Houses are better investments than Apartments?
Investor · Toledo, OH · Member since 2012 · 292 posts · 34 votes
In the book "Landlording on Autopilot" Mike Butler makes the case for houses being better investments than apartments for the following reasons:
- Houses can be bought at wholesale & sold at retail. Apartments are much harder to pick up at a discount since they're traded between investors.
- Apartments have the added management burden of common area maintenance. Houses rentals can often be structures so that the tenant is responsible for most everything except major repairs.
- Apartments have more disputes between tenants, causing you to have to play referee.
- Tenant quality is lower. They're mostly short term occupants, and less respectful of their homes.
- Operating expenses are higher due to the higher vacancy factor.
- Apartment owners have less control of individual rental pricing, since tenants are in similar units and can/will talk to each other about what they pay.
Who agrees/disagrees?
- Houses can be bought at wholesale & sold at retail. Apartments are much harder to pick up at a discount since they're traded between investors.
Granted there are less Apartments (MF)out there, but there are many in distress that be purchased under valued and sold at market
- Apartments have the added management burden of common area maintenance. Houses rentals can often be structures so that the tenant is responsible for most everything except major repairs.
Yes there is the burden of the common areas, but the increase in cashflow covers that
- Apartments have more disputes between tenants, causing you to have to play referee.
No argument here, the tenent base may be lower, but being able to afford professional management takes the problem away from you.
- Tenant quality is lower. They're mostly short term occupants, and less respectful of their homes.
Again no argument and the turnover is expected to be higher.
- Operating expenses are higher due to the higher vacancy factor.
Here is where I disagree with you. How much does one vacancy cost you? You are down 100%. what about the reserves needed to cover a couple of months of vacancy. What about the hold time while a damaged unit is being repaired. On one 20 unit property we were down 6 units and we were still paying the bills. Our vacancy factor is 5% what are you putting in for your sfh?
- Apartment owners have less control of individual rental pricing, since tenants are in similar units and can/will talk to each other about what they pay.
I don't see the difference here. Sfh still have to deal with market rates. Your sfh tenants may not have neighbors to talk to but the can see what is in the market
Who agrees/disagrees?
Now here are a few other items that were left out. You have many more options as to adding value to a property when you are dealing with MF. When we look at a MF property we always look at the value plays. These could include decreasing vacancy, increasing rents, charging utilities to tenants, laundry services, vending machines, adding storage units for rent, fixing up the units for higher rents, charging for garages instead of open parking, etc.
[b]Now you may think that this may only slightly increas the cashflow and that may be correct, but the difference between the way sfh and mf are valued is the key. The value of sfh is based on local comps. Increased rent may up the value some, but not much.
Let's say you can increase the occupancy in your mf by 1 unit for the full year. Let's say the rent is $750 or $9000 per year. Assuming no significant increase expenses and you are in an 8 Cap market you have increase the sale value by ($9000/.08=$112,500)$112,500. Now where I live in California besides the rent being higher the Caps are lower. Let's use the same $9000 on a 5 Cap market.($9000/.05=$180,000). All that for keeping one more unit occupied. This is also why you see a lot more mf properties being held for 5-10 years and the next property being purchased. The increase in the value gives a great kick when it is sold.
Now the big negative on MF is the high price. This is why we partner with other investors to get more bang for the buck.
I would prefer a 50 unit mf with professional managemnt, over 50 sfh and the management that goes with it.
Jeff
You know it is funny. The more and more I think about SFR vs Apartments I keep feeling SFR is a better investment. I agree completely. The argument for Apartments is that they produce more cashlow. I personally think SFR produce more cash flow per unit with all the other upsides described above. I feel like every house I buy could be purchased one day by a tenant for twice what I paid within 5 years. However, I will never sell.
It really depends on what one's goals are.
Apartment buildings are bought and sold based on current and projected future cashflows and expected rates of returns (based on the interest rate environment).
SFR have the added option of being able to renovate for a retail sale in the future as Andrew mentioned for a potential larger return at exit.
