One question that we often receive from aspiring real estate investors is whether they should begin their investing portfolio by purchasing their own single-family home or investing in a multifamily syndication. Although every person’s situation and preferences are different, we always like to highlight the additional risks that actively investing through single family properties has which are less problematic when passively investing in multifamily due to its economies of scale. Here are three risks that are greatly reduced by the economies of scale in multifamily.
This is perhaps the largest risk that an investor has who owns one or even a few single-family properties. When you are renting to a single tenant, the day that tenant leaves the property or quits paying, your income is cut from 100% to nothing. Investors of single-family homes must be financially prepared to handle this risk. Investors who are not prepared face challenges with being able to pay expenses and are therefore more inclined to rush into finding a new tenant who might not meet their ideal criteria. When vacancy is considered from the perspective of a multifamily investor, loosing one tenant across say a 100-unit property results in a loss of only 1% of income. This means that even the loss of a few tenants in a given property will have little impact on the investor returns.
2. Professional Management
While the concepts of how to properly manage a property are relatively simple to understand, they can be challenging and time consuming to implement. For investors who are working full time jobs this can be especially taxing when trying to fit the activity of land lording into an already difficult work-life balance. Having a professional full-time manager who can oversee the property and handle the day to day tasks is an enormous advantage that the economies of scale in multifamily allows. Some single-family investors also choose to hire a property manager for their investments but pay a large portion of their returns to the manager.
In the same way that a single vacancy in an investors single family portfolio can have a huge impact on their returns, a single large expense can also have a large negative impact. If you are operating one single family home that cash flows $300/month and the $4000 AC unit quits working, you have just lost almost a years’ worth of income for that property. On a multifamily property although there are more AC units that could go out, the chance of all of them going out at once is highly improbable. This is another example of how the economies of scale reduce risk for the investor. Additionally, it should be noted that income valuation method used on commercial real estate also allows the property to generate sufficient income for these expenses. This is not always the case in the single-family investing world.
There are many important considerations when evaluating a multifamily deal and we make it our mission to careful vet each of these items. If you would like to learn more about passively investing in multifamily, please check out our free ebook "Achieving Financial Freedom Through Multifamily Investing."