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This short article will briefly highlight the differences between residential and commercial multifamily properties. Residential multifamily applies to assets between 2-4 units. This includes duplexes, triplexes, and quads. 5 or more units fit into the commercial multifamily category. Although lots of investors plan to move into larger commercial family after residential, there are things to consider for both.
Competition
Believe it or not the competition is often more strenuous in residential multifamily than commercial. The truth is there are more residential family investors than commercial. The smaller residential deals are less intimidating and small mistakes have smaller consequences. Also, the cost to close is significantly less. Most investors can take these deals down by putting their names on the mortgage documents and making the down payment with cash saved. Finally, some investors prefer smaller deals because they never have to partner with other investors and can exercise complete control over decisions affecting the property.
Management
Larger commercial multifamily properties have a lot of tenants, and therefore lots of turnover and maintenance calls. If you are planning on self-managing a large multifamily asset 1) it should be less than 50 doors, and 2) you need to be local. More than 50 doors will typically require out-sourcing property management and some lenders prefer or require this for larger deals. If less than 50 doors, you should not try to manage from outside the geographic location (more than 30-minute drive). You are not going to be the resource the property needs in order to improve NOI, and will likely be selling in the near future. As investors, we love going directly to self-managers who live out of town since they are usually ready to offload the property at a great rate. Don’t be these owners.
With residential multifamily you can usually self-manage, even if you live out of town. Turnover is rare and maintenance requests are too. Plus, you get the experience of managing a property.
Economies of Scale
This is always the main topic amongst investors when debating between residential and large commercial multifamily. Quite frankly, it’s an uphill battle for residential investors to win this debate. Investing in larger deals allows you to scale up your portfolio at a quicker rate for a few reasons
- Purchasing a complex with 100 or 200 units takes nearly the same time and effort as purchasing a residential quadplex. Sure, the cost is more, but you have a team in place and the deal will potentially involve investor capital to help close and cover renovations.
- All of the units are in one place. You have one property manager to handle all the units. Most residential investors we talk to try to stay in the same market because scaling up with properties all over the U.S. creates logistical headaches and means you are managing too many property managers. In doing this, residential investors limit themselves to a single market.
- The value-add strategy is much quicker and easier with more doors. A team of experienced contractors can make improvements to 100 units with matching floor plans at a very quick rate as opposed to moving from house to house and encountering different challenges at each door.
Lending
Lending is one edge we give to residential property investing. Residential investors enjoy residential lending which entails a 30-year fixed rate that is usually lower than commercial debt. Commercial lending is usually done by small local banks and is due in 5 to 10 years. This means commercial investors are required to either pay off the mortgage in a short amount of time or refinance. Most commercial investors look for favorable terms during this period such as interest-only payments over a number of years to leave room for capital expenditures and investor distributions.
Conclusion
Smaller residential properties are a great place to start investing in real estate, but as with anything you should choose the path that most aligns with your investment goals. If you are trying to replace your income quickly then commercial multifamily is probably the best path. If you know your local market well and have the bandwidth to self-manage then maybe residential investing is a suitable path.
