Real estate investing has a lot of moving parts, and each part affects the others. That’s why I created this awesomely helpful blog series on the REI Essentials. As you go through the series, you’ll get a good overview of the basics that you need to know to build a strong and successful business.
In the previous blog post, we looked at the different types of sellers. This information will be a great tool for you as you talk to sellers and attempt to put together a deal that will fit their specific needs. If you missed that blog, go back and check it out.
In today’s segment, you’ll learn more about branching out into other types of RE investing. If you’ve been concentrating on single-family dwellings up till now, you may be ready to consider other types of properties. Here’s an overview…
Single Family Homes
We’ll begin by looking at the most common property and that’s single-family homes. They’re easier to rent out than other property types, and they’re easier for new investors to wrap their head around when running the numbers. Also, single-family homes typically have the best financing options available. This makes them highly desirable and a natural first step for investors.
The biggest downside to investing in single-family homes has to do with the economies of scale. This means a couple of things…
First, it means that when you lose your tenants, you lose all of your cash flow, which obviously is never a good thing. It also means that you could have negative cash flow if home values and rental rates in the area have dropped over time, but debt servicing and expenses stay the same. Again, not a good scenario.
We’ll begin our discussion of condos by looking at some of the advantages of owning one. As an investment, they’re typically cheaper than single-family homes. The Homeowner’s Association (HOA) maintains the premises. The unit is easy to maintain because you’re not responsible for replacing roofs or doing exterior repairs.
One of the disadvantages of owning condos is that the HOA dues can dilute the cash flow. Additionally, you’ll find there are less financing options available. Another downside is that condos appreciate a lot less and they’re the first to feel the effects of a down market.
When it comes time to resell and exit the investment, you may find it difficult to do so. Plus, you will have a loss of control due to the rules and regulations of the HOA.
Overall, I guide my students away from condos. Exceptions would be if it sits directly near a university or a highly desirable vacation area. In the case of the latter, you could turn it into a vacation rental.
One final exception might be if the condo was so cheap, and the rental rates were strong in the local area, it might then make sense to buy a condo.
If none of these exceptions fit your case, then my suggestion is to stay away from condos.
I’m a huge fan of multi-family and I highly recommend this particular property type. Here’s why…
If you were to purchase 8 single-family homes, you will have to maintain 8 properties. But if you purchase one 8-plex, you have to repair one roof and do landscaping at one place. The overall expense goes way down on a multi-family property.
Investors describe multi-family properties by the number of doors that they have. So, a duplex will have two doors, a triple has three doors, a four-plex has four doors, and so on. Anything under five units (five doors) is considered residential real estate and can qualify for residential financing. Anything five doors or above is considered commercial real estate and will need a commercial loan or cash to purchase.
Those that are five doors or less are treated much like a single-family dwelling. They can fluctuate with the local market much easier than, say, a larger multi-family project whose value can be better controlled by good management.
There are many benefits to investing in small multi-family. They kick off decent cash flow. You’re able to spread your risk over multiple units so if one goes vacant, the investment still produces income. Plus, smaller complexes are easy to manage.
Residential financing is available making it easy to leverage your money. In most cases, they appreciate like a single-family home.
The downsides include the fact that the more tenants you get, the more you increase your legal risk. And even though they’re simple to manage, there’s definitely more to manage than a single-family home.
I have purchased many small multi-family units over the years, and I’ve done quite well with them. So, I think overall, as long as you understand that there are some slight differences between multi-family and single-family, and as long as you structure your legal entities correctly, you can make investing in smaller multi-family projects extremely fun and profitable.
The last property type I want to talk about is large multi-family complexes, also known as apartments.
I can’t really teach from experience on this subject because I’ve never owned or managed a large multi-family property. I have many friends who are apartment-building owners. They all say the same things…
When managed correctly, investing in an apartment building has a huge cash flow advantage. There’s a lot less competition than investing in small complexes. Their ability to afford management goes way up because you’re able to spread the cost of management over a lot of doors or a lot of units. The economies of scale make apartments a lot less expensive than purchasing the same number of single-family doors.
As with anything, there are some downsides. The first and biggest downside is they’re very expensive. Both the purchase and the repair costs eliminate many new investors from even considering this type of property.
Dealing with this many units and this many tenants can become a property management nightmare that only a professional property manager should endure. Also, the exposure to that much legal risk can present a scary proposition.
And last of all, an apartment building would be harder to resell. It would be less liquid than a single-family home or even a smaller multi-family complex.
Bottom line, I would say that apartments are a great investment for anybody who is highly experienced and who has a lot of capital – or access to capital – to cover all their bases.
Before making a decision about which type property to invest in, it’s best to go back to your original goals list… What do you want your business to look like? What will work best to get you to where you want to be?
Just because a good deal is staring you in the face doesn’t always mean you should jump on it. Stay true to your own life plan and take the route that best fits that plan. And that includes choosing the property type that will be right for you.
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