the biggest time suck of this thing so far.  It won't be as bad in the future after I've retrained the tenants but the prior owner would let them get months behind and forgive late fees constantly.  I'm the new bad sheriff in town who puts late notices on doors the very next morning and demands my late fees.

Honestly though, if you're in VC and can get into some early rounds of funding on some decent projects you'll make a whole lot more money than buying 4 plexs ever will.

Pete T. · Answer

If you are using PMs and you are already 1.5 hrs away, you might as well just consider the best out of area market to invest.  I feel it is a lot easier to find a deal for a 4 unit that 50k cash works than for a 16 unit.  Plus a 4 unit is an opportunity to learn small mistakes and determine if it is even something you want to invest more time, money, and energy into.

John Henry · Answer

Thanks @Jeremy Hunter and @Allen Hayes

Allen, I see now how clarifying my goals is the real determining factor. I do intend to become a full-time real estate investor, but not at the moment since I'm having tremendous fun being a full-time Venture Capitalist.

Perhaps a low-key, low maintenance investment then is the right way to go for me at the moment then.

May I ask, Allen and Jeremy, what are the key numbers you look at in a property that indicates to you that it's a good deal.

For instance, is the ultimate consideration how much net-net income you'll have after servicing the mortage and all other expenses (regardless of how big or small the mortgage may be)?

Thanks for your time.

JH

My First Property: 4 Unit or 10+ Units?

Most Popular Reply