The difference between buying a single-family and a multi-family property.
Most people eager to become real estate investors start with what they know: single-family homes. These are properties that house one family, and are usually in a form of a detached house, a townhouse, or a condo. This is usually the most obvious choice of purchase as the investor almost always already owns their home. Although this is a good start, most quickly realise that long-term wealth building lies in multi-family properties. This is assuming one wants to invest in residential properties, as there are many other choices that will not be considered here such as land and rent-to-own.
The biggest risk that I’m uncomfortable with when investing in single-family homes is that if there’s one vacancy, it’s a 100% vacancy. And although we’ve done our homework, purchased in the right neighbourhood and upgraded the apartment, you never know what forces hit the market (ex. winter time is the worst time to try to find a tenant), and the next thing you know your property is sitting empty for 3 months in a row. That means you have absolutely no income for 3 months in a row. Now for someone that’s been hardly breaking even and has no reserve fund, this means that the mortgage payment is coming out of your own pocket.
Of course, there are other reasons why single-family homes are not my favourite form of real estate:
- Other than putting a lot of renovation money into the place, and hoping someone has the same taste as you, you have no control of the value of the property, and it is very susceptible to market lows and highs.
- Most big banks have a cap on the number of “residential properties” you can buy, which are less than five apartments in one building. This cap ranges between four and six.
- Property management fees can get expensive, and most often the rents don’t cover management fees.
To balance things out, here are reasons why multi-family properties (for example a 12-unit building) are more suitable for a serious long-term real estate investor:
- One vacancy in a 12-apartment building for 3 months means an 2% vacancy, and the rent from the rest of the apartments can usually cover a vacancy or two for at least one month – so you don’t end up paying out of your pocket.
- Less expenses – it’s cheaper to fix one roof over 12 apartments, rather than 12 roofs over 12 houses.
- Less property management fees – property management companies usually charge a fee based on a percent of rent collected, and the bigger the building, the less the fee.
- The value of the building is directly related to the income it generates – this ratio is called the cap rate, where Cap Rate = Net Operating Income/Price (value). Thus, increasing the rents and decreasing the expenses automatically improves the value of the building. Whereas, no matter how efficiently run your single-family property is, it will be hard to sell it unless someone A) can afford it and B) falls in love with it. This is precisely why multi-family properties have proven their resilience during recessions.
- The rental pool is always larger than the buyer’s pool. Demographics favour multi-family properties, as immigration into cities boosts the demand for rental accommodation.
- Limited supply – when is the last time you have heard of a developer building an apartment building? Most developers today focus on condo developments or conversions. That means not only that there are no new apartments built, but that some of the current buildings are being converted into condo and sold off individually.
- Multi-family Construction Leading the Way (buyfixrent.wordpress.com)
- 2011 real estate market showcases regional variation (myfraserheights.info)
- What is considered a single family dwelling (wiki.answers.com)