Real estate investing has been one of the main, preferred investment vehicles for thousands and thousands of years! Owning land and property has been an important principle that has been passed from generation to generation all over the world and it’s one of the major factors fueling the beloved American Dream.
Real estate will always have a seat at the table when it comes to investment strategies, and it’s more important to talk about real estate now more than ever, especially with the rapid population growth and the national shortage of affordable housing.
Just like in most industries, there are numerous ways to make money. You can develop properties from the ground up, get your hands dirty and start flipping houses, or put on your landlord hat and start building a portfolio of rental properties, amongst other viable methods. However, all real estate investing strategies are not created equal; some are more active than others and some more passive.
Most people are attracted to real estate investing for the potential of passive income. With this in mind, we’re going to put two real estate investing strategies toe-to-toe and see which one will come out on top.
The Race to $10,000/month: SFR Investing vs Apartment Investing
For our “case study”, we’re going to compare single-family residence (SFR) rentals to investing in apartments through apartment syndication. We’re going to assume that you want to build up an income of $10,000/month or $120,000/year in passive income. It is possible, and even realistic, to do this using either strategy, so we’re going to take a look at which one will get you to $10,000/month faster!
SFR investing, for simplicity’s sake, will be characterized as buying single-family houses with your own money for down payments on loans and then renting the house out for income.
Apartment investing will be defined as buying a property with 50 or more units through apartment syndication deals, in which you are a passive investor, and you and the rest of the partnership rents out the units for income.
The categories we’ll be comparing the two strategies on are risk, scalability, and barrier to entry.
1) Risk
With no risk, there is no reward! All investing strategies have some level of risk associated with it, and there will always be pros and cons list that comes with any investment. In real estate specifically, some investing strategies are considered riskier than others. For example, real estate development is considered riskier than SFR rental investing or apartment investing, and that is where you need to look yourself in the mirror and be honest in identifying your risk tolerance.
The typical monthly cash flow from a SFR rental property is $100-$200/month, which adds up to roughly $1,200-$2,4000/year in positive SFR rental cash flow per property. This profit margin can be very fragile, with the risk of it being depleted, or even going in the red and causing you to come out-of-pocket if there are any maintenance issues. An HVAC system can cause thousands of dollars, but even if you consider less severe issues such as plumbing, this can still cause a huge dent in your profits, with the typical job like repairing faucets, toilets, sinks, or bathtubs costing between $175 and $450 to fix.
Another profit-drainer that must be taken into consideration is any vacancy you may have due to a non-renewed lease or an eviction. When there is no one renting your single-family house, there is no one sending you checks each month, therefore, there is no profit being made. While you may have a heads-up about an upcoming vacancy, what can be somewhat unpredictable are the cases in which old tenants cause your turnover costs to skyrocket.
Just think how quickly costs can add up when you have to repair or repaint walls, get carpets cleaned or replaced, deodorize pet smells, etc. These profit-drainers, can not only impact your monthly profit but can potentially wipe out your entire cash flow for the year.
When you take a look at multi-family rentals and apartments, a major benefit is the risk distribution. You no longer have one unit that can only be rented to one family at a time, you now have multiple units that can help offset vacancies. Isolated instances of vacancies, evictions, and maintenance issues should have a significantly smaller impact on your cash flow, as the tens or hundreds of other units will be there to balance it out and protect the cash flow. This type of risk distribution would not be possible with SFRs until a larger portfolio of 10+ houses has been built.
In the category of risk, apartment investing through syndication better mitigates risk factors.
2) Scalability
The longer it takes you to scale your rental portfolio, the longer it will take you to build your cash flow, pretty simple and straightforward. Now, there’s no argument against the idea that both SFR investing and apartment investing can get you to your $10,000/month goal. The argument, again, is which one will get you there faster, in which the level of scalability will play a major role.
We know that a SFR will average $100-$200 in cash flow a month, and with some quick math, we realize that you’ll need somewhere between 50-100 SFRs to generate around $10,000 in monthly cash flow. There are two fundamental issues with this; the cap of conventional mortgage loans and the amount in down payments that you’ll need to fund these transactions.
The cap on traditional residential loans is set at 10, however, many banks will stop lending after the 4th loan, as this is associated with a higher risk of default. Of course, you can build strategic relationships with local banks and credit unions to get closer to 10 loans, however, after the 10th house, you’ll need to get creative and get private funding or find portfolio lenders.
This leads us to the next hurdle. In most cases, you’ll need at least a 20% down payment on each property, which adds up to around $1,000,000 needed in down payments if we keep it simple and assume you’re buying each house at $100,000. If you make $200,000/ year and invest $50,000 each year, or one-fourth of your yearly salary, to buy SFRs, it would take you 20-40 years to buy 50 to 100 SFRs that would bring in $10,000/month in cash flow at the average cash flow of $100-$200/month per SFR.
If you were to invest in apartment syndications with the same amount of money, you wouldn’t have a cap on the number of syndication deals you can have at one time, unlike the cap on traditional residential loans. Also, if you invested the same $50,000 into a syndication deal with a preferred rate of return of 8%, this would break down to $333/month in cash flow, which is above the average cash flow of a SFR. This doesn’t even take into account the profit you will receive once the apartment is sold in 5-7 years, which would make the average monthly cash flow throughout the life of the deal higher than $333/month.
It’s a clear winner in the category of scalability: apartment investing.
3) Barrier to Entry
The barrier to entry refers to the level of ease to start investing in either type of investing strategy; SFRs or apartment investing through syndications. To invest in SFRs by using conventional residential loans, you typically will need a 640 credit score and above, however, your income can vary as long as your debt-to-income ratio satisfies the lender’s requirements.
To invest in apartment syndication deals you either need to be an accredited investor or a sophisticated investor, with many syndication deals you run across requiring you to be an accredited investor. A sophisticated investor has to be able to prove extensive experience in real estate investing, which can take years to build. An accredited investor has a single net income of $200,000 or more per year, a joint net income of $300,000 or more per year, or a net worth of $1 million or more, not including the primary residence. This creates a higher barrier of entry either in experience or in income when it comes to participating in a syndication deal.
In this case, SFRs win in the category of the barrier to entry.
The Final Score
With a 2 to 1 final score in the categories of risk, scalability, and barrier to entry, apartment syndication comes out on top as the better investment strategy when trying to get to $10,000/year in passive income. Once you’ve overcome either the experience or income hurdles, apartment investing through syndication proves to be the better investment strategy.
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