Scaling up quickly vs. maximizing COC return?

Question

I am a relative newbie investor, focusing on small multifamily (at least initially). My goal is to scale up as fast as possible, in order to build cash flow. Is there any advantage in doing a larger (more expensive) deal that produces a relatively low COC return but gets me more doors, as compared to a smaller deal (less expensive) with fewer doors with a higher rate of return? My gut tells me the deal with more doors is just locking more cash into a poor rate of return; however, I have heard on BP podcasts that scaling up is the key to building wealth in multifamily investing. So I'm wondering if there is some reason to sacrifice a better COC return in the beginning in order to scale up faster. Any advice in this regard would be greatly appreciated.

Benjamin Aaker · Answer

Hi @Jordan Becker. Great question. This is always the cash flow vs. equity question. The answer depends on your means and your goals. Just starting out, you will depend on cash flow so that you can pay for more real estate investing and possibly quit your day job. Later on, or if you are a high-performer, you'll want less cash flow (read taxes) and more equity. That equity, rather than cash flow, is used to purchase more properties, via lines of credit. Don't worry about the doors, they don't matter. It's all about the cash flow and equity.

Randall Alan · Answer

My wife and I have purchased 24 properties in 3 years, totaling 40 units, plus do flips on the side. We worked our corporate jobs until we had about 20 units, then, with enough cash flow we quit our jobs and now do real estate full time. Much of your answer depends on your resources. For us, cash flow is king, so low COC return is a non-starter. I think the only reason I might consider it would be if you thought there was a substantial appreciation play to be made down the line, because we have found that by buying units cheap we have been able to double to triple our money in less than 2 years on some of the properties we have sold recently. Outside of that angle, we look to maximize cash flow by buying cheaper properties that will still rent well. If buying using residential financing, know there are a limited number of loans you can have. If your credit score is under 720 it is 7 loans. Over 720 credit score it is 10 loans… but there are also increasing reserve requirements you must meet as you build your portfolio.We started out buying multi-family properties, but soon switched to single family. They are far more plentiful, and appreciate faster than multi-family in our experience. You are going to be fighting institutional investors for larger multi-family properties… and it seems like they really don’t care too much about what their return is, as long as it is better than the stock market. We, of course, do care, so we find single family homes to provide a good opportunity for lower entry point, faster appreciation, and still good rents. Typically we net 50% of a property’s monthly income on a financed property, including accounting for taxes, insurance, and a 10% maintenance reserve. It takes buying a property right (read: cheap) to pull that off, but we have been able to do it. No way would I ever consider a 4-7 cap property. Randy

Jill F. · Answer

We started out in 2016 with that same focus buying small multis at 15-25k per unit 2% (or higher) deals. But in 2017 we bought what was for us an expensive deal (56k/unit) it was a 1.25% deal. And by Jan 2020 the 35% market and forced appreciation from that more expensive deal allowed us to by a group of 8 duplexes (16 units) with almost no cash out of pocket by cross-collateralizing the appreciated properties. So we have changed our strategy to avoid those blighted neighborhoods that just won't appreciate. Plus while we have had rent increases across the board, our nicer properties have our highest percentage rent increases. We're at 59 units now. by the end of this year we'll have 32 units (very) nicely renovated and all properties stabilized with a back log of 3 renovations. We plan to start buying again middle of next year.

David M. · Answer

@Jordan BeckerIts really a matter of your strategy/intent and the market you have to work with. As stated, for some cash flow is king. But, the old, tried and true of equity still holds. There was a long thread we dsciussed that and it does seem new investors forget about that. For example, a hypothetical zero cash flow property worth $1mil could be very lucrative after 30 years. for the cost of the money down, you now have $1mil PLUS whatever its appreciated. Try to get that from cash flowing properties over 30 years... people talk about $100 per door per month... hmmm....if you "listen" to "older investors," they need to cash flow because that is what they are living on. Many of them actually started with a long term growth strategy then moved into an income strategy --- its no different, in my opinion, to investing strategies for the stock market. You grow aggressively when you are younger then move into a more "fixed income" type investments.Hope this perspective helps as you are evaluating your deals. Good luck.

Jordan Becker · Answer

Thanks, all, although I think the last couple of responses kind of missed the point of my question. I have already decided that cash flow is my prime goal. Any equity is just a bonus. My question was, given that my strategy is to scale up my number of doors as quickly as possible, whether buying more doors at a lower COC return is better than buying fewer doors at higher COC return. Anyway, I really do appreciate the responses, so thanks again!

David M. · Answer

@Jordan BeckerOh… in that case my initial thought is it’s a gamble on what increases faster, rents or expenses. For example, with more doors a $20 increase in rent means more overall incoming money. However, so could your expenses..My properties are cash flowing better now because rents have gone up Faster than my expenses…Good luck

Jordan Becker · Answer

Thanks for the (lone) reply, Randy @Randall Alan. Very much appreciated!

Gerald Pitts · Answer

Self managing. But it's not a lot of work with strs as long as you automate as much as possible. And I don't necessarily make more than others that self manage. More than some, less than others. A lot more than people that use antiquated property Management.

Travis Frenchak · Answer

In my opinion its all about COC return. Why not own 5 units if they can produce the same return as 10 units? My concern when buying is COC returns and forced appreciation. I don’t care if that is with 14 units or 50 units.

Gerald Pitts · Answer

To me, I think of highest, best use of money. I invest in vacation rentals. These are technically single family, but I quit my job after 2 SFHs (or 2 doors), and their growth paid for #3 and will pay for half of #4 I could not have necessarily have done that with 10 doors of LTRs.