All right folks, it’s that time again. Go ahead and grab some popcorn and a beverage, get some friends together, and sit back for another showdown of epic proportions with this week’s episode of Birgo Battles. Today’s contest features two familiar characters, each of which are beloved by their devoted fan bases. We’re talking about the classic residential real estate investor’s conundrum: single-family vs. multifamily. It’s an age-old debate, and while both of our contestants have merit, in life there are winners and losers. Today we’re going to look them up and down, side by side, and determine who we’re voting off the island… and who we’re going to keep on the squad.
Who has humble beginnings? (Upside Potential)
When it comes to upside, it’s important to consider which one of these has the more attractive starting point. Despite the crazy red hot housing market in virtually every corner of America, single family homes are still cheap relative to international markets. On a median income, the average American can afford approximately 700 square feet of residential real estate; this is more than twice the home that median earners can afford in most developed countries around the world. The price per square foot of single family real estate in America is shockingly inexpensive.
There are similar but different economic drivers that factor into the appreciation of single family homes vs. multifamily apartment complexes. Whereas multifamily values are derived almost exclusively from the income that the property generates, the value of single family homes is tied more to their merit as a use-asset or consumer good. Single family home values are also driven in large part by the availability of consumer mortgage financing, which has historically been, and will continue to be, a priority of American lawmakers.
Multifamily real estate certainly appreciates over time, but that is largely driven by the work and skill of an operator to execute on a business plan to increase net operating income. Absent significant value-add or cap rate compression, it’s difficult to drive value increases in multifamily properties. (As an investor, Birgo Capital generally builds very modest appreciation assumptions into its modeling.) Given that demand for single family homes as a use-asset is ever increasing, and the relatively low current price point for American single family homes, we’re better on single family.
Point: Single Family.
Who’s the safer bet? (Risk)
Risk matters. The last thing you want is to keep someone on the island who ends up being super annoying or just can’t keep up with the game plan. So, it’s important for us to think through the downside potential of bringing on dead weight.
This one is pretty simple: it’s generally accepted that the risk of multifamily investing is lower than it is with single family rentals. The single family serious delinquency rate with Fannie Mae and Freddie Mac tends to be notably higher than the corresponding rate for multifamily properties. For the most part, we can assume that this is because multifamily investors spread their risk across - wait for it - multiple families. Any one tenant coming into hardship is not likely to sink a multifamily investment, but if a single family renter has an interruption to income, it could seriously jeopardize the asset’s performance. Since prudent investors care about the likelihood of things going terribly wrong, this simple risk analysis tells us we should buy a one-way plane ticket to send our single family friend home.
Who’s more resourceful? (Capitalization)
We can’t turn a blind eye to which one of these is smarter with dollars and cents. The “best athlete” can’t be a money pit. When it comes to financial matters and investment real estate, the types of financing that are available are a significant consideration for each type of asset.
One of the strengths of residential real estate investments of all kinds is the inexpensive capital that can be leveraged to acquire them. Similar to our assessment of the risk profiles of each asset type, multifamily is our clear winner on this point. Lenders view multifamily real estate as the darling of asset classes, and their terms are generally most aggressive for multifamily. These tend to be larger loans because multifamily properties are larger assets, so they are more worthwhile for lenders to compete on. The existence of Fannie Mae and Freddie Mac makes both product types financeable at very strong terms, but even Fannie and Freddie’s terms for investment real estate are more favorable for multifamily assets. Loan-to-value ratios, debt service coverage ratios, interest-only periods, interest rates, the list goes on… all of these tend to be slightly better for multifamily assets.
Who’s easier to get rid of? (Liquidity)
A key consideration for us should be how… disposable our new companion is. In terms of our island analogy, let’s think of this as, “If we end up changing our minds, who is easier to get rid of?!” As investors, we hope and intend to make good long-term capital allocations that will prove to be prudent for many years to come. However, access to capital is the name of the game in varying economic climates, and -- yes, even for real estate investors -- cash is king. This is another easy point to think through, as the nimble nature of single family assets can’t be overstated.
Single family homes are the most liquid form of direct real estate investment because they double as a usable asset. Whereas selling a multifamily property can be an extensive process that requires a well capitalized investor in order to execute on a transaction, generating liquidity through the sale of a single family home is a very simple, predictable process. Potential buyers of a single family home are the entire homebuyer marketplace, which includes an order of magnitude more participants than the professional multifamily investor market. For investors who care about the ability to be agile with their capital, the liquidity of single family homes wins out.
Point: Single Family.
Who’s more high maintenance? (Operations/Management)
We’ve got two votes for single family and two votes for multifamily, so it’s time for the rubber match. This one is for all the marbles, and it’s the granddaddy consideration for many real estate investors: maintenance. This is of the utmost importance, and it’s definitely a factor in who stays and who goes.
This one isn’t an easy call -- both assets have their benefits and pitfalls as it relates to the amount of capital and effort they require to keep them fresh and happy. At single family homes, tenants tend to take care of more maintenance items themselves. They typically cut the grass and shovel the snow. Some investors argue that single family tenants treat their rental more like a “home,” so they care for it better and cause less wear and tear. On the flip side, multifamily investments allow for economies of scale. 50 tenants paying rent can cover one roof replacement more easily than one tenant paying rent. With multifamily investments, significant capital outlays tend to go further and provide benefits to an entire complex. Multifamily properties also allow for on site managers or maintenance employees to help care for the asset.
This is a really close call, but the economies of scale for multifamily investments win out for us at the end of the day.
Welp, that’s a wrap! Multifamily takes the cake and stays on the island with three points compared to two for single family. If you’re a reader of the Birgo Capital blog, we have to think you’re not surprised, considering it’s no secret that we’re a multifamily investment company. We actually do like the single family investment strategy, particularly for beginner investors who are looking to enter into the industry or diversify their portfolios. But, if it’s a matter of who stays and who goes… no question. Give us multifamily, all day long.