I keep getting asked why I've come to dislike small multi-families (2-4 units) in my area, and I wanted to make a list to see if maybe I'm missing something. I’m not saying small multi’s don’t make sense in other areas, and I’ll readily admit that a lot of my criticisms are derived from my own, personal values/priorities that may be different from others. Also, I should say that I do hae a fourplex and it performs fine. Here are my criticisms in no particular order.
(1)·They are valued on the sales comp approach. It doesn't matter if I do an awesome job of going in, fixing it up, and raising the rents or cutting expenses (thus increasing NOI), the value does not change much. If my bozo neighbors next door decide to sell theirs for a cheap price (maybe due to deferred maintenance or whatever), that's the market price that is used for appraisal purposes and financing. You can probably push the value up a little on your building due to improvements, but you can't ever fully escape the sales comp. approach.
The same is true for SFRs
(2)·They are harder to finance and refinance than SFRs. There are not as many of them so it can be hard to find comps for them to appraise. This also makes them harder to sell. SFRs are generally very easy to refinance due there generally being more available comps.
I would agree there are less comps. But appraisers don't use 100 comps, they just use a few. And there are facets to duplex/fourplex's that can make them easier to finance - the rental income that they will generate. When financing a duplex, for example, an owner-occupant can count the potential (meaning it doesn't even need to be currently rented) from the 2nd unit in the income to debt ratio calculation - one of the biggest, perhaps the biggest, hurdles to getting a home loan.
(3) I think it's harder to find value-add plays. Having directly marketed to both types, you generally get big discounts when there's a lack of symmetry in information. You are more likely to find this in the SFR market than the small multi-family market. That is, sellers of small multi-families tend to be more savvy than sellers of SFRs.
I would clearly agree that owners of small multi-families are more savvy than those of SFRs! haha. But your point is certainly valid, it's much easier to take advantage of the typical uneducated (in terms of real estate), SFR home-owner than it is an owner of a duplex/fourplex - whom most likely bought it because he/she certainly does know a thing or two about real estate, and consequently the market.
(4)·Value plays are essentially done the same way as small SFRs. You basically have to find a dilapidated building, go in and fix it up, and then it will now be worth the retail value what other buildings are selling for. (Again, it's the sales comp. approach) It's not like a commercial apartment building where you can buy, improve the building, and then cash flows improve such that your NOI (and thus value) goes up. Put another way, with a small multifamily, your ability to add value seems limited to buying at a significant enough discount to the retail market. With larger commercials, it seems like it's tied more to your ability to increase NOI, which gives you more creativity and flexibility to improve value. (I'm not sure this is really a point so much as continued gripe of the stupidity of the sales comp approach.)
I think your point is that with more total expense and more total revenue in a larger multi-family building, there is more room for improvement to the bottom line via expense reduction or revenue increase. I would agree with that. However, from a percentage perspective, I don't think it would be all that different.
(5)·You do not get the benefits of economies of scale. Having researched apartments quite a bit lately, your really don’t start to get economies of scale until you can have onsite (or at least full time) management and maintenance. With small multis, you still have to use contractors (which are more expensive than employees) and off-site, fee-based management (typically around 10%).
While I agree you don't get the economies of scale as you would with a large multi, you most definitely get better economies of scale than the SFR. The 4plex owner can send one carpenter to one location to repair one roof that protects 4 income producing units. Try that with an SFR!
(6)·The pool of potential buyers is more limited, which leads to less liquidity. With SFRs, I can sell to an owner-occupied or investors. With small multis, it’s generally just investors, who tend to be more savvy.
Can't argue with that :-) I wonder though; which pool is greater - the pool of investors looking for SFRs, or the poos of investors looking for 2plex and 4plex's?
(7)·I think people drastically underestimate the management headaches of small multis. As soon as people are sharing walls, there is eventually going to be drama. You don’t have this as much with SFRs
I agree. I do contend, however, that management headaches are 90% a result of your tenant selection - and not so much down too the circumstances of the property. And while sharing walls is negative for tenants, it's a positive to your expenses in the same way the aforementioned 1 roof for 4 units is :)
(8)·For the fourplexes in my area, the tenants tend to be of a lower socio-economic status and thus cannot absorb rent increases as well as my SFR renters. @Ben Leybovich wrote a great blog on the problem of stagnant wages and rents that I found to be very insightful.
They are certainly poorer on avg compared to the SFR probably. But a lot of great tenants are poor - students, for example. You just need the right location. And if your tenant cant afford the rent increase, get a new tenant! As for stagnant/decreasing wages; I don't see that as an issue. As long as you're in a desirable location, as one renter pool gets poorer, so will the one above it and thus enter your market and replace those exiting it. That is to say, as Joe at the tire shop becomes unable to afford your place, Chip the attorney is looking for a place to save money...
(9) A corollary to the above point is that, particularly for fourplexes, many times the landlord has to pay water. Water rates have gone up quite a bit in my area, and I expect they will continue to do so. (Fortunately, with my fourplex, the water is tenant paid.) Stagnant rents and increased expenses are not a good combination, in my opinion.
A sound point. But this is something that is priced into the rents.
(10)·Living next door to your tenants is horrible idea. I see people talking about buying a small multi and then living in one of the units. These are almost universally people with no landlording experience and I think they underestimate the stresses/annoyances of living next door to their tenants.
I have no experience with this, but I don't think you do either. I think my fears are the same as yours. Regardless, it again comes down to tenant selection. That will overwhelmingly determine whether or not you have good experience.
(11)·I don't see generally much if any discount on them on the MLS compared to SFRs. I can buy a $100,000 house that rents for $1000/month or a $200,000 duplex that rents for $2,000. (the numbers are little better for fourplexes but not enough to justify the management headache) The maintenance costs and square footage are about the same (and duplexes around here are not even two story such that you would have a smaller roofing cost). If I'm inclined to pay retail, as some investors are, why wouldn't I buy the house (with less management headache and broader selling pool) than the duplex?
All your points are valid, I don't mean to attack you - merely just to present the other side of the coin :)
Patrick K.
