Looking to invest in real estate?
It’s a wise choice. Between the opportunities for passive income, profits on the sale of the property, and numerous tax benefits, there is a lot to like about real estate.
The next question is, will you invest in single-family or multifamily real estate?
These two categories represent distinct approaches to residential real estate investment, each with its own considerations. In this article, we’ll highlight these distinctions to help you make an educated decision for your portfolio.
Multifamily vs Single Family Real Estate
On the surface, the definitions seem rather obvious. There is some nuance that is worth explaining however when comparing single and multifamily properties.
Single-family real estate refers to standalone houses designed for one family or household. These properties are familiar to most people. They make up neighborhoods around the nation as individual homes on plots of land.
Multifamily real estate covers a range of property types that house multiple living units under one roof or within a single complex. This category includes duplexes, triplexes, apartment buildings, and larger residential complexes. Multifamily homes are found everywhere from the suburbs to city centers.
At Colony Hills Capital, we specialize in Class A- to B garden-style multifamily properties. These are typically properties with 200 units or more and other benefits like shared common spaces, fitness facilities, or a pool. For the purpose of this article, we’ll discuss multifamily real estate through that lens rather than duplexes or apartment buildings.
Benefits of Investing in Multifamily Real Estate
Multifamily real estate offers a compelling set of advantages that attract both new and experienced real estate investors.
These benefits are:
- Diversified income streams: With multiple units under one roof, the impact of a single vacancy is significantly reduced compared to a single-family property. This diversification can lead to more stable and predictable cash flow, a crucial factor for many real estate investors.
- Stronger potential for scale: Multifamily properties allow investors to spread costs across multiple units, leading to more efficient operations. For example, maintenance expenses, property management fees, and even marketing costs can be shared across units, potentially increasing overall profitability.
- Higher cash flow: The cash flow potential of multifamily properties is often higher and more stable than single-family investments. This is particularly attractive for investors seeking passive income. Additionally, the value of multifamily properties is typically based on the income they generate, offering savvy investors the opportunity for forced appreciation through improved management and increased rents.
- Significant tax benefits: Real estate offers numerous tax benefits, however multifamily real estate especially entices savvy investors with cost segregation and depreciation deductions.
These advantages make multifamily real estate an attractive option for investors looking to build wealth and generate passive income through real estate. Let’s look at an example of a single-family and multifamily investment side-by-side next to highlight the key differences.
An Example: Suppose You Invest $100,0000
Enough theory, let’s review an example.
Suppose you invest $100,000 in a single-family home or a multifamily real estate deal (like the ones Colony Hills Capital offers), here is what you can expect.
What to Expect When You Invest $100,000 in a Single-Family Home
Suppose you invest $100,000 into a single-family home. You can expect the following for upfront costs:
- Purchase Price: $350,000
- Down Payment: 20% ($70,000)
- Closing Costs: $5,000
- Initial Repairs/Improvements: $10,000
This gives you a total initial investment of $85,000. Assuming a 30-year fixed rate mortgage at 6% interest, your mortgage will be $280,0000.
Now that we have the initial investment out of the way, let’s calculate your monthly income. To help us do this, let’s assume the following:
- Monthly Rent: $2,400
- Vacancy Rate: 5% (1 month vacant per year)
- Property Management: 10% of rent
- Maintenance: 5% of rent
- Property Taxes: $4,200/year
- Insurance: $1,400/year
- Annual Appreciation: 3%
- Rent Growth: 3% per year
In your first year, you can expect your gross rent to be $28,800, and the following costs deducted from your gross:
- Vacancy: $28,800 * 5% = $1,440
- Property Management: $27,360 * 10% = $2,736
- Maintenance: $27,360 * 5% = $1,368
- Property Taxes: $4,200
- Insurance: $1,400
- Mortgage Payment (P&I): $1,679/month = $20,148/year
Your Net Rent (gross rent - vacancy) is $27,360, which gives you a Net Operating Income (NOI) of $17,656 (net rent minus property management fees, taxes, maintenance, and insurance). Now we can calculate your year one cash flow, which is your net operating income minus your mortgage payment. Your cash flow in year one is -$2,492.
