Which is the better property investment?

Which is the better property investment? A single family dwelling or a multi-family dwelling?

Real Estate We come to real estate investment for various reasons. In my experience, investing is usually a means to an end such as creating a desired lifestyle now or at a future time. You’ve already made the decision to invest in residential real estate and now you’re trying to determine which type. This raises the question which is the better property investment: a single family dwelling (SFD) or a multi-family dwelling (MFD) like condominium, town-home, and duplex? I’ll tell you my conclusion right now – It depends. There isn’t a single definitive answer.

As a real estate investor you know that there are a number of factors to consider when determining which type of property in which you’d like to invest. You also know that investing in residential real estate is a low risk, conservative investment opportunity compared to other types of real estate as demonstrated by this table:

1 = Highest risk, 6 = Lowest risk

  1. Raw Land
  2. Hotels – Motels
  3. Resorts
  4. Industrial
  5. Commercial
  6. Residential

House vs condoWith this in mind, let’s take a closer look at the question of SFD investment properties vs. MFD properties such as condominiums and townhouses.

Some people will argue that SFDs are the better investment as:

  • there aren’t any strata or Home Owner Association (HOA) fees or official special assessments.
  • you have control over the condition and maintenance of your SFD compared to the fact that MFDs have common property as well as very close neighbours who may not take the same level of care of their property as you do yours.
  • SFDs typically appreciate more as they include a larger land component relative to the dwelling than MFDs , but bear in mind they can also have greater corrections when the market is in a down turn.
  • Depending on the market conditions, SFDs may be more liquid/sell more easily than MFDs at times.
  • SFDs can have a lower tenant turnover rate, as they attract families which tend to have a greater need for stability in their housing (particularly if they have children); there can be higher turnover in tenants in a MFD with the accompanying costs in obtaining new tenants, making repairs, etc. Regardless of whether you manage your property directly or have a property management company each tenant turnover cost money and/or time.

Others will argue in favour of investing in a MFD especially those that:

  • have a great location, especially in an urban market.
  • are in a well-maintained building with a solid contingency/reserve fund.
  • are in a market that is trending upward and has good opportunity for resale in the longer term.
  • have good cash flow – the rent to purchase price ratio in MFDs is usually much better than that for a SFD, you can typically achieve a higher monthly gross income for a lower cost with a MFD.
  • provide the opportunity to invest in more than one unit within the MFD property; this also has the potential advantage of reduced vacancy risk which is always 100 percent when a SFD is vacant.
  • have a larger number of individual owners (more than 4), as the operating, repairs and maintenance costs are shared amongst the owners so that you gain economies of scale, unlike SFD where the owner is generally responsible for all the operating, repairs and maintenance costs.

I believe that both SFDs and MFDs have to be a part of your strategic real estate investment portfolio, so it’s important to consider both types of properties. For each investment opportunity you should consider:

  1. your desired outcome as an investor,
  2. your skill set and involvement beyond making the financial investment,
  3. the property location and opportunity, and
  4. your risk tolerance as an investor.

Desired Outcome:

opportunitiesIf your desired investment outcome is a short term flip-style investment, then either type of property can work well for you. In order to be successful, you need to know your market, stick to your budget for purchase price and renovation costs (if required) and be sure that your market has the capacity to give you a good resale price in the timeline that you need. I caution investors who wish to go down this path as, in my experience, many individuals and developers have been caught by trying to flip or sell during a down-turning market when their projections were based upon a flat or rising market. Market timing can be your friend or enemy. The tax implications for a short term flip are also quite different from a longer term rental property investment and this will impact the return on your investment.

However, if your desired outcome as an investor is to have a property that provides good cash flow and holds its value for resale in the longer term, then you should include both forms of residential properties as this creates diversification within the asset class. Appreciation is a function of the local market and can’t be controlled by the investor, but you can control your knowledge of the local market and use that information in making your purchase, determining the level of improvements and deciding when to sell.

Some investors prefer MFDs, as their purchase price is typically lower than a SFD and this may afford the investor the option of purchasing more than one unit within a MFD or area, or even across multiple areas/markets for the same financial investment as that of a single SFD. As noted above, MFDs may also have a better rent to purchase price ratio than a SFD especially in mature, high demand markets with constraints like Vancouver. MFD units are also attractive to first-time buyers and people downsizing from their houses because of comparatively lower purchase pricing and a more carefree lifestyle as the maintenance is taken care of through the condo/strata/HOA fees.

Housing purchase prices are based upon the supply and demand of the local area/market, while rents are primarily based upon renter affordability. This means it’s important to do your research and understand the local market as this ratio varies not only between MFD and SFD properties, it can also vary greatly from neighbourhood to neighbourhood, from city to city, and region to region. Check the MLS and rental websites to get a handle on this ratio for the area in which you plan to invest. I also refer you to my recent article on what makes a good cash flow property to understand more. For many investors MFDs may be more affordable, especially as they start to build their strategic real estate portfolio.

