There are many different ways to invest in real estate, and one of the most common is buying single family houses (SFHs) to hold as rental property. Many people who already have full-time jobs are lured in by the idea of passively owning rental homes and the promise of “mailbox money.” To make it even more passive, you can choose to use using a turnkey provider to handle the transaction from start to finish, complete with a property manager to take care of problems. It’s a win-win, right?
Let’s compare this to apartment investing. Passively investing in apartments involves investing in an apartment syndication, which is a partnership between a sponsor who handles every aspect of the transaction and the passive investor who funds a portion of the down payment for the property. Both sides share in the profits, but the sponsor takes care of the work from start to finish. Sound familiar?
Both strategies are passive, but they are in two very different types of real estate. Benefits and drawbacks of each are distinct from one another, so we should compare them to figure out the best option for you. Let’s get to it!
Affordability
If you want to purchase a turnkey SFH, you are going to likely need 20% down for the mortgage loan. For a $100,000 rental, you are looking at around $20,000 and change. Depending on your access to VHA loans or other creative financing, you can get properties for less than 5% down, further reducing the barrier to entry.
In contrast, the standard multifamily syndication will require a $25,000-50,000 minimum investment.
Advantage: SFHs
Economies of Scale
This simply means spreading fixed cost over an increased number of units. For SFHs, you have fixed costs spread over fewer units. For instance, if you have three rentals and one is vacant, you are at 66% occupancy and likely breaking even. You need to purchase more units to increase your economy of scale.
Once you reach 10 single family rentals, you are no longer permitted to receive traditional loans from most lenders. You will have to seek out other creative financing methods (portfolio loans, all-cash purchases, angel investors, etc.).
Meanwhile, the national average apartment occupancy rate has been steadily above 92% and rising since the 2008 recession, and was above 87% even during the recession. Considering that the breakeven point for most apartment syndications is 60-65%, you are much less likely to lose money in apartments.
Also, once you have been vetted by a sponsor, you can usually invest in an unlimited number of apartment deals without worrying about securing or qualifying for financing. This increases your ability to scale.
Advantage: Apartment Syndications
Diversification
It is so important not to put all of your investment eggs in one basket. Since SFHs are easier to purchase than apartments, it is generally easier to acquire more properties in a multitude of markets. You may feel comfortable investing locally because you know the area, and that is entirely possible with SFHs. That being said, you can be priced out of certain markets by your available cash on hand – if you plan to purchase a rental home in a metropolitan area where the average SFH is $500,000, you’ll need $100,000 to make that happen.
With apartment investing, it is possible to diversify across asset class (A, B, C, D areas), complex size (50 unit vs. 250 unit), and locations (primary, secondary, and tertiary markets), and neighborhoods without paying any more than the minimum investment of $25,000-$50,000. However, you have to wait for the deal to come to you, which is a drawback. You may never have an opportunity to purchase near where you live, depending on the operators you choose.
Advantage: Draw
Versatility
If you own a single-family home, you can rent it out in any number of ways depending on local laws. You can do traditional long-term rentals, Airbnb or vacation rentals, short-term corporate rentals, or a combination of any of these at your leisure.
If you’re in an apartment syndication, you don’t really have any say here. The operators will determine the best use of the units, but there is an important caveat. Most lenders at this time do not count income from short-term rentals in their apartment occupancy numbers, meaning that the value of an apartment building will drop even if short-term rentals are bringing in plenty of profit. For this reason, many operators shy away from them.
Advantage: SFHs
Management
With a turnkey provider, your SFH should be set up from the purchase date with a property manager (PM). From that point on, you are in charge – if the PM does something you don’t like, doesn’t update you properly, or starts charging you too much, it is on you to research other PMs and make the switch. If you have rentals in different markets, you will have to keep track of several different PMs and the job they are doing.
Many apartment sponsors will select a PM they are comfortable with or they will make plans to self-manage the property. If changes need to be made, the sponsor is in charge of making them. No matter what markets you’re invested in, your sponsors handle the dirty work of monitoring, hiring, and firing PMs.
In both of the scenarios listed, there are costs involved. But there is a lot more work required of owners of single-family rentals.
Advantage: Apartment Syndications
Which is the better investment?
Let’s look at our scoreboard so far:
- Affordability: SFHs
- Economies of Scale: Apartment Syndications
- Diversity: Draw
- Versatility: SFHs
- Management: Apartment Syndications
It’s a pretty tight race! Let’s continue our journey by looking at five more factors.
Risk
You have 100% ownership as a SFH owner, which means you participate in 100% of the upside and 100% of the downside. You are responsible for property taxes, repairs, upkeep, and turnover costs. Because you don’t have the economies of scale of apartments, your management and contracting fees are higher. Monthly income can be highly volatile, depending on expenses or repairs. However, having 100% ownership means you have greater long-term upside.
Passively investing in apartment syndications is less risky because you aren’t actually signing on a loan. Your risk is reduced from day one because you are investing in multiple units. Your costs (and therefore, your risk) are also reduced because of the economies of scale that come with hundreds of units in a centralized location, resulting in smoother returns and more steady income.
