Real estate has been an established investment tool for the wealthy and a form of forced savings for the average person through ownership of a primary residence. Acquiring more real estate can be a desirable opportunity for those who have experienced the value of their personal home increase and may want to branch out into investing. With many real estate investment options available, the familiarity of equity growth in a personal home can make purchasing another single-family property a very desirable first real estate investment. However, multifamily and other commercial real estate assets may be overlooked as a viable option for investing but should receive more consideration.

Obstacles in Single-Family investing

Lack of reserves. Single-family rentals usually only have one lease that is providing little or no cash flow to the property. Subsequently, this provides no economies of scale which is the competitive advantage for a building with multiple leases. Also, any maintenance that comes up is the responsibility of the owner. This will take away from any previous profit the single-family rental was yielding. These combined factors can make the property vulnerable to income stream volatility.

Taking on personal risk. The owner is fully responsible for taking on recourse debt, which puts personal assets and credit on the line.  The financial stakes are, therefore, greater than the cost of the single-family rental’s purchase price. In a worst-case scenario, the owner could be responsible for more than just the value of the home. The risk to the owner is greater as compared to a commercial multifamily investment where nonrecourse debt is typical and the owner’s personal assets are protected.

Vacancy problems. At all times a single-family rental is 100% or 0% occupied whereas multifamily investments are underwritten for occupancy minimums and have the ability to cash flow positive with less than 100% occupancy. 

Real Estate investing is a business. Single-family investing, in reality, is creating a new business. It takes away the passivity of real estate from the investor and turns them into a business owner. Operating a property takes a team. Like most investors, hiring property managers to service tenants, maintenance, and leases is a strategy used to maximize the operations of the building. These activities must be either outsourced at a cost or performed by the owner which incurs another type of cost. Also, single-family investing is for the most part limited by an investor’s local market unless a management company is hired for an out of town market. Being location restrained to one’s local market can limit opportunity and diversification.

Passive Income through Multifamily

Truly passive. Multifamily investing is putting money into a functioning business and the cash flow from that property will be returned as passive income. The operating group is responsible for increasing the value of the property while lowering the expenses. Unlike single-family, there is a limited downside when investing in multifamily. The limited partner investor has no personal liability and financial risk is capped at the initial investment.

Not correlative to the market. Since commercial real estate valuation is directly correlated to net operating income, it means you can make money in a wider range of general market conditions. Unlike single-family, this allows you to be invested in an operating business instead of making a bet on the local single-family real estate market which is more highly correlated to the valuation of comparable properties rather than the operating fundamentals.

Leveraging professionals and diversification. Commercial real estate investors are analyzing markets outside of the one they live in and are not limited by location. Partnering with professionals that have a track record can allow the investor to mitigate risk and maximize passive income. By leveraging professionals it gives the investor greater options for real estate investments. Different groups have different markets, business plans, and return targets.

Forward-thinking Real Estate Investing.

Single-family homes can be a great way to get a start in real estate investing. It provides wealth and opportunity for many. There are many factors to think about before investing in any type of property. The purchaser’s desire to start a business versus having truly passive income, the different risk types, the opportunity to add diversification, and the possibility of leveraging a professional team. For individuals looking to invest like institutional managers, doing so may mean stepping up to commercial real estate assets.