There are countless reasons why rental real estate can be a great investment, but it might not be as clear which method of rental real estate is best. Is a single-family rental or apartment building a better investment? Take a look at the pros and cons of investing in a single-family rental and multifamily (two units or more) to help determine which method of real estate investing may be a better fit for you.
Pros of investing in single-family rentals
It's fairly common for new investors to start real estate investing by purchasing single-family rental properties because, in most areas, a single-family property is cheaper than commercial real estate.
Lending institutions typically require at least 20% down for the purchase of an investment property. Meaning if you wanted to buy a $100,000 single-family rental you would need $20,000. If you wanted to buy a 10-unit apartment building priced at $1,000,000 you would need $200,000 to invest.
The lower upfront cost makes this avenue of rental real estate investing more approachable, especially when getting a start in real estate will still offer the same tax advantages and benefits of larger-scale rental real estate.
Scale your rental portfolio slowly
You can build your rental portfolio as quickly or as slowly as you'd like. You can buy one new rental property each quarter, each year, or each decade.
Since residential real estate is typically cheaper to purchase, it's easier to acquire more properties in different locations or markets. This diversifies your portfolio, allowing you to benefit from owning rentals in markets that offer higher cash flow or have higher demand while hedging against negative changes in a market like a loss in job opportunities, high vacancy rates, or other factors that would affect the rental income.
It's important to note, owning single-family rentals alone does not mean you've diversified -- it's broadening where the rental properties are located that allows for diversification.
Leverage and liquidity
As you grow your portfolio and purchase more single-family rentals you can sell or leverage the individual properties as needed. If you own a 10-unit apartment complex and want or need to sell, you're getting rid of all of your cash flow. However, if you own 10 different single-family rentals you can sell one or two of them without jeopardizing your entire income stream.
Cons of investing in single-family rentals
Managing one rental is typically easier than managing several rental units like an apartment building, that is until a certain point. If you own multiple single-family rentals, especially in different locations or markets, managing each property individually can become arduous.
When a single-family rental is vacant, there is no income. If the unit stays vacant for longer than expected, it could significantly lower the investment's return while expenses like property taxes, insurance, and debt payments are made.
Holding costs for single-family rental properties, especially if you own several, can add up quickly. You pay property taxes, insurance, and ongoing maintenance and upgrades for each property. If a major expense like a roof or A/C needs to be replaced, you can see your entire cash flow for the year be eaten up.
Pros of investing in apartment buildings
More income faster
Multifamily properties have multiple rental units that produce more cash flow at a faster rate than a single rental unit. Rather than having to buy several single-family rentals over time, you can make more cash flow with the purchase of just one building.
With a multi-unit investment like an apartment building, there are multiple rental units that can be used to offset a loss in rents from vacancy. If 20% of the units are vacant, 80% are still producing income which allows you to cover costs like debt service, property taxes, or other related property expenses.
Economy of scale
Economy of scale is spreading fixed costs over an increased number of units. Property expenses and holding costs relating to an apartment building are typically far less than a portfolio of single-family rental properties because there are multiple units under one roof.
Property taxes, insurance, and management fees are generally fixed and the cost to replace the roof of a single-family home or a small apartment building that has six units under one roof are relatively the same. As the number of rental units increases, income is increased while reducing your cost, making it more cost-effective than multiple single-family rentals.
Cons of investing in apartment buildings
The largest downside to investing in apartment buildings is affordability. Multifamily properties can be expensive and require more upfront capital to get started. Investors should expect to have around 20% of the purchase price. There are opportunities to raise capital using syndications. This is by far the largest barrier and is often why people invest in single-family properties first.
Managing an apartment building can fall under both pro and con, similar to managing a single-family rental. On one side, you're managing all of the tenants in one location, typically under one roof. You don't have to drive all over town. However, there are more tenants and units to maintain and manage, meaning more responsibility, organization, and in general more potential problems.
So which is the better investment?
It really comes down to personal preference, your financial goals, and the funds you have available to invest.
If you have more money and would like the benefit of having multiple income streams under one property, apartment buildings may be a good option. If you don't have a lot of money to invest, but want to benefit from the tax and financial benefits of rental real estate, it may be better to slowly build a portfolio over time starting with single-family rentals.
Determine which method of rental real estate makes sense for you based on the time you can commit, the funds you have available to invest, and your financial goals.
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