I would love to hear arguments for both. I just got back from an rei meeting and listed to a couple of guys tell me that 4 plexes and bigger is the way to go. My eyes were definitely opened tonight! I know the 2% rule for single families, does that apply to 4 plexes too? I would love to hear formulas, arguments, pros and cons, and success or failure stories from both. Mike, you wanna go first? :biggrin
I’m not a true fan of 2-4 units. They tend to be a hybrid - not SFR and not a real apartment and often getting the worst of both.
The advantages of SFR is there are lots of them, financing is relatively easy, and they are more forgiving if you make a mistake. Their long-term profitability is more tied to how the rest of the market goes, so you can make a profit even if you don’t do a lot.
Their negatives are they are just 1 unit - so if you have a vacancy you have 100% vacancies. Generally they are much more difficult to buy to get a good, positive cash flow. Your profit is based on the overall market - so you can do a lot of things that theoretically would make you property more valuably - but if subjectively buyers don’t like what you did, or the market goes bad - you make no profit.
Multi families - have advantages that they are recognized as a pure investment and their value is mostly due to their income/expense/cash flow situation. So just by being a better manager you can increase rents, decrease expenses and vastly increase the value of the property with no extra outlay. They also have the advantage of economies of scale - your vacancy rate will be more stable. Because you are talking about replacing 20 sinks you can get them cheaper than replacing just 1. Management for 50 units generally is less proportionately than it is for a SFR. However - overall, multifamilies are much more profitable - unti-for-unit, then SFRs
Multifamily disadvanteges: There are fewer of them than SFRs, so finding a good deal takes more searching over a wider area. Financing is often more difficult. While there are a number of motivated sellers, there is also a higher ratio of sellers who are more sophisticated than a typical SFR seller. Transactions are much more complicated and are much more dependent on local laws, zoning, tax consequences, landlord/tenant responsibilities, rent control and the like so you have a much greater need for having a talented and reliable team (attorney/CPA) to help you with the intracacies.
Apartments are generally not for the inexperienced. It normally is better to buy a few SFRs first so you learn, make a few mistakes when they don’t hurt so bad, and build a war chest, before tackling something bigger.
I own SFH, as well as 3 families, and looked into purchasing 6 units and up.
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SFH’s cash flow poorly in expensive high appreciation areas. Have a rental with FMV or $425K, and FM rent is around $2,200/month. Taxes are high. I cash flow on it only because I bought it over 20 years ago for $70K, and owe less than $50K on it.
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Here in NYC, I find I can run 3-4 familes like a SFH. They generally have one driveway, and I got the guy renting the garage and driveway do snow removal. I got another tenant handling the garbage for $50 discount on rent each month. What I like about it is when a tenant moves from a 3-family, it’s 33% vacancy instead of 100%.
A nice thing about them is you can get low cost, straight line, self amortizing, 30 year mortgages, even at investor rates, about .5% more.
Another advantage is neighborhoods in 2-3 family zones are predominently middle class, white collar, professional, legal residents, unlike the neighborhoods where 6-8 units are found. I have better tenants, with less hassles. In fact, had a Harvard MBA investment banker once as a tenant, and another who’s a writer of a local newspaper column.
Tax rates in NYC for 1-4 families are lower, with caps on rate increases. Commercial properties does not enjoy this advantage.
- Looked into 5-units and up. There’s loads of 6-8 families around here. The big problem in NYC is they’re under rent control. But this is not the only problem I find with them. I have to get a commercial mortgage, at higher rates, with shorter amortization, which cuts into cash flow tremendously. As I mentioned, tax rates are higher, with no annual caps. But even if I got one at a good price, another issue is most are built with central heating systems, and heat costs more with large stairwells and hallways, unlike garden apartment designs in suburban settings. Also, by it’s nature, it is necessary to have a tenant to work as the “manager” as it is more management intensive compared to 3-4 families, where I can get away with paying a tenant $50/month to handle the garbage… The rent discount generally runs 50% or more for 6 to 8 units for the hassles, so for rental units that runs $1000/month, that’s costing me $500/month for the building manager alone.
