What types of real estate investments bring the best ROI is it the multifamily buildings or the smaller properties and how do you choose?
By Scott Russell
Investors in rental real estate have a lot of options when it comes to the type of properties they buy. From single-family homes to apartment buildings, rental properties vary widely in quality and the number of units in the building. We’ll discuss the differences between various types of rental properties, as well as the features of these properties that affect return on investment (ROI).
Types of Properties
The most common type of rental property is a single-family home. Single-family homes are great for new investors. Many real estate investors start with single-family rental houses because they live in the house for a few years, then keep the house as a rental when they move into another home. Single-family rentals are easy to finance, and they are very desirable for tenants. Many tenants prefer single-family homes over apartments because they offer more privacy and often have additional features like fenced yards for pets and kids.
From an ROI standpoint, single-family homes have some pros and cons. On the plus side, rent rates are usually higher than they are for a similar-sized unit in a multifamily building. They may have garages or basements that provide additional storage, which is another great selling point when the rental is being advertised to prospective tenants. Re-sale is also typically easy for single-family homes, as the prospective buyer pool consists of other investors as well as buyers who want to live in the home.
One downside to single-family homes is that they don’t benefit from the ability to spread expenses over multiple units, as we’ll discuss a bit later. Many investors refer to this as “economies of scale.” Another disadvantage is that there may be some expenses, such as HOA fees or private road maintenance agreements, that aren’t as common with multi-family properties.
Short-Term Rentals vs. Long-Term Rentals
It’s worth noting that single-family homes can sometimes generate higher ROI as a short-term vacation rental real estate investments. However, this arrangement will certainly result in higher expenses, such as additional cleanings between rentals, utilities being paid by the owner, furnishing costs, higher property management fees, and more advertising costs. The rental rate will almost certainly be higher, but there may also be a higher vacancy rate.
For the purposes of this discussion, small multifamily properties consist of two to four units. This is an important distinction, because multifamily properties with four or fewer units are easier to finance conventionally.
Multifamily properties consist of duplexes, triplexes, and quadplexes, as well as single-family homes with an ADU (additional dwelling unit) such as a detached garage apartment or a studio basement apartment. You can find multifamily homes for sale from many real estate websites with MLS listings, and many are localized (like this Asheville multifamily homes page).
One of the big advantages of having an ADU is that the owner often lives on-site, making management of the ADU easy. The ADU may be a long-term rental or short-term vacation rental.
For more traditional duplexes (2 identical units under one roof), triplexes, and quadplexes, economies of scale come into play and create cost savings for landlords. For example, when it comes time to replace a roof, the cost can be spread over multiple units. The same goes for other capital expenditures, such as re-paving a parking lot. Even routine maintenance like mowing the grass and cleaning the gutters is typically less expensive per unit.
Property management firms sometimes offer a reduced management fee if the rental owner has enough units under management. And the owner’s fire insurance policy can be less per unit when the property has multiple units under one roof.
Keep in mind that there are some potential added expenses for multi-family units, especially if they are under construction or otherwise required to be brought up to code. Newer multi-family building codes may require an interior sprinkler system or fire walls between individual units. It’s always worthwhile to check with your local building department to see what safety and code upgrades might be required.
For more experienced real estate investors and corporate real estate investors, larger multifamily properties (five or more units) have a lot of appeal. These properties are typically apartment buildings, but we should include mobile home parks as well.
Experienced “mom-and-pop” real estate investors can buy large multifamily properties, and may even live on the property. For buildings with five or more units, self-management is still feasible, but it also takes a lot of time. It’s certainly worth considering a property manager at this point.
If the property is large enough, there will be an on-site manager. This may be a tenant in an apartment who receives discounted rent proportionate to the number of hours worked for the landlord, or a mobile-home tenant who maintains the grounds at a mobile home park in return for lower lot rent or assistance with a mobile home payment.
Larger apartment buildings (typically 20 units and up) are usually corporately owned. These properties may be owned by real estate investment trusts (REITs), hedge funds, or other entities. Economies of scale are most effective in these types of properties. Usually, the majority of the owners never even see the properties. They are more likely silent equity partners.
About the Author
Scott Russell is the owner of Freestone Properties, an Asheville real estate brokerage. He has been a realtor since 2005, has produced well over $100 million in career volume, and has extensive experience in evaluating the condition and ROI potential of investment properties.