Someone considering entering the real estate investment industry may wonder which property types offer the lowest risks and greatest return on investment. While there are many asset types, rental property investors typically sort all the opportunities into either commercial or residential properties. Residential rental assets can be further divided into two main groups—single-family or multi-family homes, such as duplexes, apartment buildings, multiplex housing, and townhomes or condos.
For those who have decided that residential rentals are best-fit for personal risk tolerance and financial goals, the next step is deciding whether to build a portfolio with single-family homes or multi-family properties.
Making that decision may be easier by looking at a depreciation schedule for a rental property, as well as a side-by-side comparison of the advantages and drawbacks associated with each rental category. Let’s start with single-family homes.
Building a Single-Family Rental Home Portfolio One Unit at a Time
One of the most obvious advantages of building a rental property portfolio from scratch with single-family homes is that your initial investment for a stand-alone house will usually be less expensive than buying a four-plex or small apartment building. When money or credit is limited, buying homes one at a time may be the only option for a new real estate investor.
Managing the upkeep and maintenance of one house, mobile home, or rental cabin should be easier, require a smaller time investment, and be less expensive than maintaining a large apartment home community. Also, when you upgrade your rental home with new appliances or energy-efficient replacement windows, you have increased the value of your entire portfolio.
Investing in individual rental properties typically includes lower startup costs than buying a group of townhouses. Although, you may not be able to add new properties as quickly as you would like, limiting overall revenue potential.
In the beginning, the investor may choose to handle all maintenance and repair, rent collection, and marketing personally, or hire a professional management company to assume responsibility for some or all daily operations.
Building a Multi-Family Asset Portfolio
Buying a fixer-upper or a modest individual home in a working-class neighborhood with plans to convert the house to an investment property is relatively simple. You can typically find out how the listing price compares to other homes in the area, calculate how much it will cost to get the unit ready for the market, and establish a competitive rental rate based on what other landlords are charging for similar properties with comparable amenities.
Buying a large apartment building, having a few duplexes built, or investing in townhouses that have income potential takes a reasonable amount of due diligence to determine whether the property will generate a healthy return on investment without elevating risk levels.
For one thing, you’ll have to decide what type of multi-family housing solution is most likely to help you reach your financial goals. You may want to build, buy a less expensive property that needs significant repairs, or look for rental real estate that is already performing well in the market. Some people may want to invest locally, while others may be looking to take advantage of growth potential in a major city in or out-of-state. Metropolitan and rural areas offer unique benefits and challenges for real estate investors.
For example, the first half of 2019 saw $101.4 million in commercial and multi-family housing construction, and according to DODGE Data and Analytics, six of the top ten US metropolitan markets for commercial and multi-family construction registered greater activity compared to a year ago. And, yet, our nation is still struggling to overcome a shortage in affordable housing units for people in lower socioeconomic tiers.
Real estate investors who are considering out-of-state properties for their new portfolio may want to convert existing homes or commercial spaces to affordable housing solutions in a rural area where there is a severe housing shortage. This can help to leverage special grants, tax incentives, and federal funds to offset the costs of acquisition. In 2018, based on available research, the Metropolitan Housing and Communities Policy Center reported that the Mississippi Delta region, Alabama, Florida, Georgia, and the Southern border states from California to Texas are among our nation’s areas with the most severe need.
If you are entering the real estate rental market with multi-family assets in one of these states, or in almost any rural area where the unemployment rate is higher than the national average, populations are more racially diverse, and there is a higher reliance on manufacturing, mining, or farming. This is a good option for those interested in building an affordable housing asset portfolio.
Those who want to purchase rather than build should look for a property that is listed below market value and has a history of producing a steady positive cash flow. Whenever possible, first-time rental property investors should focus on finding properties in neighborhoods that are well-maintained and in high demand. These neighborhood housing solutions may be a bit more expensive, but typically offer high-growth and high-yield potential that is worth considering.
Property Management Considerations
Should you decide to hire a professional property management company, there are several things you should know before you sign on the dotted line.
First, and most importantly, integrity is a two-way street, and the property owners, investors, and the management team must be working together. Working against each other for personal gain will not allow you to invest your limited resources wisely, and all parties will suffer.
One place where a breakdown may occur is when investors interfere with management company policy or protocol. Property owners and investors must realize on-site management property personnel work for the management firm and not the community. It is vital that employees, such as maintenance technicians and landscaping crews, take directions and guidance from their supervisors and not community employees.
Second, a great management company will have verifiable references in the area where your multi-family real estate resides. They will also have a significant presence in nearby neighborhoods and understand the nuances and community rhythm. This knowledge helps to empower the management company to respond to the unique needs of the residents and build trust that leads to higher renewal rates.
Finally, great employees produce great results. You must be sure that the company is prepared to grow with your community. The best company to partner with has enough employees on staff, they are fully trained to meet your needs, and they will be able to accommodate your future growth without compromising service or property performance.
Comparing Asset Types
Creating an asset portfolio with single-family homes purchased one at a time allows investors to take their time learning the business. This is generally less stressful because there are fewer tenants and fewer properties to demand attention.
Buying stand-alone rental units are usually more affordable and qualifying for a mortgage is generally easier than buying multiple properties or rental units at the same time. Also, private houses tend to have higher, steadier appreciation rates. Unlike multi-family projects that are valued based on income history and potential, single-family home values are established based on neighborhood characteristics and buyer demand.
Many first-time investors may limit their multi-family property purchases to duplexes or four-plexes, choosing to gain some experience before taking on a 100-plus-unit development.
Some new investors are drawn to multi-family housing solutions because they offer more substantial benefits. Income potential is greater—more units mean more rental payments and more income each month. And, there is the opportunity to live in one of the units, assuming the role as on-site manager. Free rent, so to speak, and all the perks that come with a full-time job, plus the tax deductions associated with employee benefits.
In addition, multi-family housing offers larger scalability capabilities. Owners may want to convert their residential building to a mixed-use building with retail stores on the first floor and living spaces on the upper floors. This strategy opens the doors to leveraging new revenue streams to enhance property performance.
Another factor that makes multi-family assets more desirable than single-family rentals is the expansive tenant pool available for multi-family homes. Since most apartment homes are built near major centers—universities, shopping malls, schools, hospitals, and work districts—young professionals, students, and newly married couples often prefer living in an apartment community rather than a single-family home. An apartment or duplex in a walkable neighborhood or within easy access to public transportation is even more desirable. It means vacancies can be filled faster than re-letting a single-family home in an area far from the hustle and bustle. However, some renters are explicitly looking for a rental home in the thick of things—near the city center and all the action.
There are additional factors to consider and items not mentioned in this article that may drive investment decisions. For example, insurance is one, and risk tolerance is another. Local regulatory factors, emerging market trends, and migration patterns are a few more. Entering the rental market can be a rewarding investment decision, one that should be approached with a determination to thoroughly research the possibilities before making a business plan.
Each type of property brings a unique set of challenges and can provide both short-term and long-term financial benefits. There are pros and cons to adding single-family homes and multi-family units to your portfolio. The key to achieving success in the real estate investment industry is doing enough research before you make your first purchase to ensure you are prepared for the journey. Just remember that the market can shift suddenly, and preparedness includes being willing and able to respond to changes quickly, so you don’t lose momentum.