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.
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.
Whichever classification the single-family property belongs to, they all share the following features.
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.
One of the main appeals of single-family homes is privacy. Since there are no other tenants, the occupants can enjoy their personal space.
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.
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.
All these multifamily homes share the following features.
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.
Investors can generate income from multiple units within one property, making them more lucrative for those seeking higher cash flow.
While multifamily homes can be found in rural locations, these structures are typically located in densely populated areas like cities and urban downtowns.
For investors, there are a few key differences you must understand between multifamily vs single-family homes.
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.
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.
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.
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.
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:
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 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.
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.
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.
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.
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.
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/