Help me understand the advantage of multi's

[Eric James]

I frequently hear/read that large multifamily properties (i.e., apartment complexes) produce better returns than SFH or small multifamily (2-4 units) properties. I just can't see it in the numbers, as I can figure them. When asking why large multis are better than SFH I've gotten responses such as 'economies of scale', meaning maintenance and property management are cheaper when done in large numbers and at a single location. However, if I'm not mistaken, cap rates take these expenses into account, and cap rates under 10% just don't look like good deals to me, in comparison to SFH returns (at least those I have access to). Please tell me if you think my analysis below is on track, or if it is mistaken somewhere.

Let's say we look at every $100,000 of property value of a MFH compared to SFH. If an apartment complex is at a cap rate of 8%, this means net operating income (gross income - operating expenses) =$8000/year. This comes out to $667/month for every $100K of property value. Say the debt service is $550/month (80% LTV, 5.5% interest, 20 year amortization), that leaves net income of around $117/month. I also believe the calculation to this point does not include capital expenditures. This $117/month – capex isn't very impressive, compared to the return I'd expect from a $100K SFH purchase.

A positive aspect of MFH can be forced appreciation, that is, renovating etc. to be able to raise rents and property value. Let's say rehab is done so as to allow a 25% increase in rents (e.g. from $800/mo to $1000/mo), so as to increase cash flow by $200/month, that takes you to $317/month - capex. That is an improvement, but still something achievable with a $100K SFH that you rehab (e.g. BRRR). The rehabbed MFH will now have a greater resale value (due to the increased rents), but so will the rehabbed SFH. One positive with the SFH route is that by using the BRRR strategy you can refinance and pull all your cash (or more) back out quickly, rather than having to wait for the time it takes to rehab an apartment complex before refinancing or selling (which is an opportunity cost).

Some might say a benefit of purchasing an apartment complex is the time savings of being able to make a single purchase (for example) of $2M, rather than 20 purchase of $100K SFH. However, it seems to me that the process of finding, negotiating, doing due diligence etc. for a $2M apartment complex may not be much less than that of purchasing 20 SFH.

Another advantage I've heard claimed about MFH is that if you have 40 apartments, one or two vacancies don't hurt your cash flow that much, compared to having a vacancy in a single SFH. In this case an appropriate comparison would actually be having one or two vacancies out of 20 SFH (or whatever number would equal the value of the MFH used in the example), which wouldn't be that bad.

I can see there being an ego boost in buying an apartment complex, which could make someone feel like ‘one of the big boys’, but I just don’t see it in the numbers. I keep looking for the big advantage of large MFH, but haven’t been able to see it in the numbers. What am I missing?

[Michael Swan]

Hi @Eric James

Those are great observations you have made. However, I had 10 single family condos here in San Diego cash flowing at about $50,000 a year. Next, 1031 exchanged them for apartment complexes in NE Ohio. Now I have $160,000 in cash flow and have exponentially increased the value, by repositioning value plays, David Lindahl style. A few of these apartment complexes I have owned for less than 2 years and have increased the NOI dramatically, increasing the value of the property and NOT being at the mercy of comps.

Don't get me wrong, I have made a few mistakes, but now I have learned my lesson and have some really nice value plays that we are in the middle of repositioning and that cash flow should continue to rise. I just signed an LOI for another 34 units, about $8,000 a unit under market too.

I would read David Lindahl's Multifamily Millions book.  It was extremely helpful to me!!

Swanny