In addition, you risk lawsuits on “workman’s comp” and most owners don’t carry workman’s comp for tenant-managers. And I find the quality of the work to be poor in many cases, with the tenant-manager taking the discount, and doing little or no work in return. The main reaons is many of them hold two or more jobs, you’re the 3rd job, so they have NO TIME left to do work for you. Fire the guy, and you’ll get someone else just as bad, or worse.
On top of that, many of them would buy supplies, such as paint, cement etc., charge it to you, and then do side jobs in the neighborhood, CHEAP, with your supplies. My dad, who owns a commercial property, loves to hire the “superintendent” of the buliding across the street to paint, since he’s only paying for the labor - the paint is FREE.
My dad owned a business for many years in such an area, and his customers, mostly tenants of 6-8 unit buildings, would complain about managers letting garbage pile up, not cleaning up the snow, never sweeping the stairwells and sidewalks, which contributes to the undesireabilty of living in these areas. When I walk thru such areas, they STINK, and I get a headache. The only decent ones are ones where the owners lives in them themselves, but nowadays, they’re owned mainly by immigrant investors.
These areas are today populated mostly by lower blue collar immigrants, many illegal, many new arrivals, and you’ll need a tenant-manager that also speaks the language, such as Spanish, Russian, Greek or whatever. Some of them, retain there local customs. For instance, it is common for new arrivals from China to spit on the ground. Imagine if your manager doesn’t clean up?? If someons is behind on the rent, and I don’t speak Russian, I’ll have to get the tenant manager to go speak with them. Can I count on him to yell at the tenant, or to tell the tenant the greedy owner is an @sshole instead??
So the downside to the 6-8 units is the manager’s cost, the higher interest, amortization, higher heating costs, taxes, and management issues. PLUS the lower quality tenants that generally live in these units.
Just do the math, you’ll see I wind up paying some manager of a 6-family $500/month just to haul out the garbage, with him doing little else, compared to the $50/month I’m paying at a 3-family.
- With economy of scale, only buildings with 20 or more units can one utilize the services of a “property manager”, and on site workers more effectively. Below 20 units, it is uneconomic to pay 10% for a property manger, PLUS have someone ON SITE cleaning the sidewalks, haul out the garbage, handle tenats that locked themselves out etc.
In other words, beyond 20 units, the economy of scale offsets many of the negative issues.
Disclaimer: if anyone is offended by honesty and straight talk, please don’t read my post. It is not politically correct and could offend some people.
Jared,
I like both and own many of both. SFHs are by far the best way to start because they are more forgiving. There are millions of homeowners in the USA and therefore it is relatively easy to sell a SFH if you decide that landlording isn’t for you. In SFHs, the tenants are at the highest level of the tenant food chain and therefore it is an easier transition from being a naive, middle-class citizen to being a landlord. This transition can be quite a shock for a normal, honest, middle class person who hasn’t been previously exposed to all the drama; drugs; lying; whoring; and filth of the lower class. It was a shock for me! Just yesterday, I had a tenant that is being setout on Thursday act in a threatening and strange manner. You don’t get much of that in middle class America.
In my experience, it is also much easier to find SFHs that will cash flow than multi-family properties and SFHs generally appreciate much better than multis. Of course, if you have a goal to make X dollars of cash flow from your rentals, you’ll have to buy a lot more SFHs than multis to meet your goal.
Multis have the advantage of economy of scale. In other words, you can get a better bang for your buck. However, that is offset by the lower class of tenants in multis. Tenants in low income apartment buildings are only one rung above the homeless and they frequently act like it. The biggest challenge I have with my multis is finding qualified tenants. I get 30-40 calls every day from people looking for apartments, but it can still take 2-4 weeks (or more) to find a tenant that meets my standards (which aren’t that high). There is so much crime; drug abuse; alcoholism; filth; and other stupidity among this group that is can be difficult to find suitable tenants. Then, once you get them in, there can be a lot of tension between tenants because they are living in close proximity. In other words, the management issues with multis are many times worse than with SFHs. You also generally have more turnover and more damage and trash when they leave.
Yesterday I was cleaning out the apartment of a tenant who suddenly left, without notice. My mission was to clean out a large walk-in closet and remove all the carpet from the apartment (all ruined). The closet was so full of trash that it took an entire pickup truck and half of a 10-foot trailer to hold the contents of just the closet! In addition, one of the trash bags leaked something on me when I was carrying the stuff out to the truck. It was so bad, that when I was at the dump, the Waste Management employee said “you stink”. When a man that works in garbage all day says “you stink” - YOU REALLY STINK!
