How to Scale From A Single-Family Investor to Multifamily Investor
We have to work our way up - isn't this what we are told? Why would it be any different in Real Estate? Wouldn't it make sense that if your goal is to own an apartment with many doors one day, shouldn't you own a house first, with just one door? Most real estate investors start out investing in single-family homes. Whether you go for the flips, rent out properties as you outgrow them, or scope out rentals in hot markets doesn't matter. The reason most likely is you can pull off doing single family as a one-man band. If you pay attention at all to the world of multifamily syndication, you'll hear it is a team sport. But there comes the point where you're ready to level up to multifamily investments, and maybe you just need a roadmap to do it.
So maybe you have a few single-family houses, and you’ve scaled to your max in residential properties. With all your time, energy, and money tied up in your existing rental properties, it might seem daunting or downright impossible to imagine owning multifamily housing as well.
You can move from single-family rentals to multifamily real estate, but going in, you should be aware of some critical differences. In this article, you'll learn the advantages and disadvantages of each type of real estate investment. You will also learn why it's essential to understand how both single-family properties and commercial properties are valued. Finally, a few different methods you might use to transition from single-family rentals to apartment buildings.
The Advantages Of Owning Single-Family Rental Real Estate
Single-family is considered the introductory route for novice investors. Anyone who has gone through buying a home can identify what it would take to do it again but have it as an investment property. Heck, that is the route I took. I bought my first place intending to live there, and then life took a left turn, and I decided to rent it out. Now I learned many lessons the hard way, but it was very profitable, even really not knowing what I was doing.
Financing for single-family real estate investments is easy to access, and the purchase process is pretty familiar because, as I say, maybe you have already bought a home. You can obtain up to ten loans for residential real estate based on your credit and income, just like any other personal financial deal. You can easily purchase a single-family rental property with a low down payment, a bank loan, private financing, or even 100% cash.
Another advantage to single-family real estate investments is the various exit options. You can sell it at retail, do a lease-to-own deal with your tenants, sell it to an investor, or hold and rent it out. On top of that, you can buy one single-family rental at a time or vary the property management companies used, allowing you to diversify intentionally.
Your real estate portfolio of single-family rental homes consists of various ages and styles of single-family homes. Some large and some small, some older buildings, some newer buildings, and you use three different property management firms to help you handle them all. It seems like you’ve diversified as much as possible, and you’ve probably learned some great lessons along the way! So, let’s assume that over the past ten years, you’ve purchased a single-family home every two years in varying neighborhoods and cities within a metroplex.
So what might be some disadvantages of owning single-family investment properties like this?
The Disadvantages Of Owning Single-Family Rental Real Estate
With rental real estate, when things are good, they are fantastic, and when things get rough, they can become real bad real quick. So, consider this, the more roofs you own, the greater likelihood of needing to replace one (or more) of those roofs. The more doors you own, the more water heaters, air conditioning systems, and basements or attics you own. For this reason, CapEx (capital expenditures) can be high.
Furthermore, each property carries its own insurance, tenant lease, warranties, taxes, and management fees; plus, you must maintain bookkeeping for EACH property! I’m sure you can see how this might get out of hand quickly if you aren’t super organized or if you don’t have help with the record-keeping portion of these investments.
When it comes to expanding your investment strategy with single-family real estate, you’ll discover there are a couple of little-known or little-considered hindrances that will curb your ability to increase your number of rental units. For one, there is a cap on the number of conventional loans a single person can have on their credit. You can circumvent this for a while if your spouse is on board because each of you can have ten loans, giving you up to 20 loans total, but then what? You’ll reach a point where you can’t expand further.
The other hindrance that we’ve all probably faced when trying to sell personal residential real estate is that the value of your property is determined by the value of the neighbors’ property. Sure, you can make improvements in your single-family home, but “comps,” as they’re commonly referred to, are usually the most significant determining factor of property values in single-family rentals. Unfortunately, with single-family real estate, you can raise rent and reduce expenses, but that does not change the value of your property.