Skill set/Investor involvement:

Strength vs weaknessAs an investor it’s wise to play to your strengths and be aware of your weaknesses.

If you enjoy home renovations and improvements, and have the time, equipment and expertise to do them, then you may prefer a short-term flip-style investment approach where you can add significant value through renovating the property. But remember that doing the work on the property is one thing, understanding and capitalizing on the market fundamentals and trends is another. As a “handy” person you may also be prepared to take on a SFD or MFD where you do all the property management.

Maybe you’re the type of person who likes to do research and becomes very knowledgeable about a particular neighbourhood or area – you know which properties you want to purchase in that area, how much you want to pay and are prepared to wait for them. Or, you might be very interested in negotiating the deal to purchase or sell a property.

You may like to do it all, or you may be a more passive investor, as your time and energy is focused elsewhere. Remember, if you have a full time job, “doing it all” for your strategic real estate investments may turn out to be more than you can effectively handle or enjoy. As time is a limited commodity for all of us, you really need to value your own time and ensure that you don’t burn yourself out as mistakes can be made when you’re overextended.

It’s important to know what your strengths are as an investor and how much time you have to be involved in identifying and managing your investments. I suggest you play to your strengths and delegate your weaknesses, and that this may influence whether you have a preference for MFDs or SFDs as investment properties.

Location and opportunity:

finding great cash flow propertiesFor a rental income property, both SFD and MFD, the property needs to be in a desirable location. There’s no point in buying in an area where no-one will rent if the purpose of your investment is cash flow from rents. Likewise, you might purchase a property for a song but if there’s no opportunity for resale then it’s not a sound investment property. In an active major market, like Vancouver, Calgary, Edmonton or Toronto, where MFDs make up most of the new construction, it’s tempting to buy what you can regardless of location. Once again, this isn’t necessarily a sound strategic investment unless you have a market of potential renters and/or good resale opportunity. This is where understanding what’s happening in specific neighbourhoods becomes increasingly important:

  • who is moving in or out,
  • what industries or commercial growth is present,
  • is the local infrastructure being improved? And if so how and when?

Understanding the impact of transportation, economic growth and any demographic changes within an area in a busy market is critically important. In Vancouver, this situation is profoundly demonstrated with the growth along the “once rough” Main street corridor as a “desirable” place to live and similar shifts along Fraser Street. In Vancouver, the highly desirable west side can’t move any further west, it can only move east. Housing tends to be less expensive as one heads to the suburbs, but there is a cost to that in terms of transportation and time. Families tend to buy or rent the homes in neighbourhoods where their children can play outdoors, are safe and can get to school easily. This is one of the reasons many cities experience outward growth to the suburbs. We are also now seeing smaller families that are adjusting to condominium life and staying in the urban centres due to affordability and convenience. As always, do your research and make sure you make an investment you’re comfortable with for both the current and the future and not just one that’s “too good to be true”.

Risk tolerance:

risk toleranceEvery investor has their own level of risk tolerance, for example when we’re young we’re typically more risk tolerant, but as we age we become more risk intolerant. It’s important to understand your level of risk tolerance and ensure that the risk of your investments matches your risk tolerance. Let’s face it, most of us want to reduce our risk whenever possible.

In addition to other investment vehicles, diversifying your real estate investment portfolio by investing in both SFD and MFD properties can be an effective way to reduce risk. Each type of property has pros and cons with respect to steady month over month cash flow and/or resale value and opportunity. For example, the vacancy risk for a SFD is 100 percent when a tenant leaves until your property is rented again, however with a MFD (if you have opted into a rental pool program with other investors in the property or own multiple units in that complex) tenant turnover usually means that there’ll be some income flow from rented suites, even when you have one that needs to be re-rented.

Geographic diversification is another effective way to reduce risk. Being aware that there can be different opportunities for SFD and MFD property investments in different locations is an important consideration. Real estate moves in cycles, so investing in different geographic locations and different types of property may help to even out the ups and downs experienced by one type of property vs. the other.

In conclusion:

It’s easy to get caught up in the “Is it better to invest in SFDs or MFDs?” question, but the wise investor realizes that the answer is “It depends” and I recommend that you be prepared to investigate both types of properties to determine the right strategy for you. What’s more important for your portfolio is that investing in residential real estate will always be effective as “housing” is one of the three basic human needs. Remember that beyond whether or not a property is a SFD or a MFD, each property will have its own unique set of characteristics that may make it an appealing and appropriate investment for you.

keys to successIn order to be successful in real estate investing, there are a few things you need to do:

 

  • develop a plan, review it regularly, adjust as necessary
  • have a team of experts to help you,
  • pay attention to local real estate trends regardless of whether your property is SFD or MFD,
  • take action, and lastly,
  • Review your portfolio and know when to implement your exit strategy.

At Strategic Investment Realty, we assist hundreds of busy clients who wish to build a real estate portfolio that they own and control, but don’t wish to create a new job for themselves.

Happy investing and good luck!

 

 

By Andrew Schulhof
28 Aug 2014