One other thing that I’ve discovered is that these low income tenants are all looking for a way to win the landlord lottery. Many (most) of them are too lazy to work and their entire hope for the future rests on hitting the mega lottery or the landlord lottery. If they get hurt in any way (and sometimes even when they don’t), they want to sue you in hopes of getting rich. I’ve got a tenant right now, that tripped over a bunch of junk that she had on her steps and sprained her ankle. I haven’t received anything from her lawyer yet, but I know that she has contacted one of those low-life scumbag contingency lawyers from TV. All of that nonsense is a normal part of the world of multi-family rentals.
Finally, all the same purchase rules that apply to SFHs apply to multis. Expenses are still 45% to 50%; the 2% rule still applies; and you MUST still do a cash flow analysis.
Good Luck,
Mike
Thank you three for your input. I think for me when I start building my rental empire it will be with single families at first. I feel the quality of tenant will be a little more to my liking and something I can handle a little easier than a multi unit. Let me get a few under my belt before I tackle a 4 plex. I was shocked by your straight talk Mike! Never have I heard such filth!! LOL Thanks guys. :biggrin
I’ve owned a couple duplexes for a while now, and had a 6unit building for about a year.
In my area, I can get a duplex for cheaper than the same square footage SFH. Each unit in a duplex can pay the mortgage/insurance/taxes by itself, so having 50% vacant doesn’t put you in the red.
I used land contracts to finance all my purchases, but have either paid them off or transfered to mortgages at this point. 1-4 unit properties are great since you can still use a regular mortgage to cover them.
I haven’t owned any SFHs… so I guess I’m not the best person to compare them, but I would probably buy a 2-4 unit building over a SFH.
cant you get different rents when using 50% and the 2% rule?
I mean by using the 50% on 100k mortgage you would have to get roughly 1,533 in rent per month, where as using the 2% rule you should get $2,000 per month
I am confused… what I am missing here? :help
Gee I never had any of those things happen in my commercial properties.
Ahhh, the memories…
The fights, the stink, the trips to the dump, the clean outs, the cat piss infested carpets, the mentally ill tenants, the concealed weapon carry permit, the evictions, the lawsuits…
I can’t understand why I got into commercial properties when I had all that fun in residential???
Oops, just remembered…CAUSE IT SUCKED!!!
BUT…without those pain in my *ss residential rentals, the commercial stuff would have taken me a lot longer to get to. So listen to Mike’s advice and you can make money.
phatman,
The 2% rule is a screening tool. You still need to run a cash flow analysis (using the 50% rule) to determine that the cash flow is as desired.
Mike
Mike,
I hope you drink, at least occasionally.
Hmm Mike, it sounds like you could really use a property manager, no? 
Hmm Mike, it sounds like you could really use a property manager, no?
What would a property manager do for me, other than take a bunch of my profit and overcharge me for repairs? If I did have a manager, exactly what would I do with my day? I only work 3-4 hours a day, 3-4 days each week now and I don’t like soap operas.
Pay a property manager? NO THANKS!
Mike
Jared,
Pick up Mike Butler’s book, Landlording On Autopilot.
Debates this issue very well…SFH hands down favorite.
With Propertymanager’s book…and Butler’s…you’re off to a running start as far as building your rental portfolio…especially combined with your rehab experience. [I should qualify that…for a rental you’ll want a much more bare-bones approach with regard to how much you expend on rehab cost]
-Mike
P.S. Butler has a well-contrived systemized approach to accumulation of wealth thru SFH portfolio
In my area, it will be very difficult to find SFHs that cash flow. Even multis are hard to come by.
Scott
Scott,
In EVERY area, it is hard to find SFHs or multis that will cash flow correctly. What have YOU done to find good deals?
Mike
I know i’ve asked this question before, but do not think I had ever got a response.
How do you factor in closing costs to your cash flow analysis and/or decision to buy a rental SFH?
Obviously not enough!!
Phatman,
Just include the closing costs in the acquisition cost of the property (purchase price + rehab cost + closing costs). Then, use this number for your cash flow analysis.
Mike