Information presented here is what we learned, not advice on what you should do. It is presented only for self-education. This is not expert advice. This is not legal advice. I am not a lawyer. I am not an accountant. I am a licensed real estate agent in California, but I am not your agent. Consult a professional that works for you. If you liked this text, take a look at the index of the texts at [Start here] What we learned about real estate.

Summary

A colleague at work asked what are the pros and cons of:

• Investing in single-family homes
• Investing in 2-4 units
• Investing in 5+ apartment buildings

It inspired me to make the following set of tables, and list all the bullet points that I could think of. I hope it is useful to you. Do let me know if I missed out on something. The tables below are about real estate investing in the USA. Since so much of real estate investing is shaped by lending practices and government policies, and since real estate is hyper-local, I do not know how much of what is written here applies to outside the USA.

Investing in single family homes

This concerns good old houses we all know and love.

Pros

• Easy to conceptualize. There’s a house. You buy it, you rent it out, you make some money on it. (in theory)

• Easy to finance for people with a steady income stream. Conventional loans, or jumbo loans based on similar principles.

• Lowest interest rates due to favorable loan programs.

• Easy to build a sizable portfolio in small incremental steps.

• Houses tend to appreciate.

• “Flip” and “Buy and hold” strategies are possible.

• “BRRR” strategies are possible.

• If you connect with a good agent, they can be willing to coach you.

• You can get a 2nd home and rent it out, provided that you uphold the guidelines for 2nd homes. (Loan rates are typically lowest for primary homes, then +0.5% for 2nd homes and yet another +0.5% for investment homes).

• Long term, fixed rate debt (30 years!)

• Loans do not have a prepayment penalty.

• Forgiving to minor errors.

Cons

• If you buy for appreciation, you have no control over it. Appreciation fully depends on demand.

• Loans are not assumable.

• Doesn’t really prepare you for multifamily if this is something you ultimately want to do. But perhaps a necessary stepping stone.

• Easy to fall into the appreciation trap, buying cash-flow-negative property hoping for an increase in value… which may never materialize.

• Managing a portfolio of SFH may get labor intensive. Though there are people who have successfully offloaded this.

• Turn-key operators may be overly optimistic of the property’s performance.

• Higher vacancy risk: 1 SFH = 1 tenant. When the tenant is gone, you have 100% vacancy.

• Dealing with HOAs (where this applies): nasty people, fees, ordinance.

• Onerous zoning, many things are forbidden in residential zones.

• You can finance a limited number of SFH with conventional loans (up to 10).

• Got hit badly in 2008 so we know values can plummet during a recession.

• Not a liquid investment.

I’m a bit surprised that both pros and cons of 2-4 unit residential ended up being this short.

Investing in 2-4 units

This is still considered “residential” real estate, though you have multiple doors under one roof.

Pros

• Still easy to finance. Lending practices treat 2-4 units the same as single family homes.

• Some economies of scale can be used: a 4-unit has one roof. A property manager can visit 4 units by driving to a single address.

• Allows “house hacking”: live in one unit, rent the others out.

• A stepping-stone into 5+ if you are into that stuff.

• Smaller vacancy risk. If 1 unit is vacant in a 4-plex, that’s 25% vacancy at that time.

• Property managers may have better rates for 2+ unit properties, if you use a property manager.

• Builds portfolio faster: it is about the same amount of work to acquire 4 units as it is to buy a single house.

Cons

• Since lending for 2-4 units is still essentially the same, forced appreciation plays don’t work.

• Not big enough to fully warrant a property manager. So it may end up being you.

• Liability exposure: more tenants, more chances something goes wrong.

• Some people don’t like multi-families, and prefer to buy high-end houses for appreciation instead.

• 2-4 units can not be 2nd homes - you must finance them as investment properties.

• Less forgiving to errors.

• Not a liquid investment.

I would consider 5-20 units to be “small” multifamily; 20-100 units “medium” multifamily, and 100+ units “large”. This is my arbitrary classification, mostly used to classify quickly the way properties are found, financed and operated. Definitely not set in stone.

Perhaps the most important distinction is how you typically finance them:

• Small: you could buy yourself, with an appropriate loan.

• Medium: you can probably get a partner and appropriate loan.

• Large: you probably need investors, and an institutionally backed loan.

I’m also neglecting the weird disparity in RE valuation between coastal areas (e.g. San Francisco Bay Area and friends) and the “rest” of the USA. In the US Midwest you can buy a medium multifamily for the price of a single upscale San Francisco house. Lending benchmarks float a bit, but door-wise lending is still very similar: you can’t use a commercial loan to buy a single house in SFO, for example.

Investing in 5+ units

Pros

• Economies of scale: it is easy for a property manager to handle (vs comparably sized portfolio of single family homes). 1 roof for many units.

• Less sensitive to crises vs small multifamily and SFH rentals: in 2008 the foreclosure rate of multifamily was 0.4%, vs 4% for SFH.

• Attractive lending options for 5+ units with loans starting at $1M, and (almost) limitless max amount.

• Forced appreciation is possible. Since 5+ units are evaluated based on NOI, it is possible to improve the operation of the property or fix issues, and add value.

• Accelerated depreciation is possible.

• Non-recourse financing is possible.

• Benefit from economies of scale: instead of contracting a property management firm, hire a property manager if the property is large enough to allow that.

• Loans are assumable (but fees may apply)

• You can get very creative in your dealings. Pretty much anything goes. The more creative you are (e.g. resolving problems on properties), the more money you can make.

• Opportunity to work with OPM (“other people’s money”) if you are so inclined.

• Law of large numbers takes over, your line items in the financial report become statistically predictable. Your vacancy rates also become statistically predictable.

• Builds a portfolio very fast.

• Tax advantaged schemes: opportunity zone investing, PILOT programs, subsidized housing – though for experts only.

• You only need one sufficiently large good deal to be set for life.

Cons

• If you are investing your own money, these might start being beyond your budget. (“serious money”)

• Sometimes requires corporate ownership. This is not always the case; but large properties (think 100+ units) must have corporate ownership.

• Practically impossible to self-manage. Or, if you want to do it, it’s a full-time job.

• There is a “lending vacuum” for multi-family properties that aren’t large enough to be financed by agency debt ($1M or more in debt).

• Other buyers / sellers are professional investors or RE brokers (“sophisticated”): your broker will not explain the ropes to you. You are expected to know them already.

• In case of a dispute, you may get sued for actual money, and people are sometimes litigious.

• Because of larger amounts of $$$ involved, plenty of opportunity to risk and lose it.

• Can take a long time to sell the property.

• Loans have a prepayment penalty.

• Something fishy is always going on in a multifamily. There is always some clogged toilet. There is always someone facing eviction. There is always someone who’s threatening to sue. If you can not deal with that, perhaps it is not for you.

• Don’t forget there are other commercial real estate asset classes too!

• Success and failure subject to survivorship bias: if you get lucky with deal #1, deals #2 to #10 are easy. But if you get unlucky with deal #1, may be game over for you.

• You only need one sufficiently large bad deal to wedge your financial future.

• Seriously not a liquid investment.