Why to buy larger unit buildings vs 2-4units?

Question

Say I have $200k to invest in downpayment s and purchasing MF buildings.  Seems like the larger unit buildings don’t have as good of a return?

I plan to be in this situation by next year, and I don’t know if I’m better off buying the largest apartment building I can find or if I should just buy a bunch of doubles, TRI- and 4 plexs?

Goal would be best return on my money.

Jeffrey Donis · Answer

As always, it depends on your goals and your current situation. Do not be afraid to start big- I recommend finding a coach/mentor/partner that has experience with larger assets if you choose to go that route. The reason people typically recommend starting bigger is because it is more scalable, takes a similar amount of effort, and at first may not produce as much profits if you are splitting up the profits with you partners however in the long term you will see greater results. I like to keep in mind what your end goal is- if you would like to go into larger properties don't be afraid to just take the right steps to avoid making unnecessary mistakes + it does have a larger barrier to entry than smaller deals due to the competitiveness. Let me know if you need any help with anything!

Lee Yoder · Answer

You pose a good question @John Gach and you've received some great answers so far. This is why BP is great!

I totally agree with all the benefits that @Elizabeth M Williams detailed so well in her posts regarding apartment syndication. I am an apartment syndicator myself in SW Ohio and I pretty much agree with everything Elizabeth said. However, I do still believe you will make more money buying your own properties vs. investing passively in someone else's deal IF you buy right and manage right (and those are some big "IFs").

I also think @Evan Polaski makes a great point about how difficult it is to find four good 4-unit properties to purchase vs. finding one good 16-unit property. I would add that it is much easier to manage one 16-unit property as compared to four 4-unit properties as well.

Good luck John and God bless!

Tushar P. · Answer

@Elizabeth M Williams I hope that in your future advertisements you can put a disclaimer upfront that there is no guarantee. Otherwise anyone who dumped money in the stock market a year ago can start guaranteeing 300-500% annualized return with zero effort.

By the way, anyone who dumped money in a diversified stock index (like s&p500) 10 years ago has had 15% annualized return with zero effort, but even that can’t be guaranteed. Anyone who dumped money in Facebook stock 8 years ago has had 10x return (33% annualized) with zero effort, but that can’t be guaranteed either. Get the point?

With syndications, it is important to point out who will be left holding the bag when the deal goes south.

Eric James · Answer

Beware of people trying to get you to invest in their syndication. They'll blow smoke up your butt telling you you're going to have high annual returns. But MFH are at 5% cap rates.

Remington Lyman · Answer

I would start with 1-4 units so you can use conventional debt. Then when you have 10 roofs, you should move to bigger stuff and leverage commercial debt.

John Gach · Answer

@Eric James

Definitely,

That’s one thing I’m noticing even with cap rates in the 6-8 range to me it seems like for the amount of down payment to purchase these large apartment buildings it’s still not cash flowing good at all.

Put $200k down and it cash flows 1-2k a month, but even if all the rents are only $50 low compared to market. Once you raise all 10 units $50 bucks it’s only another $500 a month, you could probably do that every year and after maybe 4 or more years it would make a good return, but then a few renovations would take away all that income.

So unless people are happy with that poor return, or the rents can go way higher, or have less vacancy’s, I don’t see how it’s worth it.

I supposed after 4 years you could refinance and pull some money out but even then you sacrifice the cash flow now.

Evan Polaski · Answer

@John Gach, there can be many efficiencies created with more units versus less.  But it all comes to the assets, since I live in the older neighborhoods in Cincinnati, most assets I look at have a fair amount of deferred maintenance/capex needs.  Things like landscaping costs more for bigger properties, but typically it costs less per unit.  Same with things like roof replacement.

And then, there is also the speed by wish you can place capital.  Are the 2-4 family properties plentiful, or will you be sitting on dry powder for a long time trying to find deals?  Meaning, if you could by a 16 unit or 4 four families, how long will it take to find the 4 four families?  How far apart will they be around town, and the general management efficiencies.

Chris Levarek · Answer

@John Gach If goal is purely return, then I'd say go and invest into duplexes, triplexes and quads. I would also suggest you wear many hats. The more roles you can play, the higher your return can be. Someone able to put the time in, can make some great returns in real estate as you don't have to pay the middle man.

HOWEVER, you give up time, you assume all risk, you are responsible for all capital and are dependent on your experience to be successful (yes, some cases may vary as you outsource some pieces...)

My point here is, it will be entirely dependent on your goals and lifestyle as what a good return is. I personally don't have the time to invest into duplexes any more simply because the drain on resources, time, management and headaches are not worth it to me(46 units later).

