This article looks at two of the most popular ways to invest in real estate - single-family residential and multifamily. Which is right for you?
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One of the reasons so many people are attracted to real estate investing is its diversity. There are many different product types, including but not limited to office, retail, residential and industrial.
In this article:
“Residential” real estate is the umbrella term used to describe several housing types. This includes single-family homes, apartment buildings, student housing, and assisted living communities.
The term “residential real estate” is often used synonymously by investors referring to single-family rentals, or SFRs. Single-family rentals are individual homes purchased to use as income-generating properties.
As we’ll discuss in more detail below, many investors start by investing in SFRs because they are relatively affordable, making them a lower barrier to entry than multifamily real estate.
Multifamily properties are those with two or more residential units. The smallest-scale multifamily buildings are:
Any property with two to four units is considered “residential” while any property with 5+ units is considered “commercial” property.
Multifamily real estate can be significant in scale.
Some apartment communities have 300+ units and larger complexes will often have several of these buildings, putting the total unit count well over 1,000+ apartments.
Naturally, these large complexes are expensive and, therefore, difficult for individual investors to buy. Institutional investors own most large-scale properties like these.
Many investors will find a happy medium in apartment buildings ranging from 20-50 units.
These properties are often even more desirable to multifamily investors looking to execute a value-add investment strategy on top of the strong and consistent cash that even small-scale multifamily can provide.
Watch: Single Family vs Multifamily Real Estate- What To Know Before Investing
Commercial investors looking to purchase residential real estate are often at a crossroads: should they invest in single-family rentals (SFRs) or multifamily?
There’s no one-size-fits-all approach. Indeed, both strategies can be highly lucrative.
Here is a list of important considerations when determining which property type is right for you:
Let's go into more detail for each below. 👇
In some markets, single-family residential properties are not cost-effective from an investment perspective.
For example, in Los Angeles, the median price for a single-family home is now upwards of $1 million. In Greater Boston, the median single-family home price is over $900,000.
These sky-high sales prices make it difficult to invest in these properties as rentals. The pool of renters who would be able to rent these homes is too minimal, especially since owners need to charge a premium to earn any positive cash flow.
It is generally more affordable for people to rent apartments in high-cost areas, thereby making multifamily investments more attractive.
Prospective investors should consider an area’s median household income vs. the rent they can get per unit. A good rule to follow is that renters should spend no more than 30% of their income on housing.
For example, an area with a median household income of $200,000 would mean that the average renter could afford to pay $60,000 per year in rent (or approximately $5,000 per month). This means that apartments for rent below $5,000 would be more affordable in the market versus apartments over $5,000
A key metric residential investors use to evaluate properties is “cost per unit.” For single-family rentals, the purchase price is the cost per unit.
For multifamily investments, the cost per unit is the purchase price divided by the total number of units. For example, if you purchase a 10-unit apartment building for $2 million, the cost per unit is $200,000.
When evaluating SFRs vs. multifamily investments, consider the cost per unit relative to competing investment options. Then, compare this to the expected rent. Typically, investors want to buy properties at a lower price per unit; all else is considered equal.
Watch: 4 metrics for investing in real estate
Always consider the demographics of the local market.
Start by looking at the share of homeowners vs. renters. Nationally, an estimated 65% of people are homeowners versus only 35% of renters. However, in some markets, the reverse is true and in big cities and college towns, they can be heavily dominated by renters.
Next, look at the demographic profile of the renters. Do the renters tend to be young professionals and empty nesters? Or does the population skew toward young families? If the former, multifamily rental properties might be the better investment option. If the latter, you may want to consider single-family residential homes instead.
One important caveat: multifamily properties with 3+ bedrooms and larger floor plans can also be attractive to families, especially if priced right.
It can be challenging to scale a portfolio of single-family properties as there is a lot to manage for each home. Investors looking to achieve scale are generally better off investing in multifamily rental properties.
Scale is significant when facing a potential economic downturn.
Having more units per property provides some insulation against both:
As units in a multifamily building turn over (usually throughout the year), the owner can increase the rents of those units one by one to accommodate inflation.
Single-family homes are rented for 12 months (sometimes two years), so there are fewer opportunities to raise the rent as costs rise. This makes it difficult for SFR owners to mitigate inflation or other pressures on rent which can, in turn, diminish their cash flow.
Here is a side-by-side look at how residential single-family homes compare to commercial multifamily real estate investments.
There are certainly benefits associated with investing in single-family rentals. The primary draw is that these properties are generally less expensive to acquire (in total) than multifamily properties.
Here’s a look at the other benefits of residential real estate investing:
Generally, each market has more single-family than multifamily, meaning there is more activity within the single-family market. It is easier to find and acquire single-family properties than it is multifamily. In some communities, few (if any) multifamily opportunities may be available.