That’s just your first year though. Let’s skip ahead to year five when you sell the house.
Here is what you can expect:
- Projected Rent: $2,782 (assuming growth rate from earlier)
- Gross Rent (Year 5): $33,387
- Vacancy: $33,387 * 5% = $1,669
- Property Management: $31,718 * 10% = $3,172
- Maintenance: $31,718 * 5% = $1,586
This gives you a NOI of $21,360 and a cash flow of $1,212. That’s an improvement over the negative cash flow in year one, but costs still eat into your profits.
Now let’s assume the following when selling the property:
- Property Value: $350,000 * 1.03^5 = $405,730
- Mortgage Balance After 5 Years: $261,781
- Equity Upon Sale: $405,730 - $261,781 = $143,949
- Selling Costs: $405,730 * 6% = $24,344
After selling your net proceeds are $119,605 (equity upon sale - selling costs). Not bad! This is the power of real estate in action.
Now let’s calculate your total return on investment. To do this we’ll assume the following:
- Total Cash Flow Over 5 Years: Roughly $-8,000 (Slightly negative cash flow over 5 years)
- Net Proceeds from Sale: $119,605
- Total Return: $119,605 - $85,000 (Initial Investment) = $34,605
- Annualized Return: ~$6,921/year or ~6.9% annually over 5 years
Your cash flow is negative in year one but becomes positive by year five, while the property’s appreciation drives the bulk of your returns. Your total return is $34,605 over 5 years on a $100,000 initial investment (~6.9% annualized).
Let’s see how this compares to the same amount invested into a multifamily property.
What to Expect When You Invest $100,000 in a Multifamily Property
Now let’s compare the returns a multifamily deal from a firm like Colony Hills Capital can return for your $100,000 investment.
Assuming the same $100,000 initial investment, let’s look at what a deal with a 20-25% IRR (2.5x multiple) could generate for you.
This return would generate:
- Year 1 Cash Flow: 2-4%= $2,000-$4,000
- Year 2 Cash Flow: 3-5%= $3,000-$5,000
- Year 3 Cash Flow: 6-8%= $6,000-$8,000
- Year 4 Cash Flow: 7-9%= $7,000-$9,000
With a total return of $250,000. This far surpasses the return on a single-family home, but it’s not all you’ll get. Thanks to depreciation you can offset your passive income cash flow (with the potential to pass on to other passive income).
Clearly multifamily real estate wins this round. Multifamily real estate has stronger cash flow potential and removes you from the day-to-day operation making it an excellent option for your portfolio.
How to Invest in Multifamily Real Estate
Investing in multifamily real estate doesn't follow a one-size-fits-all approach. For investors seeking a more passive approach, there are several options:
- Real Estate Investment Trusts (REITs): Publicly traded companies that own and operate multifamily properties, offering a way to invest in real estate through the stock market.
- Real estate syndications: These structures allow investors to pool their money with others to purchase larger multifamily assets, typically managed by experienced sponsors.
- Crowdfunding platforms: Online platforms that provide access to multifamily deals, often with lower minimum investments than traditional syndications.
Regardless of the chosen method, successful multifamily investing requires careful due diligence, a solid understanding of local real estate markets, and a clear investment strategy. Check out our guide to selecting the right market to invest in and our guide to selecting a multifamily investment firm for more information.
By offering multiple paths to entry and the potential for attractive returns, multifamily real estate continues to be a cornerstone of many successful real estate investment portfolios.
Download Our Free Multifamily Investing Guide
Multifamily real estate can be an excellent investment choice for your portfolio. Multifamily real estate provides many benefits to investors such as
- Potential cash flow
- Appreciation of the property
- Tax advantages through deprecation
And as you’ve seen from this article, a much stronger potential for returns. If you are new to multifamily real estate, then we invite you to download our free multifamily real estate guide. In this guide, you’ll learn about your options for investing in multifamily real estate, how to select the best markets, and how to choose the right firm.
