Property investing is generally divided into residential and commercial categories. Apartment buildings with four or more units are considered commercial investments even though they house residential tenants. In some cases, they are more advantageous than single-family homes and duplexes. When it comes to scale and funding, they cannot be beaten.
Scale and funding are the top two reasons some real estate investors choose apartment buildings over single-family homes and duplexes. With scale comes revenue, and with revenue comes more flexibility in funding options. Combining the two allows real estate investors to build strong portfolios that can easily add up to hundreds of units being rented every single month.
The Economics of Scale
The economics of scale is a principle that dictates the ability to make a greater profit margin as a business grows. It is easy to see the principle in retail. Big-box department stores make a lot more profit than their mom-and-pop counterparts, despite offering much lower prices. How do they manage to do so? By selling more product. Their size gives them access to lower wholesale prices as well. It all adds up to greater profit potential.
We can apply the same principle to rental housing. A single-family home might rent for $2,000 per month as opposed to just $1,000 for a two-bedroom apartment. But a building with four apartments brings in $4,000 per month. On average, investors earn more money per square foot with apartment buildings as compared to single-family homes and duplexes.
Investors can also take advantage of scale in terms of maintenance and repairs. Just like size gives big-box retailers access to better wholesale pricing, scale give real estate investors access to better management contracts and lower prices on bulk supplies and materials.
Funding Commercial Apartment Buildings
In terms of funding, Salt Lake City’s Actium Partners says that real estate investors tend to have an easier time obtaining financing for commercial apartment buildings. It all boils down to risk. Banks and private lenders alike perceive less risk in a large apartment building because there are more renters. With a single-family home, all the risk rides on a single tenant paying rent.
Investors can fund apartment building acquisitions with straight hard money loans. Lenders like Actium Partners only need to see enough value in the property being acquired. Another option is to go with a bridge loan. Under such a scenario, the investor would borrow from a hard money lender long enough to acquire a desired property. Shortly thereafter, they would obtain traditional bank financing to repay the hard money loan.
As far as banks and credit unions are concerned, they do not offer traditional mortgages on commercial apartment buildings. But business loans are another matter. Commercial apartment buildings are considered business opportunities as much as investments, so they are eligible for certain types of small business loans.
Not All Sunshine and Roses
Commercial apartment buildings do make lucrative investments. However, they are not all sunshine and roses. One of the biggest downsides to this sort of investment is a lack of liquidity. In other words, commercial apartment buildings are harder to sell than single-family homes and duplexes. If an investor has to get out quickly, that may not be possible.
Management can also be more difficult with commercial apartment buildings. The more units and tenants there are, the more there is to manage. In simple terms, it is just a lot more work.
Investors looking to put money into residential housing should look at commercial apartment buildings. Scale and funding are the two biggest reasons to invest in them.
