What Makes a Better Real Estate Investment?

Single-family homes? Or multifamily syndications?

Both are real estate investing but are very different from each other. In this blog post, I’ll walk you through the differences between the two to help you decide which one is best for you.

Definition of Terms

First, let's define our terms. With multi-family syndications, we're really talking about commercial, multi-family real estate. We're dealing with larger apartment buildings. So let's say 50-units plus.

With single-family homes, we're talking about residential real estate. We're talking about one-unit houses. We can also talk about duplexes, triplexes, fourplexes — anything that falls within that residential range of real estate when you're talking with the lender. Some lenders will deem anything under six units, or sometimes under seven units, as residential investing.

The Overall Strategy is the Same

Now what are the similarities? There is a big similarity in terms of the overall strategy. It's just how we apply where it becomes different. So whether it's a commercial multi-family property or a single-family home, how we make money remains the same.

We take an underperforming asset — maybe it's dated, maybe the rents are below market value, maybe it needs renovation — and bring that property up to market value or improve it above the average standard market value. When we do that, we make money. We make more money in terms of rents. Another buyer will offer us more money for the property because we've improved it. It’s a lot better than it was before.

It’s the same whether we're dealing with an apartment building or with the house everybody watches on HGTV and all the flipping shows. With apartments it's basically the same idea but on a much larger scale. And of course, the time frame extends out because we're now renovating maybe 30 or 40 units rather than just a single house or a duplex.

But like I said, overall, the strategy is the same. We're taking an underperforming asset and improving it — whether it's through operations management, physical value ads, and doing renovations. That is how we make money in real estate.

Here Are 3 Main Differences

1. Valuation

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With a commercial multi-family property, the property is valued using what's called the income approach. It's all based on — as the name implies — the income the property produces.

So you know how I was talking about how we make money in real estate investing by improving the asset and raising rents? Well, with commercial property, especially an apartment building, if you can raise the rents, you’ll be getting more money for every dollar the property produces because people — other investors and buyers — are willing to pay more for each dollar that property produces.

So more cash flow means more money in my pocket as a seller. This is what we want to do. So whether it's improving rents through renovation, improving our bottom line by optimizing expenses, putting utilities back on the tenants instead of us as the owner absorbing them, there are all sorts of strategies that we can use, but at the end of the day, it's all about improving what's called the NOI — net operating income.

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Now, when we hop over to the residential side with residential real estate, we use the comparable approach. The issue we have with the comparable approach is it relies on other properties in that neighborhood — comparable similar properties that are selling.

And so we compare the property that we have, doing apples-to-apples comparison. So if two houses on the street sold for $400,000, then our property, if it's similar, is likely going to be valued at 400,000 regardless of the rent that it produces.

So within the commercial side, everything is valued based on the income — the NOI — the property produces. Which is good, because for us as investors, if we can improve that NOI, we are rewarded in terms of market value.

On the residential side, we could be charging way more rent. Is the lender going to really care? Not really. What the lender really cares about is the comparable approach — by doing an apples-to-apples comparison. He’s going to be looking at what all the other houses are doing on the street. So that's a huge difference.

If you’re wanting to control the valuation more and really be able to maximize the value of the property, the commercial side with multifamily really wins in this case.

2. Debt

Debt is an extremely important part of real estate. If you have bad debt, it can ruin a great deal. But you can actually make an average deal really great by having good debt.

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There are two unique things about commercial debt which is not found on the residential side:

First, we have interest-only periods, where we don't have to pay the principal of the loan. We just have to pay the interest, which helps improve cash flow. This makes more cash flow available to do the renovations. This will make us the money to improve the NOI. This in turn will raise the valuation of the property. So that extra cash flow is really a big deal if you're implementing a value-add plan over a year, year and a half, or two years. That cash flow can really be valuable for you. So those interest-only periods can really be important.

Second, we have a non-recourse debt. It’s the opposite of recourse debt. But within the commercial real estate world, lenders don't really care about you as a borrower. They just want to make sure you are purchasing a property that can support itself. Because what will happen is, if you default on the loan, the lender will just take your asset (and those assets are very valuable). So they are able to offer non-recourse debt as opposed to recourse debt.

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On the residential side, when it comes to debt, the lender looks at you to support the debt debt payments. In the lender's eyes, you as the borrower come first. Your income, your resources, have to be able to support the property's debt. The lender will, of course, look at the property second. But it doesn't really matter what the property is producing for rent because the lender cares about you. And if you don’t pay your mortgage — if the renters stop and something happens — the lender will come after you and seize your assets. You are on the hook to make the lender whole again. That is called recourse debt.

So if you're looking at acquiring property, try to acquire a commercial property. Take advantage of the interest-only periods in that mortgage. If you're able to structure it that way and then also get non-recourse debt, you're taking that load off your shoulders and placing it on the property.

The lender won’t be looking to you to bear the burden in case things don't work out. There are several advantages to the commercial and multifamily side, just through the nature of commercial financing.

3. Cash Flow

This is the “holy grail” of real estate.