Moreover, because single-family homes are usually more affordable than multifamily, they are financially easier to acquire. This low barrier to entry makes SFR homes attractive to those with modest capital to invest.
One benefit to investing in SFRs is that platforms like Zillow and Redfin have acquired robust information about these properties and nearby competition. This can make it easier for real estate investors to evaluate potential homes.
Data on multifamily is more challenging to find, primarily since many are held in LLCs or trusts. You often need to use a broker or specialized software like CoStar and LoopNet to find detailed information about multifamily buildings. Even those who have access to these tools will find that sometimes, there are typically no local multifamily comps to use when comparing deals.
Managing one or two SFRs is relatively straightforward. There are not as many tenants to deal with (vs. a multifamily property), which makes day-to-day oversight much more straightforward.
Many real estate investors will find that they can self-manage a small portfolio of SFRs, whereas a multifamily investment often requires third-party property management – something that comes at a cost.
People tend to come and go from multifamily apartments, but SFR tenants are often described as “sticky.”
People who lease a residential home often treat that home as if it were their own and, in turn, stay there for years. This limits turnover and vacancy (and reduces the need for extensive marketing during tenant turnover).
One final benefit of investing in residential real estate is that when it comes time to sell, there is a large pool of potential buyers.
Individuals and families may purchase the home for their use. Meanwhile, if the house has substantial cash flow, it may attract investors’ attention. This is a good way to preserve an owner’s liquidity: if they want to sell, they usually can within 30-60 days.
Multifamily properties can sometimes take 3-6 months between marketing, due diligence, financing, etc., before closing.
Despite the many benefits associated with single-family residential investing, there are many good reasons to choose multifamily properties instead:
While SFRs may have lower total acquisition costs, multifamily properties tend to trade at a lower price per unit.
For example, it might cost $250,000 to acquire a SFR (1 unit) but $1 million to acquire an 8-unit multifamily property in the same market. In this case, the multifamily would trade for $125,000 per unit—less than half of the single-family home.
Other costs are also spread across the units, lowering costs per unit. The more units per building, the more those costs can be shared. For example, if the tax bill at a 10-unit rental property is $30,000, that equates to just $3,000 per unit.
Multifamily properties also benefit from economies of scale. For instance, hiring a property manager to oversee three single-family residential homes might not make sense. However, owning three multifamily properties with ten units apiece (or a single building with 30 units) often warrants hiring a property manager.
There are other economies of scale, too. For example, it only takes one due diligence process and closing to acquire a 30-unit apartment building. It would take 30 transactions to achieve the same scale if investing in SFRs.
Another example of economies of scale pertains to supplies. Owners will often get a deal on bulk purchasing items like refrigerators, cabinets, and vanities that they can store off-site until they need to be replaced in the units. They can stock-pile things like paint and then use it in each unit.
Owners of single-family residential properties rarely get the same deals on supplies since they’re buying so few at a time.
Arguably the most significant benefit to investing in multifamily is that it offers diversified rental income streams.
With a single-family home, if that tenant leaves, the owner must pay all expenses (e.g., mortgage, utilities, and other carrying costs) until the rental property is re-leased. Worse, if the tenant stops paying rent, the owner could go for months without receiving any rental income while they pursue an eviction.
Multifamily properties benefit from having multiple income streams. In a 10-unit building, if one tenant moves out or stops paying the rent, the owner still has reliable rental income from 9 other units. This makes it much easier to float the costs while they deal with the vacancy.
People who want to grow their real estate portfolio will find it much easier to invest in multifamily properties than SFRs. It could take years to aggregate a portfolio of single-family homes, whereas someone can achieve scale with multifamily in just a few transactions.
Multifamily rental properties are also typically more recession-resilient.
In a worst-case scenario (like the Global Financial Crisis and housing collapse in 2008-2010), people forced to sell their homes often end up renting apartments in multifamily properties. They might continue renting those apartments for years while they rebuild their credit.
Multifamily tends to be the rental property class that is hit the least severe and rebounds the quickest during periods of economic turmoil.
As noted above, single-family homes are considered “residential” properties. So are multifamily properties with 2-4 units. Any property with 5+ residential units tends to be classified as “commercial” real estate and, therefore, must utilize commercial loan programs.
The primary difference between residential and multifamily financing is the cost. Residential properties can generally qualify for lower rates. Owners can lock in those rates for a standard, 30-year period.
Commercial loans are usually at least 100 basis points (1%) higher than residential loans. However, although these loans are more expensive, lenders have greater flexibility to customize them.
For example, an investor pursuing a value-add multifamily project may be able to secure a 12-month interest-only period from commercial lenders. This makes the payments radically lower during the first year of ownership, during which the owner can make improvements before releasing the property at higher rents.
Are you interested in investing in real estate but don’t know how to start? Some people find it easiest to dive in and make the plunge.
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Learn the secrets of passive investing in multifamily and how investors are compounding their net worth.