My personal opinion is one should ALWAYS start with SFR in order to "understand" real estate investing. Use SFR to grow wealth, use apartments to maintain wealth.
Don, very well put. I still plan on purchasing apartments in the future as well. Mainly to diversify in different aspects of real estate.
- Houses can be bought at wholesale & sold at retail. Apartments are much harder to pick up at a discount since they're traded between investors.
Granted there are less Apartments (MF)out there, but there are many in distress that be purchased under valued and sold at market
- Apartments have the added management burden of common area maintenance. Houses rentals can often be structures so that the tenant is responsible for most everything except major repairs.
Yes there is the burden of the common areas, but the increase in cashflow covers that
- Apartments have more disputes between tenants, causing you to have to play referee.
No argument here, the tenent base may be lower, but being able to afford professional management takes the problem away from you.
- Tenant quality is lower. They're mostly short term occupants, and less respectful of their homes.
Again no argument and the turnover is expected to be higher.
- Operating expenses are higher due to the higher vacancy factor.
Here is where I disagree with you. How much does one vacancy cost you? You are down 100%. what about the reserves needed to cover a couple of months of vacancy. What about the hold time while a damaged unit is being repaired. On one 20 unit property we were down 6 units and we were still paying the bills. Our vacancy factor is 5% what are you putting in for your sfh?
- Apartment owners have less control of individual rental pricing, since tenants are in similar units and can/will talk to each other about what they pay.
I don't see the difference here. Sfh still have to deal with market rates. Your sfh tenants may not have neighbors to talk to but the can see what is in the market
Who agrees/disagrees?
Now here are a few other items that were left out. You have many more options as to adding value to a property when you are dealing with MF. When we look at a MF property we always look at the value plays. These could include decreasing vacancy, increasing rents, charging utilities to tenants, laundry services, vending machines, adding storage units for rent, fixing up the units for higher rents, charging for garages instead of open parking, etc.
[b]Now you may think that this may only slightly increas the cashflow and that may be correct, but the difference between the way sfh and mf are valued is the key. The value of sfh is based on local comps. Increased rent may up the value some, but not much.
Let's say you can increase the occupancy in your mf by 1 unit for the full year. Let's say the rent is $750 or $9000 per year. Assuming no significant increase expenses and you are in an 8 Cap market you have increase the sale value by ($9000/.08=$112,500)$112,500. Now where I live in California besides the rent being higher the Caps are lower. Let's use the same $9000 on a 5 Cap market.($9000/.05=$180,000). All that for keeping one more unit occupied. This is also why you see a lot more mf properties being held for 5-10 years and the next property being purchased. The increase in the value gives a great kick when it is sold.
Now the big negative on MF is the high price. This is why we partner with other investors to get more bang for the buck.
I would prefer a 50 unit mf with professional managemnt, over 50 sfh and the management that goes with it.
Jeff
I have both, but points favoring MFR:
The monster difference is ..... FINANCING! You simply can no longer effectively create substantial wealth with a SFR portfolio, because of all the bank financing limitations that you hit (unless you run a hedge fund, perhaps). With MFR, there are many more opportunities to lock in attractive financing, and banks of all sizes (plus govt lenders like Fannie Mae) are open for business and eager to lend.
Also, you can grow you unit count and achieve scale in your business much more rapidly. One MFR acquisition can bring a huge # of units at one time, versus the slog of buying SFRs.
There are also lots of good PMs for apartment complexes, and the fees are lower. It can be very difficult to find a good PM for SFRs.
Really good replies!
I have an unproven theory that MFR are more susceptible to inventory glut / overbuilding from money rushing into these spaces to fill the need /demand for apartments. Here in Denver I read somewhere that there has been a rush on permits for MFRs. That hasn't happened yet for SFRs. Additionally, condo projects can be converted to rental apartments.
It also appears that a lot of new renters in the market are people that previously owned homes--SFR's-- and lost them. It is likely that they will want to rent SFRs rather than apartments.
