5 Reasons Why Investing in Multifamily Makes More Sense

My personal investment goal is to create passive cash flow. To achieve this goal, I prefer investing in multifamily apartment buildings rather than single family homes. This blog will cover my five main reasons for this.

As residential real estate investors we need to collect rent from tenants who live in the homes (defined here as single family homes, apartment units, mobile homes, etc.) that we provide.

The definition of "home" is the place where one lives--it could even be a tent or tree house.

1. Multiple Income Streams

The more homes you can provide the more rent you will be able to collect. It’s as simple as that.

2. Centralized Management

For me, it makes much more sense owning multiple “homes,” or “doors” as we often call it in the industry, under one roof than owning multiple of single family homes around town. From management point of view, having a single structure, yard, insurance policy, property tax, termite contract, and waste service all in one place just makes things much easier.

For me, it’s not only the easy centralize management approach that is appealing, but also the ability to scale up to a large number of doors faster.

3. Scaling Up in Multifamily

As active investors we need to look at many potential deals before we actual find one that makes sense. The time it takes to find the deal, analyze the numbers, go back and forward with the broker and/or seller, draft the purchase and sales contract, pay for inspections and an appraisal, talk to lenders etc., etc., etc... Ouch!! That takes a lot of time and energy.

It takes as much time to negotiate one house as it takes to negotiate one 4- or 30-unit multifamily apartment building. Granted, the due diligence may take a bit longer but once you know what you’re doing and have some systems and checklists in place, that process gets much easier.

4. Economies of Scale

When you purchase a value-add apartment building that requires renovations, having large numbers of units will work to your advantage. As an owner of large apartment building you will be able to negotiate a better price for the materials and labor. This, in turn, might reduce the repositioning cost and save you thousands of dollars as you reposition the property.

Economies of scale will also benefit the ongoing operation of the building and the portfolio as a whole.Apart from getting better rates from property managers and contractors, once your portfolio is closer to 100 units you might have a dedicated on-site leasing agent and maintenance personal on salary. That alone can save you thousands of dollars every year which would increase your portfolio’s net operating income (NOI). With multifamily apartment buildings, that increase in NOI would in turn increase the property value.

Property Value = NOI/Cap Rate

The benefits of multifamily apartment buildings go a long way towards tenant retention too. Having a large number of apartment units under management can benefit the tenants themselves through things such as competitive cable, internet rates, house cleaning, garbage valet services, dog walking services negotiated with local service providers.

5. Reduced Risk of Vacancy Loss

No doubt the biggest risk we face as landlords is vacancy loss. I’m not referring to vacancy loss caused by an unforeseen event like flooding, fire, or earthquake that can be mitigated by having the appropriate insurance cover. I’m talking about vacant units that are rentable. When a property is vacant, there is no rental income. In this situation the landlord can be short on paying the mortgage payments or not have enough cash flow to cover the landlord’s personal living expenses.

When an investor owns a multifamily apartment buildings with multiple doors, the investor has a better “cushion” against vacancy loss because the likelihood that all rental income will stop is less likely. This cushion is also called margin.

A margin analysis is a part of a stress test to see how the property performs against vacancies.

The margin is the difference between your net income when the building is 100% occupied (no vacancies) and your breakeven point (the point where you’re bringing in exactly enough income to cover your expenses). If you’re within the margin, the rental income will cover all your expenses. If your vacancies exceed the margin, you’ll be forced to cover the shortfall with out-of-pocket cash.

Having multiple income streams under one roof allows results in a bigger margin because a multifamily property can have some vacancy and still have sufficient cash flow to cover the operating expenses and debt servicing. One could argue that a single family home investor can achieve the same results by owning multiple houses. While this is true, investors with only single family homes cannot realize some of the other benefits listed above.

Calculating the Margin:

Margin = 100 -Operating Expenses + Debt Servicing

Gross Potential Income

Example of a 6 unit Apartment Building:

Gross Potential Income: $42,000 per year.

(100% Occupancy)

Operating Expenses$18,000

Debt servicing$12,000

Total Expenses $30,000

Accordingly:

Total Expenses $30,000 / Gross Potential income $42,000 = 71.4% Breakeven Point.

This is a Margin of: 28.6%

(100% Rental Occupancy – 71.4% = 28.6% margin)

The 28.6% is your cushion, or allowable vacancy before you incur out-of-pocket expenses.

As you can see, investing in multifamily properties provides an investor with greater safety net against vacancies as compared to a single family home in which there is zero income when there is a vacancy.