I go bigger now because economies of scale, partnerships and calculated risk profile make it more worth my time. Is the return less than a BRRRR or duplex flip, possibly but if i calculate the time consumption on the C class BRRRR I could afford for 200k, versus a B+ apartment complex with partners, I will choose the latter at this point. This is my opinion of course. Hope that helps in some way!

William Costello · Answer

@John Gach it does depend on your goals and what you are looking to accomplish. If you were looking to go big, have you thought about syndication at all? It is a great way to invest in a larger property that one may not be able to obtain alone and without doing all the heavy lifting going out on your own. In addition, finding a great mentor that has experience is always helpful. It is a relationship business at the end of the day. Good luck!

Elizabeth M Williams · Answer

@Tushar P. Thank you for your comment, and I assure you that this is covered during any conversations with prospective investors.

By their very definition, both sophisticated and accredited investors are deemed have sufficient knowledge and expertise in financial matters to weigh the value and risks of an investment. We are also required to have all investors fill out a suitability form prior to investment. Unlike with the ease of buying into the stock market, we have lengthy conversations with our investors, understanding their needs, and answering any questions about the deal, specifically, and MF investing, more broadly. This includes any questions around 'what could go wrong?'

Re anyone can get 300-500% returns with zero effort - for someone to do that, that would mean they were invested in higher risk plays, which doesn't fit the profile of the average MF investor.

Investing, by definition, carries risk. Sadly, 2020 & 2021 saw a lot of people, without a lot of experience, chasing meme stocks & SPACs, often with the use of margin accounts, getting badly burned. They've relied on reddit and other groups/sites/youtubers for their picks, often unaware that they have been part of the Wall Street manipulation, and only to see both their gains and their savings wiped out.

So we know that putting money in the bank or in a safe will end up costing us money, in the end, as inflation is real, and savings accounts and mattress stashes will lag inflation. So our option is to invest, and with eyes as open as possible. Personally, and I'm in the stock market, as well, I see MF syndications as great addition, and in some cases, alternative, to the market. Why? It's not as volatile; it's not subjected to price fluctuations because of a short report, or a hedge fund's actions, or any number of news events globally that can wipe out returns. Also, because at the end of the day, it's a physical asset that you own, which will always have intrinsic value.

Similar to the market which has bull and bear runs, real estate is also cyclical. And as you know, it's time in the market that counts, not trying to time the market. Similar to the market, what you pay for the asset has a large impact on the performance, long term.

There is a reason that many projects have a 5 year hold in their investor summary. It's to mitigate risk for its investors, ie to account for downturns, and unforeseen events. On value add deals, renovations are typically done within 18-24 months, and often rent escalations inline with renovations are fully implemented within 2 years, perhaps 3. So it is in the interest of the investors & the operator to sell once rents are stabilized, and move onto the next deal. Furthermore, it is imperative that investors understand the deal & its terms, and to ensure that the business plan is conservative. A lot of these deals, speaking to risk, have break even points at 60-70% occupancy, in complexes where historic occupancy is 90% and above. That's a lot better risk profile than many stock market investments.

Speaking to that, in the stock market, investors mitigate risk by investing in dividend kings/aristocrats, broad market etfs, and staying long in the market. Again, you MIGHT get huge returns by betting on GME or AMC or the latest meme stock, but you are more likely to lose. Similarly, investors in MF syndications can mitigate risk by going deep into a deal (and it is my job, above all else, to help investors both become educated in MF, and to help them look at deals, often ones that I don't raise for). They can mitigate risks by investing in bigger projects, in bigger metro areas, in areas not dependent on a single industry for its economy, by investing in certain classes of apartments, with experienced operators. The terms of these deals are such that distributions are cumulative, so if there is an unforeseen circumstance, they will be made whole on their distributions.

Lastly, there are some investors who consider this a bond proxy, given that the fixed income market has been, and looks likely to be, delivering pretty poor returns in the coming few years. With a degree of due diligence, and with conversations with people who can help navigate you through the pros and cons of this, or any other type of investment, MF investors can enjoy either class a shares, giving a steady income of normally 9-10%, with no participation in the upside (a good choice for retirees) or class b shares, where they get some skin in the game, and generally can anticipate 18% or more annualized returns.

In my humble opinion, being diversified is important. Some people like 100% real estate, or 100% equities. Not me. Maybe if I was 20 years younger, who knows? Creating as many current and future income streams as you can, across multiple asset allocations, is a well-known way to further mitigate risk & protect your assets.

Why to buy larger unit buildings vs 2-4units?

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