Finally, the amenity of the garage is likely easier to get with an SFR than a MFR. This piece ties into the the one directly above. But if you want to live in a home with a garage, pets, and a yard, I think you will be more likely to want an SFR.
Again, I don't have any data to prove any of the above (except for the unlinked piece about a rush to build apartments in Denver), so fire away.
Erik,
I won't fire away at you as I agree that MF are more susceptible to over building in some markets. My understanding of the Denver market is they can use more apartments as the demand is huge. The asking Cap rates look like my home state California.
At this point in the national recovery there has been no significant new MF construction for years. This has produced a pent up demand for more. The echo boomers are trying to start family's, and yes they would prefer to live in a sfr, many especially the lower end of the economic scale, will never be able to move to sfr.
We hear everyday about the erosion of the middle class, so we will continue to see the demand for inexpensive housing. As the shadow market (foreclosed inventory) is reduced the availability of good potential rentals will be reduced. Those that have them will be in a good position.
David brings up some good points. Legislation has made it more difficult to "create substantial wealth with a SFR portfolio", and "One MFR acquisition can bring a huge # of units at one time, versus the slog of buying SFRs." Professional management is also a key point. Being tied down with management cut out the time you have for new acquistions.
At some point everyone runs out of their own funds and in MF it is much more lucrative to bring in equity investors to fund the equity portion of the deal. You can even bring in an investor to help qualify for the loan and still have a fair piece of the pie for youself.
I understand starting out with sfr as it is easier to understand the ins and outs. The numbers are also easier to deal with. Everyone has to deal where their own comfort level, but if you are talking about leaving your 9-5, being financially independent, and not being tied down to another job, then in my book it is MF hands down. No problem hanging onto a few cashcow sfr, but the big money is in MF.
Jeff
Jeff, great posts...couldn't have put it any better. I have both, and would never have been able to scale up as quickly without the growth from my MF's because I started investing in RE later in life. But I do love my handful of cash cow SFR's too and will continue to hold them long term. Either can bring you wealth over the long haul if structured appropriately, it's just a question of how fast you want (or need) to grow...MF absolutely provides a unique opportunity to scale much faster for the reasons you've already stated above.
Sean,
I have to agree with Don that the strategy determines the vehicle. I will say that personally I prefer multi-family properties, and I own both. I do not generally flip, and I do not buy property in hopes of appreciation which may or may not come to fruition. I buy revenue streams represented by buildings. There are a few things to consider:
1. When we speak of value, the SF world is very different from the multi. In SFR the value is set by the comps. That's it. This doesn't offer a lot of opportunities for expandability. On the other hand, multi property is valuated based on income, so there are plenty of opportunities to improve the value by improving the NOI.
2. It is true that singles tend to attract more long-term tenants. Why? Because they feel like a home and not just some place to stay for a while. Can you accomplish this with a multi? Yes – you have to chose the right property.
3. Where I live, the rents I receive for good apartments are practically the same as SFR. However, I can buy apartments for a third less per unit. For instance, I have a 10-plex under contract as we speak for a bit under $375k. That's $37,500 per unit. Each of these rent for around $600. Half a mile away I have a single which rents for $650. I paid about $40k for it and spent $15k on the remodel four years ago. Today, that single would have cost me $30,000 but I likely would have had a bigger remodel…
4. I can replace a roof on a 10-unit for quite a bit less than on 10 individual SFR.
Bottom line, there are benefits to both. If the stars line up and a really great quick flip opportunity presents itself – sure, why not. But long term – multifamily is more stable and more predictable in my opinion.
I pick multifamily for the simple reason of economies of scale. There are no EOS with SFH. Also SFH are tied to the comp appraisal model. Also hard to find non-recourse lending for SFH.
For a starting investor, get a few SFR under your belt. In my area right now, they are undervalued because of all the foreclosures and give you a great balance to use as collateral to buy the MF's. Let them do the heavy lifting to get to your real estate goals quickly.