SFH more profitable than MFH right now?

Question

I've been considering 10-31 exchanging my SFH's for an apartment complex. Trouble is, few of them have a cap rate worth investing in, let alone a cash on cash return worth investing in considering leverage, and even then, the cash flow is very small compared to the total return on my SFH's. For example, I could buy a 4 million dollar apartment complex with 25% down and make maybe 50-60K a year. Right now off four rental houses I make 200K a year between appreciation and cash flow. Since MFH is valued on rents it would seem that selling prematurely is a huge opportunity cost.

It definitely seems like exchanging into some multi family before a crash just to preserve value is a good idea, but selling rapidly appreciation Seattle area real estate prematurely seems like a huge opportunity cost. Doing it before the market crashes would help preserve value but doing it too soon will leave money on the table.

Lane Kawaoka · Answer

I only buy class c mfh. Not not get it confused with class A or a lot of class that does not make sense. I invest for cashflow and the only place that makes sense is class out of state than seattle. There is too much Accredited Unsophisticated money looking to place money for capital preservation betting on appreciation. Please don't loop Class B/C investors with the Class A in non cashflow locations like Seattle, San Francisco, Los Angeles, or any primary market.

Jeff B. · Answer

@Jack B. Hate to say this but 'appreciation' is a paper tiger and worthless until it is realized in a sale. My MFU 6 units have performed steadily for 19rys and that's a lot of NOI deposits every month over 19yrs.I never saw a check deposited for appreciation during that time.

Michael Le · Answer

You're really stacking the deck against MFH by comparing SFR in a market like Seattle to a non-value add multifamily. If you compared it to a value add apartment in Dallas, for example, then you'll have a fairer comparison. Take the typical numbers that someone is looking for when buying a value add B/C class property in Dallas. Double digit yearly cash-on-cash returns, 20+% IRR, and double your investment in 5 years. So if you put down $1m then just very high level basic math says you get $100k a year in cash flow and then in year 5 you get an additional $500k in capital when you sell, for a total of $1m. Annualized returns across those 5 years still come out to $200k a year.The difference being not everyone lives in Seattle or another appreciating coastal market. Could you buy four rental houses, today, that provides you the numbers you quoted above? Because you can find apartments throughout the country that does meet mine.

Jack B. · Answer

Yes! Increasing returns to scale, forcing value via creating additional revenues, raising rents, lowering expenses. What a great example of this you gave, the power of commercial vs. residential.

David Thompson · Answer

Jack,I like where Michael is coming from. We have invested in over 800 + units in Dallas this year and the numbers of 10% CoC and 20% IRR w/conservative underwriting is achievable. We force appreciation and that's the difference w/commercial property vs residential. It's all in the math and valuation methodologies. Case in point, if you went out and added a carport for your SFH, I doubt you'd get a return on your money. You probably can't charge more than $25 a month in rent from the neighbor next door that doesn't have one. So, you do that, does the value of your SFH change, doubt it much at all because everyone expects to have a covered parking. However, do that to a 1980s 300 unit apt, build 200 carports and charge $25. According to commercial valuations practices, I've increased the NOI by $60K/yr. But I've increased the value of the property a whopping $1M !! $60K / .06 cap rate = $1M. Give me apts anyday !!!

Jack B. · Answer

Interesting point, but yes, I could buy 4 SFH in Seattle and actually make more than 200K a year as I'd be buying even more expensive properties. The only thing is risk at these prices. With my current properties I could still make a profit in a downturn if I had to sell. If I buy now, it's much more risky. MFH being valued at NOI is less risky unless the property has major capex/deferred maintenance. In fact, I plan to reinvest in as many 500K properties (down turn properties, more like 1 million currently) as I can get loans for when the next major down turn strikes, so that I may ride the appreciation wave again. But before this existing wave ends, I need to convert the equity into a cash flow valued asset like MFH. Now is probably not the time, but it's probably the best way to protect the equity that I go into the MFH with from a like kind exchange. I had considered buying paid off houses in Florida with the money, about 20 worth, BUT...then I'm just losing equity as the market crashes while cash flowing houses, paying ridiculous taxes all the way.I think what I will do is wait, ride this train, then before it stops, years before, convert to MFH instead. This way I protect the equity since MFH is valued on NOI while I also cash flow, stacking my chips to buy more leveraged real estate in Seattle when the market plummets again, Even now I'm saving cash for that purpose. Also it's more tax advantaged and involves less closing costs that buying 20 houses, and is less effort.

Jeff B. · Answer

However, Equity is not the same as Appreciation. The former can be accessed via a Refi while the latter is vaporware and accessed only via liquidation.

Jack B. · Answer

So Warren Buffett is not worth tens of billions of dollars? After all, appreciation is a paper tiger as you say....The thing the "paper tiger" crowd seems to miss is that equity can be converted into cash flow....