Advantage: Apartment Syndications
Leverage and Liquidity
As you grow your portfolio and purchase more single-family rentals you can sell or leverage the individual properties as needed. For instance, if you own 10 different single family rentals you can sell one or two of them without jeopardizing your entire income stream.
If you are part of a syndication that owns a 100-unit apartment complex and you want or need to sell, you’re getting rid of all of your cash flow. You are also at the mercy of the terms of the private placement memorandum that you signed, which may mean more holding time.
Advantage: SFHs
Returns and Cash Flow
As a passive SFH investor, you have 100% ownership of the property, which means you receive 100% of the profits. However, returns on a single unit are more fragile. Your cash flow for a few months, or even a few years, can be wiped out by one maintenance issue or unforeseen expense.
As a passive apartment investor, you have partial ownership of the property, resulting in a smaller percentage of the profits. However, since your investment is spread out over tens or hundreds of units, any expenses, vacancies, or other issues have a lower impact on your actual cash flow. Since you are typically offered a preferred return before a sponsor receives payment, your cash flow is even more protected.
The value of a SFH is determined by the local market, which is largely out of your control. In an appreciating market, you can double your property value. But you could also be unlucky in a stagnating or depreciating market.
Apartment values, on the other hand, are determined by the revenue they produce from rents and other income streams. This is completely within your sponsor’s control – they can increase rents through renovations and increase revenue by offering different amenities such as carports, storage lockers, on-site laundry, and the like. The ability to increase revenue is dependent upon the skill of your sponsor instead of the whims of the local market.
Advantage: Apartment Syndications
Time Commitment
While there are no investments that are 100% passive, some are more passive than others. For turnkey SFHs, you must vet the turnkey provider, qualify their deals before purchase, and stay up-to-date on the property and property management after purchase.
Evaluating a SFH is not inherently complicated – most of us have evaluated a home before. But the multitude of available deals can make choosing a home a much more time-consuming process. Also, going through the purchase process can be exhausting, as anyone who has dealt with a lender can tell you. There are endless documents to sign, and buyers must constantly update their financial information for the bank. Once the property is in your possession, then you must stay on top of your property manager; this includes going over repair and upkeep expenses, reviewing marketing of the property when vacant, and vetting tenants.
Educating yourself on apartment investing is admittedly more of a time commitment on the front end. The asset class is more complex than SFHs and most folks are less familiar with the process. However, once an investor has obtained that knowledge, they need only wait for their sponsor to supply them with investment opportunities. Once an investor decides to invest in a deal, it is a relatively straightforward process of getting the money to a sponsor. You will receive regular investment updates to review, and you can ask questions at any time. Then, the cycle repeats: the sponsor sends you a deal, you decide whether or not to invest, and you send in the required funding. No worries about qualifying for financing, which reduces your ongoing time commitment and increases your ability to scale as you desire.
Advantage: Apartment Syndications
Goal Alignment
This is a crucial point, but it isn’t talked about much. When making an investment, it is important to know that your investing goals are aligned with those of your team.
With a turnkey SFH, there are several conflicts of interest. The home you are investing in is likely a fix-and-flip, meaning that the provider bought low with the intention of fixing it up and selling high. This means that the turnkey provider is incentivized to sell high to you.
The conflict doesn’t stop there, though. Once you’ve been handed off to a property manager, they make a preset fee from holding your rental. No amount of work that they do raises or lowers that amount, and they are working with hundreds of rentals in a given area. If you miss a couple of months rental due to vacancy, you take a huge hit; the PM, however, takes a much smaller hit relative to the number of homes they manage. There isn’t much encouragement to treat tenants like more than a number.
This is where choosing a turnkey provider who also keeps their property management in-house is critical. They don’t want to charge you too much to purchase the home because they want to benefit from a long-term relationship in the future. All too often, though, this is not the existing relationship that investors encounter.
In contrast, the goals of an apartment syndication are beautifully aligned. The general partners actively operate the business, and they are incentivized to oversee onsite management, keep management costs low, and keep vacancies high by treating tenants well. They benefit from economies of scale that keep repair and maintenance costs low, all of which puts more profits in investors’ pockets. They pay passive investors preferred returns first before taking any profit sharing. It truly is a win-win scenario.
Advantage: Apartment Syndications
Which is the better investment?
Let’s tally up the final results:
- Affordability: SFHs
- Economies of Scale: Apartment Syndications
- Diversification: Draw
- Versatility: SFHs
- Management: Apartment Syndications
- Risk: Apartment Syndications
- Leverage and Liquidity: SFHs
- Returns and Cash Flow: Apartment Syndications
- Time Commitment: Apartment Syndications
- Goal Alignment: Apartment Syndications
Apartment syndications rallied to come out as the clear winner here. They have lower time commitment, increased economies of scale, more steady returns, and less risk overall. And we didn’t even talk about taxes!
In all seriousness, though, single family homes do benefit from increased versatility and greater long-term upside potential, so the best strategy is really up to you. Once you figure out your personal investment goals and risk tolerance, you’ll be better positioned to make the right choice for you. You may even find that a blend of both makes sense.
Guest Author:
Bobby Jones
Founder
On Call Capital, LLC
www.oncallinvestments.com
bobby@oncallinvestments.com