Max out fourplexes before commercial?

Question

Hi friends,

There is a question that I have been searching for an answer for a while.

Should I max out the fourplexes (up to 10, residential) vs, going “big” by purchasing a 10 unit+ property (commercial)?

I know it’s a deal by deal analysis but I hope to get a general direction. My goal is to have a fund if possible to invest in real estate.

Maybe helpful to think in a framework.

- Cash flow % (commercial higher)

- Appreciation potential (commercial lower)

- Expenses (usually more unit, more efficient)

- Loan complications (how much more complex will commercial loan be?)

- Total return (which is higher?)

Thanks a lot! Appreciate any thoughts.

Greg Scully · Answer

@Au Jia - I would say go to commercial multifamily as soon as you can.

You mentioned in your post that commercial appreciation potential is lower, I tend to disagree.  With commercial properties you are able to "force" appreciation because the value is largely determined by the net operating income rather than comps (like residential).  When purchasing value-add apartments the upside potential is significant and any proceeds from a refinance after repositioning is tax free.

The lending process is not necessarily more complex, it's just different, and because it's the same amount of work to analyze and secure funding for 10 units as it is for 100 units, I would suggest going as big as possible.  A 100 unit property is not 10x the complexity and cost (closing/due dilligence) of a 10 unit.

I think the return potential for commercial is higher, that's because you're buying a business, and there are more tax, lending, and partnership opportunities for businesses than there are for individuals.  Accelerated depreciation is just one strategy that can significantly offset other earned income (including your spouses)...I'm not a CPA.  Generally speaking too much emphasis is put on cash on cash returns and IRR instead of looking at how all the aspects of the business affect your personal situation.  Without going too deep into it, the returns can be divided among the investors too meet specific needs:  some may want more cash flow, while others need the tax shelter aspects...I'm still not a CPA.

One good way to learn more about larger multifamily properties is to invest passively.  You can find syndicated deals that have preferred returns from 6-10% and the LP also get a piece of the upside.  Typically these are 5yr holds.  You'll get a good introduction to the process, paperwork and how a property operates as a business.

FYI, I started with SFR (2), passive multi (50 units), and now owning complexes (62 and 41 units with partners).  All of which are out of state (Tennessee).

Matt Skog · Answer

@Au Jia,

Going smaller, like 5-20 units, are a great way to get started. Many apartments in my area use seller finance as well. Whatever route you choose, be careful in choosing your team.

Diana Muresan · Answer

@Au Jia if you dont currently own any MF, you should start with 2-4 units, dont worry about the 10 max financed property rule, you will not be able to have 10 MF financed properties on the conventional market, that refers to SFR, you will be able to get 6-7 MF and the last properties you will purchase will have to be OO (owner occupied). So take advantage of the low rates and closing costs before you move into the commercial world. FYI, on commercial MF, you will need to show landlord experience and have a net worth equal to the loan amount and reserves 9-12 months

Au Jia · Answer

This is tremendously helpful! Thank you all for the reply, particularly @Greg Scully thank you!

Anthony Gayden · Answer

Yes, I focus on single family. The ease of financing and the lower down payment requirement helps.

My path in real estate is slower and smaller than a lot of others and I would love to move into multi family. I am not prepared to make that commitment.

Au Jia · Answer

@Anthony Gayden

Thanks for the reply. Do you now focus on single families given that’s what’s available?

I have always been an out of state investor. California is just not doable at this stage.

Anthony Gayden · Answer

@Au Jia

That was my plan originally however that changed due to a number of factors. The first being that I was unable to find more 4-plex buildings that meet my criteria for cost and cash flow. When I bought my two in Arizona it was 2014. I didn't know it at the time, but everything was super cheap. By the time I was ready to buy more, the numbers didn't make sense any more

The second issue I had was that I changed markets and that strategy did not work as well in my new market. Omaha does not have nearly as many 4-plex buildings and single family homes were far more affordable.

Scott Morongell · Answer

@Au Jia If you have the knowledge already it is more of a mental hurdle than anything. You have more protection with larger assets.

Brian G. · Answer

@Au Jia plenty of people would say go big or go home (ie the more units the better). IMO if you are just starting out, the smaller properties are a great place to start (2-4 units) unless you are partnering with someone who is already experienced in investing in larger properties. Buying commercial is a whole different game in underwriting, management, etc. I wouldn't worry about the financing part, I would focus more on what you want your strategy to be and go from there. It is true though that conventional lending on 1-4 units is the cheapest money you are going to be able to borrow. The stakes are higher (ie higher loan balance, more management intensive) with larger properties (ie 5-50 units) so imo it makes a lot of sense to start smaller and build from there (knowledge, contacts, etc) then when you have a solid base you can cash out refi or 1031 those smaller properties and roll them into larger ones down the road rather that having all your eggs in one large property to begin with (ie sink or swim).

Max out fourplexes before commercial?

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