Does size matter (when investing in real estate)?

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Does size really matter when it comes to real estate investing, or do smaller properties pack a better punch?

Like most everything, it depends on what you are trying to accomplish in real estate investing.

Let’s break it down.

Small investments: If you want to grow your investments over time, you may opt for less cash flow up front in exchange for stronger appreciation in property value. For this a smaller single family home may indeed serve the purpose as single family homes tend to be the strongest appreciating asset. They are often easier for the beginner to access as a first-time investment since it often involves a smaller deposit. While smaller investment properties in the past were strong at value growth, they have not been as attractive for cash flow. Until lately. With the advent of vacation rentals that can bring in some hefty rents they can prove to be great cash flow properties as well, especially if you are savvy enough to invest in highly sought after vacation markets such as Florida market, the mountain areas, event centered metro areas, or other hot vacation destinations.

Larger property investments: Bigger can certainly be better when it comes to strong cash flow. Most people who begin to invest are looking for strong cash flow up front. Multifamily properties tend to be the winner when you look for strong cash flow. It is often argued that these bigger properties do not appreciate in value as well so you can gain big cash flow, however you suffer from less value growth for the same reasons. Well if you know what you are doing and invest in multifamily property with a value play you can indeed have your cash flow and value growth as well.

Let’s look at the pros and cons of both of these and you can decide what size is just right for you

Single family pros:

1. Fewer tenant turnovers; Tenants tend to call a single family rental "their home". They tend to own more things and as they are happy in their home with more belongings they tend to live there longer. This equates to less tenant turnover and less expenses for the owner as all investors know that tenant turnover is there single largest expense.

2. Better controls over expenses: On a single family rental the tenants typically pay for all utility expenses. The only expenses paid by the owner are the standard taxes and insurance (perhaps a mortgage). This provides for more predictability over the cash flow.

3. Higher equity growth: Appreciation is one of the best wealth building principles and is best captured in the single family market. The best equity growth position will of course be the property that will sell to a retail buyer at the time you sell. Retail buyers are buyers who want to buy for themselves and / or perhaps a family. The single family home has always been the most highly sought after property for a homebuyer and therefore will demand the best (retail) pricing. These properties that are used for investments tend to be the most highly sought after price points as well and therefore tend to appreciate greater than any other real estate investment class. Obviously buying the right property in the best market for equity growth position is paramount to capitalize on this equity growth.

 

Single Family Cons:

1. One tenant: (on lease) when the property is vacant there is no revenue coming in. Another reason location is so important. Always want to own rental in a highly sought after location where housing is in highest demand.

2. Price per unit: the cost per unit (commonly referred to as per door cost) is higher than the per door cost of a multifamily property. This higher (per door cost) often reduces the cash flow on a per door basis.

3. Higher repair costs: with one unit there is no economy of scale pricing so repairs can be more expensive.

Multi-family pros:

1. Economy of scale pricing: with multiple units you can often get better pricing on everything (property management, professional tradesman labor, materials, etc.)

2. Financing: Loans for multifamily properties are tied to the financial merits and performance so these loans may not affect your credit scores.

3. Higher cash on cash returns:  with multifamily investments you have a plural number of income units under one roof. This means you have multiple tenants to help pay for repairs. You also have multiple units to manage in one location so a property manager will often discount the management fees for units 5 and more (tied to economy of scale).

 

Multi-family Cons:

1. More transient tenants: one of the largest expenses to the owner is the turnover cost of tenants. Apartment dwellers tend to be smaller families or individuals who move more often. Resulting in higher cost and less predictable returns.

2. More tenant issues: the more people living under one roof the more domestic challenges you may encounter.

3. Additional maintenance cost. All common areas such as hallways maintenance, paint, electricity and cleaning, as well as lawn care and snow removal (where applicable) are the owners cost. These costs reduce the controls the owner has over expenses.

As you can see there are pros and cons to both investments. Deciding what is most important to you will help you narrow down the best investment for you.

Who tends to buy the single family investments: the investor looking for a nice passive investment where they can hire a property manager and not have to worry about a variety of issues arising. These investors simply want a nice safe and sustainable investment secured by real estate. They have a larger desire for a nice mix of cash flow and equity growth. Many are now looking to vacation rentals to increase their cash flow on these single family rentals

Who tend to invest in multi-family investments: this investor tends to be more actively involved in their investments. Even with a property manager they understand they will have to be involved with the decision making process to the variety of items that arise from the number of units they own. This investor often has a bigger desire for cash flow than for equity build up as the values of the building is only tied to the rents that are generated. Interestingly enough, these groups on investors are also finding vacation rentals to provide the strong cash flow they desire, regardless of size.

The anomaly: Vacation rentals can present variables to all of the above, pending variables such as location, customer targeting, and business structure.


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Larry ArthComment