I get this question often. “Of all the types of rental property, is there one type you’d recommend for a first timer?”. Not trying to be evasive, but my answer is always “it depends”. When I meet a new investor for the first time, this is usually a 20-30 minute discussion. Initially, I like to ask some probing questions to help develop an opinion about what types of properties may be best for them starting out, such as:
- This may seem obvious, but how much money you have to invest will play a major roll in what type/size of buildings you should look to purchase.
- Why are you buying investment property and/or how many are you planning to acquire eventually?
- How active can you (or want to) be in the properties and/or how busy is your life?
- What area(s) do you want to own investment properties?
Here are some characteristics that can help you narrow down your focus:
Single Family Home or Townhomes as Investment Properties
- There is less cash investment required to buy single family houses than multi-family, but when the property is vacant there is $0 coming in. Fortunately, it is easier to sell single family investments as it can be sold to either another investor or to a family (owner occupant), especially in hot markets.
- In my opinion, single Family Rentals typically have lower management/time requirements as the tenants often tend to be former homeowners that will require less attention.
- Finding single family houses is simple as they are everywhere, although some neighborhood price ranges may not support rentals.
- As you increase the number of single family houses, management will increase, ie: owning 12 single family houses can be significantly more accounting work than three 4-plex buildings. You will also have 12 roofs, 12 furnaces, 12 water heaters to maintain versus the 4-plex buildings that may have common elements. Ask me sometime what it was like to self-manage 28 units across 15 properties before I started a management company!
- Leasing single family houses can be easy or difficult depending upon the rent amount you are looking for. If your rent is just a small amount about the price of a comparably size apartment it is easier.
Duplex or Triplex Rentals
- These properties require an additional cash investment, but typically they generates larger cash flow. They can be often sold to an owner-occupant that wants to rent the 2nd side for additional income.
- Duplexes can be maintenance nightmares depending upon how/if it was converted from a single family house into a duplex. I have seen many terrible conversions that have poor space planning. The other problem is often the mechanicals are a mess. Whenever possible, you should attempt to find a duplex that was originally built as a duplex or one that was properly/logically converted (including having separate utilities for each tenant to minimize the landlord’s expenses).
- Duplexes are more prevalent in some neighborhoods than in others, but can be found almost anywhere.
- I believe that every investor should have a few duplexes in their portfolio to diversify their holdings. Duplexes are a good combination of multi-family pedigree with a single-family demeanor.
- You will find that, although leasing duplexes can be easy, having adequate storage space and laundry facilities for both units can be a challenge depending upon the layout of the building.
4-Plex Rental Properties
- Buying a 4-plex, as expected, requires a larger cash investment, but will often generate enough cash flow to still cover expenses when one unit is vacant. Typically these buildings are never owner occupied. Depending upon the condition, larger cash reserves may be required for larger repairs (roofs, boilers, etc).
- Because you have four units under one roof, you are beginning to take advantage of economies of scale, ie: even though you have four units, there is one front door, one roof, one yard to mow. Maintenance can typically still be done at residential standards, but may cost more because of the size. The majority of 4-plexes were built as 4 unit buildings and are therefore easier to maintain and will have held up better over the years of being a rental.
- Most 4-plex properties are in older, central neighborhoods such as Minneapolis or St. Paul. Very infrequently will you find more than one or two in newer suburbs.
- Owning a 4-plex building can require more time and management than smaller buildings because they often have common hallways and common mechanicals that smaller buildings do not have. This additional work should be off-set by the potential for higher cash flow.
- When you are leasing an apartment in these buildings, you will be competing with larger buildings on rent and amenities. A problem tenant can also affect the other tenants and turn it into 4 unhappy tenants.
Large Multi-Unit Rental Properties (5+ units)
- Buildings larger than 4 units will require commercial financing which will have higher interest rates, typically 5 year loan lengths (on 25-30 year amortizations), and 25% down payment requirements.
- These buildings can require large cash reserves as they often have commercial grade mechanicals. Replacing a roof or a boiler may be a $20-30,000 project. Some mortgage companies may even require that you set up a reserve account up front. The lender on one 40 unit complex we own required us to put up $75k until we could show that we got the income stabilized on the property
- You will again enjoy even better economies of scale if purchase correctly with larger cash flows.
- Tenants in larger buildings tend to be less loyal to the building/landlord and will move more often. You may be working on leasing a unit almost every month.
As you can see, each building style has different pros and cons.
You’re probably saying: “He still hasn’t answered the question!”. If I had to vote and give my preferred building for a first time investor (without any other factors), I would recommend a duplex. I think they are easier to manage as tenants are more loyal and stay longer, they can be maintained just like a single family house, they are normally easy to find and sell, and they will often cash flow and appreciate nicely. Sorry you had to read so much to get the answer…like I said, this is normally a 30 minute discussion!