Pros and Cons Of Different Types Of Investment Real Estate
Pros and Cons Of Different Types Of Investment Real Estate
When it comes to investment real estate there are a number of different options to choose from. Real estate investors can buy single family homes, multi-family homes, and residential properties classified as commercial in order to build an income stream to meet their investment goals. Each type of real estate investment has associated with it different positives and negatives and this article will explore those in detail.
Single Family Residential Home
One of the most common building types available and usually the easiest to purchase is the single family home. A majority of the residential properties on the market today are single family homes. With a single family home an investor is getting a property where generally one family will live and pay rent for. Some larger single family homes can be converted into multi-family homes in order to increase the amount of renters in the property but for this to happen the investor will need to comply with local zoning and building codes. Some areas may only allow single family residences and would refuse to authorize any segmenting of the home in order to add rental units.
The biggest advantage of buying a single family home is the fact that if an investor decides they no longer want to be in the residential investment business they can easily sell a single family home to another investor or to another buyer who is looking to live in the home themselves. Provided there are no tenants in the home, a single family home can appeal to both investors and owner occupied homebuyers which greatly increases the potential pool of buyers. Obtaining a mortgage for a single family home purchase is also somewhat easier compared to multi-family buildings and oftentimes mortgage lenders do not have as strict requirements for borrowing as they would for something that housed more than one family. Whereas many lenders required 25% down for non-owner occupied purchases of multi-family buildings (two or more rental units) for a single family home investors should be able to find lenders who will allow the purchase with only 20% down payment.
A disadvantage to single family homes as an investment method is that there is only one income stream from the tenant currently living in the home. If the tenant were to leave the investor would be getting no rent income while the unit is vacant. With multi-family buildings on the other hand if one tenant leaves there may still at least one or more tenant paying rent.
Multi-Family Residential Investments Four Units And Fewer
Generally multi-family buildings are broken down into two separate categories, those with four rental units and fewer and those with five or more rental units. For buildings with four units or fewer conventional mortgage rules apply which means investors can purchase these types of investment properties with a traditional mortgage or occupy one of the units in a multi-family building and use a traditional mortgage to purchase the building. When occupying a four or fewer multi-family building the owner may be able to put down as little as zero percent to 3.5% down depending on the type of mortgage product they use (VA, FHA, USDA or Conventional). For non-owner occupied multi-family buildings mortgage lenders are looking for at least 20-25 percent down payment.
As an owner occupied buyer the investment owner can rent out all other vacant units and use that to pay their mortgage, taxes, maintenance and pocket any extra money. Some of the advantages of buying a multi-family building of four or fewer units are being able to occupy as an owner which means having lower mortgage interest rates and having to bring less money for down payment. A single family home investment owner could not occupy the home and rent it out under the traditional way of renting real estate. A single family investment owner claiming owner occupied status in order to get better interest rates and a lower down payment but instead renting out the home could find themselves subject to criminal charges for falsely filing their mortgage application.
As noted in the disadvantage above for single family where there is only one income stream from one renter a multi-family investment property allows the owner to have multiple renters with multiple income streams. If one tenant happens to leave there is still rent income coming to the owner from the other units. Lending standards for four or fewer units are a little easier than they are for five or more units as the mortgage products for these still fall under conventional residential loans.
One of the disadvantages with mutli-family buildings is that as each unit has its own water heater and HVAC system the cost for replacing those items can be quite high if they all must be replaced at once. If all the water heaters are located in one place and a fire, flood or something else damages all the units the cost to replace all of them could be quite prohibitive to the owner unless they had sufficient savings. Maybe insurance will cover the repairs but if the insurance is not as quick in getting the water heater and HVAC systems replaced the owner is still responsible to make sure the tenants have hot water, and heat during the cold months otherwise they could find all of their tenants gone at the same time.
One of the major disadvantages when it comes to buying a multi-family building is the limited market for buyers of this type of property. Generally with a single family home any single family home investor and any buyer looking to buy a home for themselves could be a potential customer. With multi-family properties four units and under not many homebuyers want to buy a home to occupy one unit and rent out the rest since the prospect of being a property manager is seen as pretty complicated. Generally multi-family investor buyers are the only ones who will have a real interest in buying a multi-family property and depending on economic conditions there may or may not be enough investment buyers to get the building sold in a relatively short amount of time.
Multi-Family Investments With Five Units Or More
The biggest advantage of this type of investment property is simply cash flow. Having a large amount of renters in one location with effective property management setup, means the owner can generate plenty of cash over and above all expenses associated with running the property. The more units an investment owner can have under one roof generally allows them to be more cost effective in dealing with the day to day maintenance issues associated with multi-family building maintenance. Rather than calling an individual contractor for each and every minor problem, large multi-family investors can keep onsite maintenance personnel who can handle a variety of problems and dedicate their time to making sure the property runs smoothly.
Most of the disadvantages associated with multi-family buildings four units and below are also disadvantages for multi-family investments five units or more. One of the notable exceptions as compared to four units or less is that multi-family investments five units or greater can have a much higher cost. The initial cost can increase quite a bit especially as the amount units under one building or under one sale increases. So whereas a five unit investment may not be that much more expensive than a four unit investment in a similar location, a ten or twenty unit investment will be much more expensive than a four unit investment in a similar location. In order to obtain more cash flow the investment buyer must put in more money to make the purchase.
Another big disadvantage of multi-family investment units of five or great units is that they do not qualify for conventional residential mortgages. Not only can an investor not expect to buy a five or more multi-family investment as owner occupied they also must use commercial mortgages to make their purchase if it is not a cash deal. Commercial mortgages generally have much higher requirements in terms of credit scores, required cash down payment (up to 30%), higher interest rates, shorter payback periods (5 to 20 years rather than 30 years), property management experience requirements and a showing of sufficient cash reserves. The financial and mortgage requirements being tougher limits the buyer pool, which ultimately makes the investment harder to sell.
There are many different types of investment options available for those seeking to invest in residential real estate. Whether the purchase is strictly investment or will involve the owner occupying the home the options should be carefully considered. With different options come different financing requirements as well that can also impact what a buyer is able to purchase.
- Buying Real Estate With No Money Down by Luke Skar
- First Time Investment Property Buyer Tips by Anita Clark
- Should I Sell Or Rent My House by Joe Boylan
- What A Realtor Does For Their Clients by Lynn Pineda
- Real Estate Investments by Investopedia
About the author: The above article “Pros and Cons Of Different Types Of Investment Real Estate” was provided by Luxury Real Estate Specialist Paul Sian. Paul can be reached at paul@CinciNKYRealEstate.com or by phone at 513-560-8002. If you’re thinking of selling or buying your investment or commercial business property I would love to share my marketing knowledge and expertise to help you. Contact me today!
I work in the following Greater Cincinnati, OH and Northern KY areas: Alexandria, Amberly, Amelia, Anderson Township, Cincinnati, Batavia, Blue Ash, Covington, Edgewood, Florence, Fort Mitchell, Fort Thomas, Hebron, Hyde Park, Indian Hill, Kenwood, Madeira, Mariemont, Milford, Montgomery, Mt. Washington, Newport, Newtown, Norwood, Taylor Mill, Terrace Park, Union Township, and Villa Hills.