Friday, March 21, 2014

Single Family Home vs. Multi-Unit Rental

In my line of work I come across many people who are investing in real estate or people who want to invest in real estate. The majority of the time, new investors want to get a single family home and rent it out. Aggressive ones may concentrate on single family homes with a basement suite. Now it is my belief that getting involve in real estate investing is great, even if it's starting with single family homes.

If your strategy is holding a property for rent, and you start with single family homes, it will take many properties to make a significant difference in your financial situation. It is still possible and some people have succeeded that way. Many will run out of capital and borrowing power before reaching financial independence however.

My personal rules for rental properties is four-plex or larger; the larger the better. So why is that? There is reason to my madness. Let me explain further.

I had received income and expenses on a few properties I had been working on during the same time I had a few accepted offers in place. I was a little tied down with those, so I presented the income and expenses to two other investors to see if some of those properties was of interest to them. There was about twenty different properties varying from four-plex to 50-unit building. We were sitting around the table running numbers on these properties. I watched both of them pick up and immediately discard the larger properties. When I asked why, they explained it was too big, too risky.

They believe this because they are looking at the price tag attached to it. Is there a difference between purchasing twenty-four single family homes, six four-plex or one 24 unit building? The price might be similar (it probably would be more expensive to purchase twenty four single family homes). But it is my opinion that the 24 unit would be safer and easier to purchase.

Why safer? Well each property would have their own set of expenses; property taxes, utilities, insurance. The expenses per unit would probably be lower in the 24 unit building than for each single family homes. The rent from those properties is the income to cover those expenses. It is true that rent might be slightly higher for a single family home then for a unit in an apartment building that will even out a little the income to expense ratio. But let's look at vacancy. Vacancy is part of the rental market, you will be dealing with vacancy. Between tenants you will have to refresh the property and find a new tenant. There may be a quick turn around, but you will need to deal with vacancy. While you have an empty unit, believe it or not, you still have to pay the expenses on the property. So if you have a vacancy on a single family home, 100% of your income is not coming in and you will still have to pay 100% of the expenses. In a 24 unit building; one vacancy represent 4% of the total income. Can you see how a vacancy will not hurt as much? Therefore making the 24 unit building a safer investment.

When you want to purchase a single family home, before lending you the money the bank will require a down payment (20% for a rental house) and they will be looking at your personal financial situation to ensure you are able to cover the expenses and mortgage payment. That makes purchasing twenty four single family homes a little challenging because before long you will no longer qualify with the banks. When it comes to the 24 unit building, the chances of your personal income being able to cover the expenses and mortgage payment are so low that the bank won't even bother looking at your personal income. They will concentrate on the income of the property itself. Also they will be more willing to allow second position mortgage, lowering the percentage of down payment you will have to provide. So really, what really matters is how good the deal is. I'm no longer limited in how many properties I can procure. Or at least not based on my personal income.