People are quick to tell me why I should NOT buy a 5+ unit building. But why SHOULD I?

Question

Wife and I are in the beginning stages of going after a long term income property (In Los Angeles). We already have a 4 unit building here in LA - and a single family home we live in. Initially we were thinking 4-plex. But our agent, (who we trust very much) is asking us to simply consider a building with 5 or more units, saying that while riskier, and with more expensive and less secure loan options, they can pay off much greater down the line.

I've had many people tell me why we should stick to 4 units, mostly because of the fixed, cheaper loan. But I'm wondering what the specific pluses of owning 5+ unit properties are? There must be some advantage there... (greater cash flow?) My wife and I both like a little risk. So it is intriguing to us. Thanks in advance!

Darrin Carey · Answer

I like the 5+ unit properties for cash flow, even though I still flip single families. There are some advantages and disadvantages though. I do NOT believe a 5 unit is "riskier" than a 4 unit.

Single Families are much easier to sell, since you can sell to homeowners or investors. Commercial is only investors.

Commercials loans typically require 20-25% or even 30% down, and that puts a lot of people off.. A new investor can get a residential (1-4 unit) loan with much less down, although the days of nothing are pretty much gone.

You can get a commercial fixed loan for 20-25 years, but the rate IS higher. A lot of people choose a 5/5 ARM (no balloon) as a good balance. There are enough varied commercial mortgage products available to meet most needs short or long term.

Commercial loans are not nearly as regulated as residential loans. That gives the lender a lot of flexibility to make exceptions, and tailor solutions to meet your needs. For example, we offset someones low credit score that would normally kill a deal by getting a larger down payment, and showing available cash reserves.

Most importantly though, commercial property values are dictated by the income they produce not "comps". If I can increase the Net Income, I can substantially increase the value of my property. If I can raise the rent $25 per unit on a ten unit property ($250 per month, $3000 per year) I may easily add $30,000 to the property value with just that single change.

Aly W. · Answer

Thanks everyone, this is a great topic! I'm looking at 4-plexes, as my husband and I currently own condos and SFRs. I self manage, with a contractor to do repairs. I hadn't considered the issues of close quartered tenants, problems with the city (although that's not uncommon with SFRs), etc. Good to think about.

Robert Nunez · Answer

I found that the commercial loan was easier and better to get then the 4 unit residential loan.  Also it hasn't shown up on my credit so that is another plus since it is a commercial deal.

Plus more rents are always better, 5 beats 4 all day.  When cashing out it may be easier for a buyer to get financing for your commercial deal as opposed to a residential deal, but that varies on many factors as well.

Speak to a few commercial 5 unit owners and that may open some doors for you.  I own a 5 and a 6 unit and the biggest challenge we have had is the insurance which is pretty high but the multiple rents cover that.

Robert

Wendell De Guzman · Answer

I love 100+ unit apartment complexes (based on experience). It is big enough to afford a full time property manager and maintenance person. Hence, I actually spend less time on my 100+ unit apartment complex vs my SFRs.

Account Closed · Answer

Thanks all - This is fantastic.

Pat L. · Answer

A good friend we helped finance went from SFH, to duplexes to a semi-profitable 4-pex. Then they unloaded some of the profitable easy to run units & bought a 6-plex with a cottage.

The nightmares began trying to keep up with rental arrears, close quartered tenant disputes, & ongoing maintenance & repairs. Not to mention much higher Liab Ins & property taxes.

Then the city started hounding him with Code violations. It seems that every time a tenant gets evicted they blow the landlord in for something. They cited him & wanted a replacement exterior window (broken by a vacating tenant) frame painted in mid winter. The housing court judge threw it out. But his legal costs are also a great tax deduction!!! They also condemned the cottage because of a previous tenants damage.

He is retired so has the time to stay on top of things, including the continual vacancies, but he can't wait to unload the 'rats nest', (his words).

good luck

Joel Owens · Answer

5 to 40 units or so Is more for the hands on investor and if you want a JOB for your return. Meaning you can have a PM but really can't afford to have a full time maintenance person on site unless you own other properties and employ them across the board.

50 units and above is really where you can start to structure a full time maintenance person. The repair person knows the units and layout, parts needed, etc. to do fast turns for re-renting and  fast repairs for existing tenants.

The maintenance person doesn't have to look all over for multiple jobs to cover their existence and can have that all with your property.

Anything I do now it cannot involve becoming a problem or a job for me. If it meets that criteria it goes out the window. The number of units is a guideline and depends on your area and rents versus what you have to pay a repair person. An example is an area where rents are high but repair labor is cheap. You can have less units but afford a full time person.

Dennis Tierney · Answer

As a strictly multifamily investor I admit my bias, but, for me the biggest factor is the ability to scale up to a size that allows for truely passive investing and having a professional management company do the day to day work. If that doesn't appeal to you then you have to consider what sized property you can competently self-manage.

Michael M. · Answer

@Matt Rothwell

Yeah thanks for that, I didn't express myself too clearly. I meant that the more units one has, the more you have to juggle, per se, making management more of a task and burdensome. On the other hand, that can all be lifted given he and his wife are equipped with a good PM to do the job.

But yeah, I wasn't trying to say that each vacancy would be more costly as the "slices" of the pie are much thinner the more units you have.

-Michael

Yiv L. · Answer

I am not a seasoned investor, but I have done a lot of thinking on the matter myself. So, here are my takes:

Advantages:

5-units or more: Main advantage is getting lower cost per unit. Probably better normalized vacancies. Fewer competing potential buyers (due to loan structures and other factors), and thus lead to possibly better deals. However, if the number of units is pretty close to 4, the cost advantage is probably not there.

Disadvantages:

Need commercial loans with tougher terms, higher rate, higher costs and short-term loan (5-7 years). But to me, the main disadvantage is that, as @Tom Goans mentioned, if you get fed up by your tenants and throwing in the towel, you can pretty much get rid of your 4-plexes or fewer a lot easier.