Differences Between Multi-Family and Residential Income (5+)?

Question

I've always been told that once you get above a 4-plex things tend to get a lot more complicated due to the classification change. Wondering how much truth there is to this and what the actual differences are between acquiring and maintaining a small multifamily and a larger complex (specifically looking more at 6-12 unit buildings for what it's worth).

Would love if anyone had some insight into how these differed from smaller multi-family's as it pertains to

-Acquiring financing/financing requirements/down payments

-Insurance

-Taxes

-Overall Maintenance

-Any other factors that you feel are significantly different.

Thanks!

Michael Ealy · Answer

Hi Mike,

Based on buying over 1,000 apartment units, here's what I can say.

The bigger units - 50+ and up are actually EASIER to do. They are easier to finance as they are less dependent on your personal income (and more on the property's). Also, they are easier to manage as 50+ units (specially 100+), can afford a maintenance manager and a property manager.

Ironically, the smaller ones (6+ to 30+) are actually MORE difficult. More difficult to finance and you need to be more hands on in managing it.

Michael Dang · Answer

@Mike Goldenthal - If your other partners or investors are passive then it maybe viewed as a security or syndication.  If so, then it needs to be approached as a Reg D 506(b) offering.  Please consult with a securities attorney for clarification.

If your partners are active then the roles, responsibilities, and membership share % should be clearly defined in your company's operating agreement and shouldn't be perceived as a security or syndication.

Enrique Huerta · Answer

@Mike Goldenthal,

@Michael Ealy hit the nail on the head. I will elaborate further for your knowledge.

From 1-4 units, you qualify for residential financing. This means you can often purchase a property for as little as 3% down but they qualify you based on your personal income, personal credit, and the sales value of the property. Additionally, 1-4 unit deals are valued based on the sales comparable approach and NOT on the income approach. Thus, even if your 4-plex has higher rents than your neighbors 4-plex, you can only see at the comparable appraised value.

5+ units qualify for commercial financing. That means, the lender is usually more income focused, asset focused, and can grant exceptions for somethings you may not qualify for: net worth, liquidity, etc. You will, however, need 25-30% down payment for these assets. The upside is that it doesn't have to come all from you. You can form a JV or other partnership structure and put as much or as little as you want into the deal (TBD based on the operating agreement).

Regarding your specific example, 6-12 isn't that much larger than 4 units. The expenses will still be pretty high, and while you will benefit from commercial financing, being able to increase income, etc. you will have to bring a higher down payment to the table. Taxes will be higher (based on higher purchase price) and insurance and maintenance will increase relative to the size of the asset. Assuming you use $350/Unit for Insurance and $800/Unit for Maintenance (just an example) then you just multiple that figure by unit count so it's the same, but larger due to a relative size increase. I hope that is clear.

To Michael's point, larger assets can justify the hiring of a Property manager and thus allow you to be more high-level in your operations. This is often better, unless you enjoy property management.

If your constraints are purely financial, aka you an qualify up to 6-12 units on your own. I would buy the largest deal possible that meets your investment criteria at the terms you can afford. If you're going to bring partners into the deal, then the only limit is the limit to your resourcefulness.

Enrique Huerta · Answer

@Mike Goldenthal

Using your example of 3 passive investors, and you as the active sponsor of the Investment, I would say you get limited partner returns AND general partner returns if you invest an equal share into the deal plus do the sponsor work.

Typically, the sponsor of the deal only puts in 5%-10% of the initial investment required, they do all the work, and then use other investors money for the remaining 90%-95% of the required equity.

So 4 total people. Will you be getting the loan and bringing 25% of the total down payment as well?

The structure varies substantially based on project type, investor sophistication, and overall business plan.

Do you plan to collect fees? Acquisition, asset management, disposition fees? Or just profit share?

Oleg Shalumov · Answer

@Mike Goldenthal as mentioned by @Michael Dang your partners will be passive investors, and it will be security/syndication. I am not an attorney, but the best way to avoid having being involved in syndicating is to make sure your partners have an active role in the deal. As long as they have an active involvement in the partnership - you are good. I would suggest that you consult an attorney to properly define roles of each partner in your deal.

Mike Goldenthal · Answer

@Enrique Huerta thanks for elaborating. Super helpful! Wondering if you might be able to elaborate on JV structures. For my example, if I'm looking to go in with 3 other partners and we all contribute an equal amount of the initial cost, but I'm doing all the work (finding the deal, acquiring financing, property management, etc.) how have you seen the profit sharing structured? Trying to set it up where everyone gets what they're owed, but also valuing my own time. Any advice would be great!

Differences Between Multi-Family and Residential Income (5+)?

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