There are plenty of property types available for investors who want to build their portfolio with real estate investments. Two of the most popular categories of real estate are single-family and multifamily properties — residential structures that serve as living spaces for tenants.
Choosing between these two classifications can be difficult for first-time investors. Thankfully, Realized 1031 has shared a blog post about single-family vs multifamily properties. We’ll dive into their differences as well as the potential and challenges you can expect. Keep reading to learn more.
What Are Single-Family Properties?
As the name implies, single-family homes are meant to house one family. The most common type of single-family property is the detached house, which stands on its own and is typically found in suburban communities. However, there are plenty of other types of single-family homes, such as the following.
- Townhouses: A townhouse is typically a multi-story, single-family home that is attached to one or more similar homes in a row or a cluster, sharing one or more walls with adjacent units. Townhouse owners usually own both the interior and exterior of their unit, including the land it sits on.
- Bungalows: Bungalows fall under detached single-family homes, but the key difference is that these properties have a single-story and an open floor plan.
- Cottages: Cottages are smaller homes with charming architectural details. These are often located in rural areas.
- Luxury: Luxury single-family properties are custom-built homes located in exclusive neighborhoods. These often have premium amenities, large tracts of land, and high-quality finishes. In general, properties valued at $2 million and above are considered luxury properties.
Whichever classification the single-family property belongs to, they all share the following features.
Exclusive Use
The tenant has exclusive use of the property. The owner or landlord may not enter into a contract with another tenant while someone is currently renting the space.
Privacy
One of the main appeals of single-family homes is privacy. Since there are no other tenants, the occupants can enjoy their personal space.
Variety
Single-family homes can be found in rural, suburban, and urban locations. This variety gives investors more choices depending on their risk tolerance or investment goals.
What Are Multifamily Properties?
In contrast to single-family homes, multifamily properties can house several households. These properties have separate residential units all located within the same structure. There are separate entrances for each family. Kitchen areas, utilities, and bathrooms are also distinct for each household. However, the tenants usually have some shared common areas, such as gardens, lawns, and laundry rooms. Here are a few well-known types of multifamily properties.
- Apartments: Apartments are rows of residential units in a building. The building typically has a single owner, and the rest of the occupants are tenants.
- Condominiums: Apartments and condo buildings are similar in physical description. However, each condo unit is typically owned by one entity and may be rented out privately. Another key difference is that condominiums can be high-rise buildings with millions of square footage.
- Duplexes and Triplexes: These are detached residential buildings with separate units for each household.
- Age-restricted Properties: A well-known example of this property type is senior homes. These structures are similar to apartments or duplexes, but they have distinct amenities that make them ideal for aging residents.
All these multifamily homes share the following features.
Shared Spaces
Compared to the exclusive use of single-family homes, tenants in multi-family properties share various areas within the building except for their individual residential units. These areas include recreational spaces, lawns and gardens, hallways, and parking spaces.
More Sources of Potential Income
Investors can generate income from multiple units within one property, making them more lucrative for those seeking higher cash flow.
Located in High-Density Areas
While multifamily homes can be found in rural locations, these structures are typically located in densely populated areas like cities and urban downtowns.
Difference Between Single and Multifamily Properties
For investors, there are a few key differences you must understand between multifamily vs single-family homes.
Legal Distinctions
Single-family structures are considered residential real estate, and the same applies to multi-family homes with four or fewer units. Multifamily homes with five or more units, however, are considered commercial real estate property. Understanding the difference between these two categories is critical because of various legal, zoning, and financing requirements.
In 1031 exchanges, for example, multifamily homes are usually the only type of property qualified for the like-kind swap. Single-family homes, specifically ones that serve as the primary residence, aren’t held for investment or business purposes — a primary requirement for the 1031 exchange. Thus, these do not qualify for the swap.
Zoning
Cities have strict zoning laws for either property type. For example, multifamily homes must have features like fire escapes, adhere to ADA requirements, and ensure that setbacks are at appropriate distances. These regulations are usually meant to support community-oriented living in high-density areas.
Single-family properties, on the other hand, have their own distinct requirements. Local zoning authorities may impose minimum lot sizes to ensure adequate space for the home and any required setbacks. Another unique zoning requirement is how residential properties cannot be used for business purposes, such as holding a daycare center or short-term rentals (such as Airbnb) unless specifically permitted.
Financing
Another area where these two property types have a major difference is financing. Single-family homes are typically easier to finance with a conventional loan. In addition, the requirements set by lenders or banks are typically more lenient. Single-family properties with four or fewer units usually qualify for conventional loans, making them more accessible to small-time investors.
Given how multifamily homes are considered commercial real estate when they have five units or more, lenders may not readily approve a conventional loan. As such, most investors who want to purchase multi-family properties need a commercial loan. The mortgage for these loan contracts is different from conventional ones. You can typically expect higher down payments and stricter income requirements to qualify.
Pros and Cons of Investing in Single-Family Homes
For investors who are considering single-family investments as an addition to their portfolio, here are some of the pros and cons you’ll want to keep in mind.
Pros
- Lower Cost: Since these types of properties are generally smaller compared to multifamily investments, they are generally more affordable. New investors with modest capital will find single-family homes more accessible.