The Advantages Of Owning Multifamily Rental Real Estate
As you look to level up from single-family rentals, there are, of course, advantages and disadvantages of owning multifamily real estate too. So, you might be wondering, what is the biggest difference between multifamily investing from single-family real estate investing?
One noticeable difference is that a multifamily real estate deal can transfer ownership of multiple units in a single transaction. For instance, if you purchased a 40 unit apartment with a single transaction, you are buying 40 doors but still have one tax bill, one insurance bill, one round of due diligence, one roof, and one set of docs to sign. Alternatively, with 40 single-family homes, you have 40 tax bills, 40 insurance bills, 40 rounds of due diligence, 40 roofs, and 40 sets of docs.
Whereas you probably have a file cabinet full of documentation for those five properties we were talking about earlier, the purchase of 2-20 (or more!) units all at once would significantly cut down on paperwork.
Perhaps the most significant difference is diversification. If you have a 100 unit building, and one of your tenants decides to leave, you are 1% vacant. If one of your tenants leaves any one of your single-family houses, that house is 100% vacant. It would take a portfolio of 100 homes to match that diversification. That is a lot of roofs, tax, and insurance bills, etc.
Similarly, since each multifamily property contains several units, it's easier to form and leverage a team. A contractor, broker, property manager, and other service-oriented trades will jump at the chance to have a multifamily property owner as their client. Conversely, it's much harder to find reliable help on each single-family property.
Perhaps the most significant advantage of owning multifamily rental real estate is your ability to control the property’s value. The value of a commercial building is based on the amount of income it creates, so your rental income directly relates to the property value. In short, the value is determined by dividing your net operating income (NOI, total revenue - total expenses) by the cap rate.
With multifamily real estate, you can increase rents, decrease expenses, and directly impact (increase) the value of your commercial property. You can assert control over the value by reducing costs, capturing efficiencies, and adding income streams to the property. These value-increasing opportunities might look like installing waste-reducing shower heads in the units, energy-efficient bulbs in all light fixtures, and providing paid lock-box options for residents. And although turnkey single-family homes do offer a form of passive income, you can become more passive by investing in a real estate syndication and adding the scale by investing into assets like large apartment buildings.
If you are not keen on getting phone calls about a plugged-up toilet as you are about to sit down at the dinner table, syndications are the cream of the Multifamily Crop. The economics of scale with apartment syndications allow for hiring professional third-party property management to take all headaches of managing off our plate. I dealt with an angry tenant in a single-family rental once who threatened my partner's life. I am not sure I want that hands-on, face-to-face experience any longer. I am sure; I don't.
The Disadvantages Of Owning Multifamily Rental Real Estate
On the flip side, yes, there are disadvantages to owning multifamily real estate, and most of them are in direct opposition to the advantages of owning single-family real estate.
Perhaps the most considerable disadvantage to owning multifamily rental real estate as an investment is that you have limited exits. Not just any person on the street will be willing (or even able to) purchase the property. Your sale will likely be restricted to other investors or corporations.
Some other disadvantages have to do with the diversity of markets and property managers. If you own a single property with 50 doors, you aren’t diversified in either the market or property management. You have all your eggs in one basket. *This is where syndications help because you can own a percentage of several multifamily properties instead of a single, multi-unit property.
Another challenge to owning multifamily property lies in obtaining financing. Generally, multifamily properties have a heftier price tag, and your standard lenders cannot finance that large of a loan on your credit. You'll likely need partner investors and intentionally establish a solid track record of positive credit history as an LLC before you qualify to finance the purchase of a multifamily property.
Several of the disadvantages above filter down to one single, essential foundation of successfully owning multifamily rental property, and that is your tenant base quality. A high-quality tenant base who consistently pays rent on time, cares about the property and remains loyal long-term will boost your odds of being profitable and your chances of significantly increasing the property value.
