One of the first decisions a real estate investor has to make is whether to purchase single-family houses or apartment buildings. I’d like to make a case for why a single-family house or a portfolio of houses often make better investments, particularly if you’re just getting started.
Lower purchase price
Depending on where you invest, you could purchase a home for less than $100,000. That lower purchase price means a lower down payment. It’s much easier to come up with 20 percent of $100,000 than it is to come up with 20 to 30 percent of $1 million. This lower price also means you can do the deal yourself; you don’t have to set up partnerships and complicated business structures to raise equity capital. This bite-sized cash requirement means you can grow slowly and expand as you’re ready.
More manageable size
A single-family house is smaller than an apartment building. It’s easier and cheaper to maintain in gross costs. If the furnace goes out on your home, it’s a few thousand dollars; if it goes out on your apartment building, then it’s tens of thousands of dollars.
The smaller structure is less complicated in both construction and usage. It only costs a few hundred dollars and a few hours to inspect a single-family house. It can easily cost tens of thousands to conduct due diligence on an apartment. It also takes a significant amount of time and expertise. A home inspector and a surveyor are pretty much all you need to inspect a single-family house.
Anyone with basic math skills can review the accounting and estimate income and expenses. It takes months to conduct due diligence on an apartment building. If you make a mistake or miss something on an apartment building, it could be catastrophic financially. If you miss something on a single-family house during due diligence, it’s not going to destroy you.
More financing options
There are more favorable financing options for a single-family house than an apartment building. You can also typically get lower down payments. Most lenders advertise that they do 75 to 80 percent loans on apartment buildings, but there are also a lot of other criteria that you have to meet such as debt coverage ratios.
Even though banks may loan up to 80 percent of the value, it’s not uncommon for them to come back out of underwriting with an approval for only 60 percent of the purchase price because the underwriter decided to be very conservative with the incomes or very liberal with the expenses. You can finance a single-family house with most of the same commercial loans available to apartment investors if you want. Investors of single-family houses also have the option of financing with a conventional home loan product, so you can be fairly confident that a 20 percent down payment will get the deal done.
Easier to sell
If you have a portfolio of single-family homes, you can sell them as a package or individually. You can market them to commercial investors or retail buyers. You can sell some and keep others if you choose. Retail buyers are not constrained by capitalization rates or debt coverage ratios. They will often pay the appraisal amount, which is not tied to rental incomes in the area. You can typically sell a single-family home in a few months, but an apartment building could take years to sell.
More properties to choose from
There are more single-family houses than apartment buildings, and with a little work you can find great bargains. The key is to buy a house with equity on day one and not just any old home off the multiple listing service. This value will help you steadily and safely build your portfolio and wealth.AD
Safer to build your wealth within your means
Many investors have charged into deals that exceed their financial means and management abilities. They don’t have enough cash in the bank for unforeseen expenses and they don’t have the experience to properly manage the property. This is a recipe for disaster.
It’s better to gradually turn one house into two and two into four as you build your portfolio while you increase your savings and experience. I try to buy a home at a price low enough that I have about 20 percent equity in the home after all of my costs. I probably have to bring 20 or 30 percent of my own money into the deal initially, but I can refinance the home and pull most or all of my money out of the home once it’s stabilized. Then I can immediately go buy another house and repeat the process.
Safe investing requires three key factors: equity, cash flow and cash reserves. You need some wiggle room in the property. You’re always in a tenuous spot when there is no daylight between what you’ve put into a property and what you can sell it for. Cash flow is the most important safety factor. Your property needs to be paying you more than it costs to own and operate.
If your property is profitable, then you can keep it and sell it on your terms. Selling when you want is always better than selling because you must. Cash on hand is key to overcoming bumps in the road. If you expand your investment portfolio of single-family houses in a smart way, you can achieve and maintain all of these factors at a safe level.
Some investors probably see many of these benefits of single-family homes as disadvantages. For instance, a furnace in an apartment is more expensive in total, but it’s cheaper than one in a single-family house on a per-unit basis; you have more opportunities to lower your per-unit maintenance costs in a building. Buying houses in different locations is great for diversification, but it also increases your management costs drastically. It’s not about choosing the best investment; it’s about choosing the best investment for you.
Many investors pursue a path that sounds exciting to them or provides bragging rights. They may think buying single-family houses is less prestigious. To me, that’s another advantage. No one looks at one of my single-family houses and makes assumptions about my financial position, which is exactly how I like it. My goal is to be wealthy, not to make people think I’m wealthy.
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