Passive Investor Series Part 4: Scaling

There is often a debate as to whether an investor should invest in single family homes or multifamilies. When considering scaling a real estate portfolio, there are several reasons I believe multifamily investments are superior to single family, however, I will focus on one primary reason: Scaling.

Recently, I had a discussion with some aspiring syndicators and asked them why they want to syndicate deals. The overwhelming majority expressed their motivation to syndicate was to scale. What does it mean to scale? What are the advantages of scaling?

Scaling is the ability to exponentially grow your business or portfolio. In real estate, this could mean growing your portfolio from one property to two. Or from 10 properties to 50. When scaling through syndication, this allows the active and passive investor to efficiently grow their portfolios without the same capital resources and sweat equity required compared to going at it alone. This is because each investor is able to pool resources together to acquire the property.

Let’s take an example of a recent deal:

Prefered Return (Pref): 8%

Cash-on-cash Return: 9%

IRR: 17%

Invested Amount: $100,000

With this deal, there were 9 months in the first year with no distributions due to the need to stabilize the property, hence, the lower distribution for that period. Over 5 years, however, the cash flow totalled $49,343, which is an average of $9,868 per year.

Back when we were purchasing smaller multifamily properties in a prior life, our goal was to cash flow at least $150 per unit. So, an annual cash flow of $9,868 is equivalent to owning a property with 5.48 units ($9,868 / $150 / 12 months). What this means is by investing $100,000, the passive investor can receive cash flow equal to owning a property with 5.48 units or a purchase price of $18,248 per unit ($100,000 / 5.48 units).

Purchasing a property at this price per unit without a syndication is difficult to find and more than likely will entail a distressed property needing a lot of major rehab and may not be in the most desirable locations. However, in the case of a syndication, you are purchasing a value-add property that is going to be in better condition and likely not as distressed. The added bonus is you don’t need to do any work or put in any more capital to rehab and stabilize the property.

If an investor purchases a single family home for $100,000, then there is only one tenant and one source of cash flow. The investor will have to be all-in (including purchase and rehab) on the investment at $100,000 and have a goal to cash flow the property at least $822/month to match the investment in the syndication. Not impossible, but it will be much more work to accomplish.

Another issue to consider is if/when the tenant of the single family home moves out, then your vacancy immediately goes to 100%. By scaling into multifamily, one tenant leaving is not going to completely deplete your cash flow.

For the reasons outlined above, scaling through syndications may be a superior way to invest, especially as a passive investment. As a passive investor, you are able to diversify into many different markets and locations, enjoy solid passive income, and have the benefits of ownership such as tax benefits. Your investing dollar goes much further through the scaling and pooling of the funds.