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When we're talking about residential properties, especially one- and two-unit properties (single-family homes and duplexes), cash flow can be extremely tight, especially if you're in a hot real estate market. The rental yield just isn't there. Oftentimes, people end up acquiring properties that are negatively geared. That means they're actually making negative money every month. It can be incredibly challenging to scale your portfolio. Yes, it’s hard to scale.

This is actually what I found when I was trying to get started in real estate investing. I started with single-family homes and duplexes. Scaling was incredibly tough. One, because the lender was looking to you to shoulder the burden and the risk of all those loans put together. But then also, the cash flow is just really tough to get. Property management costs are a lot higher with residential houses. Sometimes you're 12% or 10%, but that gets very expensive.

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On the multi-family side, cashflow is a whole lot stronger. And this is what makes multifamily properties a lot more stable.

CBRE did a study where they looked at all the types of commercial real estate — retail, office, industrial, and multifamily. They found that in economic downturns and recessions, multifamily performed the best. Cash flow is one of the reasons why.

When you have a hundred units (or even 75 or 50 units), we have something called the economies of scale. That means the expense ratio is spread out over many more units. This allows us to collect more cash flow and improves our NOI. Instead of having a property manager manage a single house, now we're having that same property manager manage 100 units.

Obviously, the cost per unit for that management goes down. The cost of insurance goes down per unit when we're in this situation as opposed to a fourplex, triplex, or duplex. And property management fees can be anywhere from 2-4 percent. With these larger properties, we have on-site staff. So that includes full-time management, groundskeeping, a repairman, and leasing staff.

The property supports its full-time staff, as opposed to a single-family portfolio or even a single-family home on its own where you might have a property manager managing 50 other properties. Is a property manager on site every day? No. So could you argue that a full-time staff looking after that specific property will make that property be better run potentially? There's a good argument for that. Will problems be nipped in the bud a whole lot sooner, saving you money? Potentially there is a good argument for that.

So when it comes to cash flow, it’s especially important when we hit choppy markets. As long as you have good cash flow and the market's tanking around you, you can hold that property indefinitely as long as you have the right type of debt on the property.

How to Invest in Both of These Properties

Let's say, right now, you are a high-net worth individual. You have $100,000-200,000 to invest. Where is your money going to go? Is it going to go to the multifamily, commercial real estate side or the residential side? Well, that's a really good question. And I can't make that determination for you but I just want to highlight a couple things to keep in mind.

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First, let's talk about how we actually invest in these vehicles. With residential real estate, oftentimes with a single-family home, duplex, or triplex, you will invest if you don't have the real estate experience. But you're bringing capital to the equation. You're going to enter into what's called a JV or a joint venture. This is really a partnership.

So you're going to enter into a JV which is commonly set up like this: 50 percent of the JV is going to go towards you who's bringing the capital. And then, 50 percent is going to go to the active member managing the deal. This is the person with the real estate experience. You're bringing the capital, and you’re partners in this property.

But this is not passive investing. A lot of people make the mistake of claiming that this is passive investing. You're bringing the money, but in the eyes of the law, you are just as active as that manager. So if something goes wrong in the deal, you are on the hook. It doesn't matter who's active in managing or dealing with the tenants every day. In this type of structure, you are an active participant. So if the deal goes south, you have to keep that in mind. So again, this is not passive investing. It is active in all cases.

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With multifamily, we have something called syndication. In this syndication, what it means is we have active and passive. But it's actually true passive investing.

So we have somebody called the GP — general partner/s who are active. Then we have limited partners who are the LPs. Now here is the way this is structured and how the laws are structured and laid out.

If you're bringing capital as an LP (say you’re just investing money), you are afforded many protections under the law because you are limited in what you're bringing. You're placing your capital at risk in the market just like you would with stocks or with a single-family home.

You're risking your capital in exchange for the potential of a return. The GPs, the real estate experts in this case, are the ones shouldering all the risk. So with the multifamily syndication, you get all the benefits — the cash flow, economies of scale, all the benefits of the debt, how the properties are valued, etc. All this is working for you. Plus you get true passive investing.

So you're doing what you do best on a day-to-day basis as an investor, whether you're a doctor, accountant, lawyer, programmer, or business owner — I could list 50 different things at this point. But if you're earning that high income, putting bread on the table, doing what you do best and you want to make your money work hard for you in a real estate deal, well, you are truly passive in this case.

Plus, with the scale of multifamily, we have something called depreciation. What happens is you get all these tax credits that the government gives you just because you're buying into a larger property. And so you're able to do a whole bunch of work on the accounting side through cost segregation to really save when it comes to tax time.

So this is why a lot of investors enjoy investing in real estate — especially multifamily commercial real estate. Not only is their money earning a strong return, they're also gaining a lot of cash flow. They're also not paying a whole lot of tax, which is half the battle. After all, what counts is what you keep in your pocket and not what you just get in your check.

The Bottom Line

In summary, those are the pros and cons of multi-family versus single-family homes. It's just a different setup in terms of how the properties are valued, the type of debt we can get, the cash flow situation, and how economies of scale work in our favor or against us. If you're just getting started looking at your different options, this should give you a good starting point.