With so many real estate asset classes, which one is the best? As a real estate investor, choosing the right asset class is very important. This article will go over the pros and cons of owning single-family homes as opposed to multi-family or apartment buildings. We will be looking at these asset classes as long term investments (buy and holds, 1 year plus).
SINGLE-FAMILY HOMES
Single-family homes make up 80% of all properties in the United States, and owning a detached house is the staple of the American dream. Because of the abundance of these properties, there are more opportunities to find great deals. As an investment property, single-family homes have many advantages and maybe the right asset class for some people.
Pros
– Pride of Ownership. Good tenants usually take better care of this type of property than if they are living in an apartment building because a single-family property feels more like home.
– Families as Tenants. It’s no surprise that families who are renting would prefer to live in a single-family home. Families tend to stay longer in the properties, usually raising a family in them. You wouldn’t have to worry so much about vacancy to the property.
– Easiest to Resell. Because of the abundance and demand of this type of property, selling the property after owning it a few years is easy. There is the largest buyer pool for single-family homes, you can sell it to a future homeowner or an investor.
– Appreciation. While appreciation may happen if you purchase in the right market, it can also go the other way in a bad market. In general, property value usually rises over time.
Cons
– Management Logistics. Owning one single-family investment property close to where you live (if you self manages it) isn’t bad, but when you start buying multiple properties across town, getting from house to house can become a hassle.
– Property Taxes & Insurance. Owning multiple houses means you need to pay property tax and insurance for each house. Some higher property tax states such as New Jersey make it harder to cash flow on single-family homes.
– Capital Expenditures. More houses mean more things can go wrong to properties and maintenance (snow removal, lawn care, etc)
– No Rent when Vacant. When the tenants do decide to move, the property generates no rent. This can be especially painful if you rely on the rent to make the mortgage payments.
MULTI-FAMILY HOMES
Multi-family properties are great investments for many people looking to maximize cash flow. Two to four-family properties are desirable for investors due to many efficiencies and cost savings over single families.
Pros
– Multiple Tenants. Multi-family means more tenants under one roof and higher rent potential per property. This makes managing the property and tenants easier than single-family properties because they are all in one place.
– Fewer Repairs. There may be fewer repairs that need to be made compared to single families (ie. fewer roofs)
– House Hacking. A popular method of owning investment properties is buying a multi-family, living in one unit and renting out the rest. This is a great way to get started investing and being a landlord because tenants help pay the mortgage and subsidize your living expenses. There are also more financing options if a property is owner-occupied.
– Easy to Resell. Similar to single-family properties, multi-family properties are fairly easy to sell, especially to investors.
– Higher Income Potential. There are more options to add value to a property compared to single-family properties; Partitioning rooms, adding storage space and washer dryers are some ways to increase the property’s rent potential.
Cons
– Higher Vacancy. Tenants are less likely to treat the house as a home, which may lead to a more frequent vacancy to the property compared to single-family properties.
– Higher Maintenance. Because tenants share the property with other tenants, they are less likely to maintain the property (especially in common areas) as well as single-family properties.
– Possibility of Conflicts. Living with others under the same roof does have some drawbacks; some tenants are noisy, while others are disrespectful. Bad tenants can cause good tenants not to want to live in the property.
APARTMENT BUILDINGS
Apartment building is a type of commercial property with five or more units, sometimes as much as several hundred units, all under a single roof. Apartment buildings are much more complicated compared to single-family and multi-family properties. Because of this, apartment buildings usually require a good operator and team who can manage the asset like a business.
Pros
– Highest Income Potential. Apartment buildings with a large number of units make this a great asset to generate cashflow and good return on investment.
– Economy of Scale. A large number of units in a single building makes things cheaper. Property management fees are generally lower. Some larger properties can even support an on-site property manager to best serve the tenants.
– Value Least Affected by Market Changes. As previously mentioned, the value of a commercial property is based on the income it can generate. As long as the asset is performing well, there will be no loss of value of the whole asset even if the real estate market makes a turn for the worst. This makes apartment buildings a great asset to maintain and grow wealth.
– Highest Potential for Value Add and Gains. Unlike single-family or multi-family properties, where value is determined by comparable sold properties, commercial property’s valuation is based on the income the asset can generate. Identifying underperforming & mismanaged properties and correcting them can drastically increase the overall value of the asset. A well-executed business plan can potentially increase the equity of the asset by millions of dollars.
Cons
– Complex Asset. To run an apartment building well, good systems and a good team is a must. A professional operation helps minimize unnecessary risks to ensure tenants are taken care of at the highest level.
– Limited Buyer on Resell. Apartment buildings are considered the most illiquid of the three assets. They generally take the longest to resell, and the buyers are usually another investor (not a homeowner), limiting the buyer pool.
– Higher Turnover. Apartments generally have higher turnover compared to single-family or multi-family properties. However, vacancy for apartments is factored into expenses of the building based on normal vacancy rates of the city it’s in.
– Capital Required to Purchase. Apartment buildings, depending on the size, will require the most money to purchase. While single-family and multi-family are usually purchased and owned by individual investors, an apartment building is usually purchased by a group of investors (called syndication).
Conclusion
Which asset type is right for you? A great way to know is to review your own investment goals to see which strategy fits your goals the best. Single-family and multi-family properties are the easiest to understand and easiest to get started, while apartment buildings are more complex with higher income and wealth potentials. Hopefully, the breakdown of the pros and cons of these assets will give you better insight as to which type of asset is suited for you.
To learn about passively investing in real estate, read Passive vs Active Investments.