How To Transition From Single-Family to Multifamily Rental Real Estate
Multifamily investing is the key to reaching that next tier of wealth, freedom, and experience. It will be challenging to scale to that level if you seek real wealth, no matter how many good deals you can find. For many people, the next step from owning a single-family is doubling up and purchasing a duplex. There are a few ways to do this, but the most common is "Stacking" and "Leverage."
One gradual, potentially safe-feeling way to level up is to “stack” your real estate investments, doubling the number of doors you purchase with each transaction. In stacking, you start with a single-family home and suppose you buy another piece of real estate every two years. In just ten years (in the blink of an eye), you’d own 31 units! Well, every two years, instead of purchasing another single-family home, you buy a duplex, and then a quad, and then an 8-plex, and so on.
Joint Venturing is another excellent way to get into the world of commercial real estate. It won't be easy to sign on the loan when you are starting without any loan experience. You may then seek to partner with someone who has that loan experience. If they have the loan experience, chances are they will have operational experience as well. You are also increasing your purchasing power if you both bring the capital, and this may allow you to get into nicer, higher-priced assets. This also may reduce your risk if your loan amount exceeds $1M. In excess of $1M, loans can qualify as non-recourse debt, which means the lender cannot come after you personally.
Syndication option 1 is to leverage your earnings from your single-family investments into a multifamily real estate syndication deal. If you own five single-family properties, and each one cash flow $200 per month, you have $12,000 each year to funnel toward a syndication opportunity. Since the typical minimum on a syndication deal is about $50,000, you’ll quickly achieve that in less than five years, even with capital expenditures and maintenance on your five properties!
Syndication option 2 is to use your retirement account. I partnered on two duplexes by taking $110,000 out of my solo 401k. After making improvements and holding for 5 years, I exited with $250,000. While I profited pretty well, those properties gave me so many headaches that I decided to take all of it and passively invest in 5 different syndications. These are all still growing in my 401k today.
Syndication option 3 is doing a 1031 exchange out of your single-family either into your small apartment or doing tenants in common (TIC Structure) into syndications. A 1031 exchange refers to section 1031 in the IRS tax code that allows investors to sell investment real estate, then buy replacement "like-kind" property with little to no tax liability resulting from the gain. In a TIC structure, two or more people/entities can own separate shares of the same real property. Each person holds an individual undivided ownership interest, which helps satisfy rules and accept 1031 funds into the project. This structure is complex, but have no fear as the syndications attorney, and a qualified 1031 agent can handle the details.
When you invest a sizable amount, it is exciting to see the generous amounts of passive cash flow you can earn. We recently had an investor who built up a lot of equity in a single-family residence in a West Coast market and ended up 1031 exchanging his proceeds for an apartment syndication located in Houston, Texas. Now he'll have himself a hefty income stream of $75,000 a year, plus he will share in the profits at the sale and have the option to do another 1031.
Is Becoming A Multifamily Millionaire In Your Cards?
Most believe the path to financial independence in real estate begins with single-family properties. I don't think this is necessarily true, and if multifamily is ultimately your goal, why learn one asset class only if you need to know an entirely different one? Not to mention building a completely new team and a new network. With my experience in single-family rentals and multifamily deals, I'd always advise you to take a step back and look at your goals. Why are you investing? Does it make sense for you to own and manage 31 doors over five properties personally? Does it make sense for you to be more hands-off and collect disbursements without being a landlord?
Any choice is a great one because you’re choosing your personal, family, and financial goals over everything else and using real estate investments to help you get there. If you’re interested in learning more about syndications because the “Leverage” route sounds interesting to you, you’re invited to join the Fortress Federation Investor Club.
Inside, you’ll learn all the nitty-gritty details about real estate syndication deals, learn everything you need to embark upon your first syndication deal, and meet other fellow investors like yourself. We look forward to helping you learn how real estate syndications can help you achieve your investment goals!