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I’ve met many investors who believe that the smart way to enter the multifamily market is to start small and then “graduate” to buying larger multifamily properties. From my experience, that is a misconception that should be addressed because it prevents those investors from enjoying the many benefits associated with larger multifamily assets. I skipped the small multifamily properties and single-family homes and went straight to large multifamily properties, and I have learned that these are the three most common misconceptions that prevent others from doing the same.
But first, let’s talk about what is considered a “large” multifamily property and what is thought of as a “small” one. Though there is no official definition, large properties are usually 100 units or more, while small properties are less than 100.
Misconception No. 1: Smaller Properties Are Easier To Manage
“Smaller properties are easier to manage” is one misconception that I hear from investors all the time. Actually, the opposite is true. Having a professional property manager is critical on larger properties, because it can become a full-time job for you if you don’t hire one. They’re involved in every aspect of running the property and dealing with tenants, including rent collection, leasing units, dealing with tenant complaints, move-ins and move-outs, hiring a team to maintain the property, and so much more. If you’re planning on doing a value-add deal, the property manager will probably get involved in renovations and upgrades as well.
When you have a large property, you are able to attract a more experienced and qualified property management company due to the fee that they earn. With larger multifamily properties, most property managers receive a 3% management fee from the effective gross income (or EGI, which is income minus expenses, but before you pay the debt payments). On smaller properties, property management companies usually charge 5% to 10% of EGI, but remember that the EGI on smaller properties is much lower. Since larger properties yield higher revenues, it is easier to find more professional property management companies to manage your assets. Dealing with larger and more professional companies makes asset management easier.
Misconception No. 2: Larger Properties Are Harder To Finance
If you think financing is easier on smaller properties, think again. Most lenders are more interested in working to lend you money if you’re planning on purchasing a larger multifamily property. The government guarantees agency loans from Fannie Mae and Freddie Mac, and the bulk of these loans fall into the $1 million to $10 million category, with $1 million being the minimum on most agency loans.
Because agency loans are guaranteed, real estate investors can usually get lower interest rates on their loans with larger properties than smaller properties that do not qualify for such loans. Additionally, unlike loans for smaller properties, where lenders heavily rely on the borrower’s credit score, with large multifamily properties, lenders rely mostly on the property’s income.
Smaller properties, which would require loans of $100,000 to $1 million, are best suited for bank loans. Bank loans are often recourse loans, meaning the lender can go after the borrower’s personal assets if the loan defaults. Agency loans are generally nonrecourse loans, which are preferable for borrowers.
Misconception No. 3: Buying Larger Properties Takes More Time
The third major misconception people have is that finding and managing a larger multifamily property requires a lot more work and money than managing a single-family home or a small, 20-unit property. The reality is that finding and negotiating a 100-unit apartment building does not require much more work than a 20-unit apartment building. You might have to walk 80 more units during the due diligence process, but finding this deal and the entire legal negotiation takes almost the same amount of time. Hence, there is a significant economy of scale here: The time it will take you to find and close on a single 100-unit property is much better than five deals of 20-unit apartment building each.
Summary
The “start small and gradually move up to larger properties” concept is filled with misconceptions. Instead of it being easier to manage a smaller property, it’s actually easier to manage a larger one. That is thanks to the fact that you’ll be able to bring on a property manager or management company to handle most of the responsibilities of day-to-day operations. Financing is much easier on larger properties as well, because agency loans carry lower interest rates and often better terms than the bank loans used for smaller property purchases. Finally, you will begin to see economies of scale in larger multifamily properties that allow you to build your portfolio quickly, instead of taking the longer path through small properties.