Reason #1: In residential (1-4 units), vacancy is a returns killer.
Reason #2: Commercial multifamily holds up well in recessions.
Reason #3: Operating expenses are typically lower/unit in CMFR
Reason #4: Economies of scale make CMFR more passive-like investments
Reason #5: CMFR value is more within your control than Residential value
Reason #6: Attractive financing for CMFR
As anyone who has bought a house knows, dealing with banks can be more intrusive than getting a colonoscopy–only slightly kidding. They underwrite you as a borrower so they’ll want your latest tax filings, credit report(s), pay-stubs, explanations for recent credit inquiries, and possibly even your first-born child. Banks are risk-averse, so they’re evaluating you as a borrower because they want to know that you will make good on your note. In the CMFR world on the other hand, more important than the borrower’s creditworthiness is how the property performs. Without getting too far into the weeds (if you’re interested further, see this article), commercial deals are underwritten by lenders on the merit of the property’s profitability itself rather than you as a borrower. What does all of this mean? If the deal is juicy enough, the bank will provide you with options that you won’t get anywhere in the residential financing space: long interest-only periods, non-recourse debt, etc. While the operator’s (investor) track record and credit history does still matter, it’s less of a concern than whether the deal makes sense on its own merits.
Reason #7: A dollar saved is a $16.67 earned
Let’s say you own 20 single family homes each worth $50k. Your portfolio is $1mm and you’re sitting pretty just letting the mailbox money come in every month. One day, you decide to increase rents by $10/month for each house. How much is your portfolio worth now, given this increase in income? Sadly, your portfolio is still worth $1mm. Residential real estate (again, 1-4 units) is valued based on comparables. If you’ve increased your bottom line, that’s great for you but your house will still be tied to the worth of your crazy neighbor Tom’s house–yes, he made a reappearance this month. Now instead let’s say you’re a savvy investor who owns a 20-unit apartment complex also worth $1mm. That same $10/month per unit will equate to a $40,000 increase in the value of your complex at a 6% capitalization rate! If you’re wondering what a cap rate is, see this article for further details or schedule a call with us. It’s basically a discount rate that’s used to value a $1 of income in CMFR investing. Why the disparity in the valuation either portfolio? Put simply, CMFR assets are valued just like a business: based on their profitability. If you don’t believe this, see the math below. Now, your neighbor Tom’s affinity for hoarding broken down Chevy’s on his lawn won’t hurt your pockets. Take that, Tom!
Math behind the money:
$10/unit/month * 20 units * 12 months = $2,400 in additional annual net operating income
$2.4k/6% cap rate (assumption) = $40,000 increase in the value of your portfolio
Reason #8: Tax benefits of CMFR
While there are certainly tax benefits of investing in real estate regardless of the vehicle, investors in larger assets like CMFR have the most to gain. What’s the #1 reason why most real estate magnates pay such low effective rates on their taxes? Depreciation! It’s often said that “it’s not what you make but what you keep that matters” and we could not agree more. With that in mind, combining investing in CMFR assets and a crafty real estate CPA will ensure that you keep as much as legally possible. We at Maple Capital Partners have employed cost segregation studies and bonus depreciation to reduce our taxes on properties to as low as 0% in the first few years holding these investments! A discussion of how this is possible is probably too long for this post but if you’re interested, check out this video for more on the benefits of cost segregation and how it works. Side-note: Want to blow an hour and a half at your next meeting with your tax accountant? Ask them about the benefit of depreciation on reducing your taxes. The experts certainly understand the power of this tax strategy and so should you!
Reason #9: Virtually the same amount of work for both
Talk to any seasoned investor in the multi-family space and they’ll say the same thing: It takes virtually the same amount of preparation, due diligence, and attention to detail to take down a 4-unit and a 40-unit property. This is astounding to most outsiders but we’ve seen it first-hand. In either case, you’ll be paying inspectors, drawing up scopes of work with contractors, coordinating site surveys, doing lease audits, and performing your own due diligence on the property and operations before close. The only major difference is the number of zero’s on the loan documents. We say that cheekily, but it’s closer to the truth than most investors expect (see here). So knowing that, why not invest in the 40-unit where small, incremental changes (see reason #7) can have a way more out-sized impact on your wealth? Why play small when it’s the same amount of work?
Reason #10: The opportunity to take care of more tenants
While most of the reasons up to this point have been based around the idea of CMFR being a better investment than residential (1-4 unit) assets, we at Maple like to believe that there’s more to life than just the dollars and cents. When we invest in properties, we’re not only thinking about the financial impact of the assets on the lives of our families and our investors… we’re also just as excited about improving the quality of life for our tenants. It can sometimes get lost in all of the talk of net operating income and operating expenses per unit, but at the end of the day, we’re all compensated for providing value to others’ lives. For some of our clients, that means living in an apartment with renovated kitchens in which they can prepare meals for their families. For others it may mean speedy response times to work orders and maintenance requests. Bottom line: any worthwhile business is built around meeting the needs of its customers and, for us, that means providing safe, affordable, and clean communities in which to live. It’s our privilege to not only serve our investors but also be a part of the everyday lives of our tenants. With that in mind, we would rather improve the lives of 1,000 than 100.
The Bottom Line:
While there are definitely more than 10 items we could think of, these have been the top 10 reasons we prefer commercial multifamily vs. residential real estate investment. We hope you’ve found this post useful and hope you’ll reach out to our team with questions, suggestions, or just to chat. Until then, be well, be grateful, and be charitable! Speaking of, see below for our quarterly spotlight on a charity we believe is making a positive difference in the world.