Larger Multifamily financing risk vs smaller multis 2-4units

[James Denon]

I am new to real estate investment. I am located in Connecticut. The markets I am interested in are New Haven, East Haven, Wethersfield, Hartford, West Hartford, Middletown, Glastonbury, Cromwell, Rocky Hill areas.

I have been indecisive between smaller 3-4 unit houses and 20 unit apartments.

I need some advice.

I have ~200K to invest. I would like to go in with significant leverage and target 800K-1M worth of properties.

I am looking around 9-12CAP deals in B+, B- or C+ properties.

I am trying to decide between buying 5 separate 3-4 unit properties or a single 15-20 unit property.

I plan on holding the properties as long as they remain positive cash flow.

Financing seems to be more risky with 5+ properties since in 5 or 10 years, the loan is called back and you need to refinance at the market rate.

Lets say I bought a $1M property with 20% down, if the interest rates become 8-9% in 5 years, the property price would drop 25% yet I would still owe ~$700K. The property will appraise at 750K.

I would not be able to get financing without putting down more money out of pocket. Even if I get the financing, I would be getting it from 8-9% rate. The property may become cash flow negative because of the high mortgage payments.

On the other hand,  3-4 unit house, I can finance it for 30yr fixed rate. Even if the market fluctuates, I am safe with my original financing terms. I can exit or refinance when it is favorable during the loan term. Also, the residential loan conditions are more favorable. Lower rate and 30 yr amortization instead of 25 yr.

What am I missing about financing? If everyone thought like me the smaller multis would be on demand and larger properties would be dirt cheap.

Also, being new and not having a network, I am less likely to get the premium properties for larger multifamily since the commercial brokers float the good deals to their long term clients first. I would probably end up with scraps from loopnet. The smaller multi is more open to public through mls.

Any feedback would be appreciated.

[Andrew Johnson]

Are you look at actual properties or is this more a theoretical discussion?  You're right that 5 unit+ properties are commercial, reduce the number of lenders, and in all likelihood you will have a 5 year timeframe and then refinance.  I would say that if you think the market will drop by 25% in the next 5 years the last thing you should be trying to do is leverage.  On a more practical level, if interest rates hit 9% it's unlikely (but not impossible) that would happen without inflation and rents rising along with it.  So in the commercial property example your top line would be improving as your loan payments increase.  

Having 20 units in one complex is arguably easier to manage. It's one asset, one thing you have to worry about, and can be a little more passive. If 1 unit is vacant you still have rent for 19/20 (95%) of the units and can likely easily pay the mortgage. You probably have less yard per unit so some maintenance costs go down. Less exterior per units (more shared walls) so when exterior painting/siding/etc. maintenance is to be done it costs less per unit. You might not have to deal with garages that always seem great until they get filled with junk and then parking becomes an issue. You might be able to afford to have an onsite property manager (which you couldn't do with triplex). It would cost you more from an insurance perspective (all things being equal) to insure one building over an array of disparate properties. Not to mention when you're vetting deals the 20 unit property has probably been professionally managed so you have a better chance of getting a genuine/objective T12.

There are advantages to 4-plexes but it seems like you're leaning that way so I'll still with the "devils advocate" for larger unit complexes.  As an aside, I own both a 4 plex and a 27 unit building so I don't believe that one option is materially better or worse than the other.