- Privacy and Space: A lot of tenants want their own space away from the busyness of shared properties. Single-family properties address this need, making these investments constantly in demand in the rental and resale markets.
- Easier Management: Since investors are dealing with four or fewer residential units, maintenance and tenant management become easier for investors.
Cons
- Loss of Income During Vacancy: This challenge makes the most impact on single-family homes housing a single household. Once they’re gone, the owner will experience an interruption to their cash flow. Even so, tenant turnover rates for single-family homes are relatively low, with an average of only once every five to eight years.
- Limited Cash Flow: In connection to the loss of income during vacancy, single-property homes generally offer less income potential compared to multi-unit investments.
- Can Actually be More Expensive: In most cases, when you compare the ratio of income per square foot or income per unit, single-family homes can be more costly.
Pros and Cons of Investing in Multifamily Homes
A multifamily investment has its own advantages and disadvantages. Understanding these considerations is important to help you make more informed decisions before committing to such a large venture. Here are some common pros and cons:
Pros
- Higher Potential for Income: Given that you own more residential units, you have a higher potential to generate more revenue.
- Vacancies Will Have a Lower Impact: Even if there’s one unoccupied unit, you won’t feel financial stress or disruptions to your cash flow. Most investors try to keep their vacancy rates at 7%, and anything higher can begin making an impact on your revenue.
- Cheaper Than Single-family Homes: When the ratio between square feet and number of tenants is compared, multifamily homes are more cost-effective. You can house more people in a smaller area, helping you potentially maximize your revenue.
Cons
- Considerable Upfront Costs: The cost of acquiring a multi-family home is significantly higher than single-family properties. Plus, there are more complex financing requirements that may discourage first-time or newbie investors from trying out these properties.
- Intensive Management: Unless you’re part of a Delaware Statutory Trust (DST), triple-net lease, or similar low-involvement schemes, you will need to play an active hand in managing the multifamily investment. This demand may discourage investors who want more passive investments.
- Higher Tenant Turnover Rates: Compared to single-family homes, these properties typically have higher turnover rates, especially if your lease contracts are as short as six months to a year.
Investment Methods for both Single and Multifamily Properties
Investors can add single and multifamily properties to their portfolios through various investment vehicles. Which one is the best for your needs and investment goals?
1031 Exchanges
1031 exchanges are a method of investment where investors swap a property for another under the same asset class. The main reason why this particular investment strategy is popular is the tax deferral benefits, with an investor being able to potentially continue deferring capital gain taxes until a constructive receipt is made.
This investment strategy works l for both single-family and multifamily properties. The former is a well-known property type swapped during a 1031 exchange because of the income potential and scalability. However, even single-family properties can be swapped so long as the house follows IRS rules. For example, a duplex can be exchanged for another duplex or triplex. However, a duplex cannot be exchanged for a primary residence since a primary residence isn’t used for productive or investment purposes.
Delaware Statutory Trusts
DSTs are an investment vehicle that uses the 1031 exchange process, allowing investors to buy shares of the trust instead of the investment property. Due to this structure, single-family homes are not generally used for DSTs. Sponsors will usually prefer commercial properties, especially ones that are large enough to provide income for more than one investor. Multi-family homes are the standard for DSTs.
NNN Leases
A triple-net lease or NNN lease is ideal for single-family properties. The most common application of NNN leases is larger commercial properties, but single-family companies leased by corporations also enter such arrangements. In these situations, the tenant handles the three net operating expenses: taxes, insurance, and maintenance. Multifamily properties rarely utilize NNN leases due to shared maintenance responsibilities. It’s much more difficult to organize this net operating cost when there are many tenants involved.
Tenancy in Common
Both single-family and multifamily properties work well in tenancy-in-common (TIC) arrangements. In particular, a TIC structure helps single-family property investors pool resources to purchase assets in high-demand areas. Multifamily properties are also popular in TIC arrangements, allowing investors to co-own a property while sharing income and expenses.
UPREIT
Umbrella partnership REITs (UPREITS) are ideal for either property type, but favor more towards multi-family homes. Specifically, multifamily properties offer a high potential for steady income among UPREIT investors. Single-family homes still qualify, but they are less frequently associated with UPREITs. This property type offers similar advantages, but the potential for income is much lower, and it may fail to satisfy the investment goals of the trust’s many investors.
Wrapping Up: Single-family vs. Multifamily Properties
When it comes to residential properties, single-family and multifamily properties are the two categories for investors. Each one has properties that make it ideal for various investment goals. For example, single-family properties, thanks to their small footprint and single household, are easier to manage and access for newbie investors. On the other hand, multi-family homes are ideal for investors who want a potentially higher income from a higher number of tenants. Even so, either option has its own advantages and disadvantages you must take into account before putting your capital into your top choice.
For more details about these property types and the ways you can invest in them, Realized 1031 is here to help. Contact us today to schedule an initial consultation.
Sources:
https://www.bankrate.com/real-estate/what-is-a-single-family-home/
https://www.bankrate.com/real-estate/luxury-real-estate/
https://www.bankrate.com/real-estate/single-family-vs-multi-family-homes/