What are your passive income goals for the long term? How many different sources of passive income do you want in your ecosystem? These questions are vital because they will help you determine what level of real estate ventures you pursue.
Welcome back to the Real Estate Lifestyles series (Part 1, Part 2, Part 3), where I compare various parts of the real estate world to assist us in decision-making. Today I will talk about the difference between building a collection of single-family residences or multi-family buildings.
Definitions. Before I jump into the comparison, let’s define multi-family residences. According to the banking system, properties with four or fewer units are considered single-family residences. Why is this important? Because, when you buy a property with four units or less, you will use your personal credit report and score. When you buy a property with five or more units, banks consider it a commercial property, and you need business credit for the purchase.
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For this article, I will define multi-family as five units and above commercial real estate. This essentially means apartment buildings. I will make another comparison between single-unit and multi-unit properties in the future. Now, let’s jump into the mix.
Books to read. As always, I recommend some deep reading before you choose a career path in real estate. I own three single-family residences (SFR), so my experiences are from that perspective. Luckily, I read a lot, and I can gain perspective from other successful real estate investors.
For overall starting real estate guidance, I recommend “The ABCs of Real Estate Investing.” This book was one of the first books I read and gave me definitions of things like Net Operating Income and Cash-on-Cash return.
For single-family residences, the book “Build a Rental Property Empire” is a great read. In the book, the author talks about owning 15+ single-family homes.
For multi-family residences, the book “Zero Down” goes deeper into the world of establishing business credit and then using said credit to qualify for an apartment complex.
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The Differences. Personal (single-family) and commercial (multi-family) real estate are vastly different beasts to tame. First, it starts with the valuation phase. Single-family residences need an appraisal to determine a price. The appraiser uses the comparison method to find comparable properties surrounding the home in question.
Multi-family commercial properties use cash flow (income) to determine the value of the home. The bank will require the financial history books to determine the property’s net operating income (NOI). NOI is the profit after the owner accounts for all expenses.
Once they determine the NOI, there are many ways to determine the value of the home. That is outside the scope of this article, but here is a breakdown I found online. Just know that it is in your best interest to maximize profits in your apartment building.
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Increasing income. This brings up a great advantage of owning an apartment building—the ability to increase revenue. There are more ways to increase income with an apartment versus a single-family residence.
For a single-family home, you can perform a renovation to increase income. The community of your home limits the amount you can charge for rent. There isn’t much you can do except for time.
For a multi-family apartment building, there is almost too much to list. First, you can start by slowly renovating the rooms and charging more for rent as tenants turnover. Then you can add features like washing and dryers to the rooms to charge more.
Then you can start adding more options like better parking, upgraded facilities, playgrounds, etc., thus raising the overall value (and rent) of your property. You can even add luxury appliances that tenants can rent from you for short periods. Items include expensive vacuum cleaners, carpet cleaners, cappuccino machines, blenders, etc.
For more ways to increase your NOI, please read “40 Ways to Increase the Net Operating Income of Your Rental Property.” The more income and profit you extract from your apartment, the more the building is worth. An apartment building is a business.
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Property Management. Now we come to my favorite topic—property management. That was a joke. Finding a good property manager is the hardest part of becoming a real estate investor and holder.
If you have five or fewer single-family homes, you can probably manage your own properties. This can be especially effective if you are not working a full-time job. So if you or your spouse is staying home, being a property manager can be a great way to save money and stay busy.
For apartments, you will need a property manager. Unless you decide to move onto the property and become the full-time manager, you’ll need to hire someone you can trust. Again, that is the hardest part of real estate. I wouldn’t buy an apartment building without having a great property manager on deck already.
Income. You will make tons more money buying apartments than single-family residences, especially after the pandemic housing price boom. Say you purchased an SFR and receive a $500/month profit (which would be amazing). Then you bought a 10-unit apartment complex where you make $200/month per unit. That would be $2,000/month cash flow.
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So why isn’t everyone buying apartment complexes? Because it requires financial sophistication to buy an apartment. You need to be creative in financing every apartment you purchase. That is why I wrote the Creative Financing in Real Estate series.
There are many ways to buy an apartment building; however, you’ll need to that an apartment building is a business. You’ll need investors, a business plan, and a property manager to even start the process. It’s a huge undertaking, but one that the average person can accomplish.
Your goals. So it circles back to your overall goals. How much income do you want to achieve? Personally, I will have a military retirement in a few years—that will be the base of my passive income throughout retirement.
If I didn’t have a military retirement, I would need, say, $10,000/month of stable income. I would like to have at least three to four apartment buildings around my town. Apartments are a great way to build a pension-like portfolio of passive income.
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I would consider single-family residences as supplemental income to other passive income sources. Now, after 30 years of owning a rental property, things start to look better. You could hold the house free and clear and be making some serious cash flow. If you have multiple income streams, single-family would be an excellent way to profit from real estate. Plus, you can harvest your equity to juice your returns.
Conclusion. I could keep going because it is a great topic. Many people think that owning an apartment is out of reach, but it is very achievable. However, it all starts with your goals. If you want to make $2,000/month in rental income, buying a home and paying off the mortgage may be your best avenue.
Real estate gives you multiple options to achieve your goals; however, you will have to discover these options. Here are ten real estate books that will help you on your journey. If you need to build an empire of rental income, apartments are the way to proceed. If you aim to supplement existing income, SFR is best.
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