I'm often asked what kind of investment property I personally like best; it's all good, however, diversification and flexibility are of the utmost importance. It's better to own multiple smaller multi-unit properties rather than one large mega-multi-unit property. I am a big fan of two, three and four unit buildings. There are several reasons:

  • You can get a 30-year fixed rate mortgage on these size buildings.

  • You can also get a second mortgage.

  • You can even purchase these buildings with negative cash flow (if you've taken my class, you know I don't believe in buying negative cash flow, but it can be done).

  • These buildings are more liquid; all your eggs aren't in one basket.

In my opinion, there is no other multi-family building investment that has the advantages that a group of fourplexes have. Of course, there are also disadvantages, but personally, I feel the advantages override the disadvantages.

With the 16 unit multi-family building, you have the advantage of economies of scale and management. It's also cheaper on a per-unit basis. However, the financing becomes a whole different animal. You have now entered the territory of commercial loans. Commercial loans are for buildings of five units and above. With a commercial loan, you must have positive cash flow (a good thing), the longest fixed rate period is usually 10 years, but it can be as short as 3 years. After the fixed rate period, the loan can turn adjustable or become due. If the loan becomes due, then you must pay it off. This is a clause that will have been agreed on in the original loan so there are no surprises.

Interest rates, even for commercial properties, are at an all-time low; however, no one can predict where they will be 10 years down the road. You're not allowed to get secondary financing when the property has a commercial loan on it. The only way to get secondary financing would be a private loan, and if the lender finds out, they will become very unhappy - not good.

Diversification and flexibility are very important in this business. Consider this scenario: I want and can afford thirty units, at $5,625,000 with 33% down. So here are my options: I can purchase one building for $5,625,000, but now, everything I have is sunk into that one investment. If I need cash, I would have to sell the whole building. If a disaster happens such as an earthquake, flood, fire and so on to one building, I'll lose it all. Whereas if I stay in my comfort zone (no building smaller than 10 units for the purpose of this example), I can buy three 10 unit buildings. This option gives me greater diversification. If I need cash, I can sell one of the 10 unit buildings and still retain 20 units. If a disaster happens in one, I'm only losing 33% of my assets and income.

So let's say you want to go with the three, 10 unit buildings. You will need to get commercial loans. How hard is it to get commercial financing for multi-family units? As I wrote about last week, the only bright spot in the commercial real estate world is the multi-family market. Part of the reason for this bright spot is there is some money available. The reason there is money is because the government has made it available through the Government Sponsored Entities (GSE's) of Fannie Mae, Freddie Mac and the Federal Housing Association. The other commercial sectors don't have these options available and the cost of the capital is much higher when it can be found at all.

Through the GSE's, multi-family investors can obtain 10-year fixed rate loans far below 6%, a payment schedule based on 30 year amortization and up to an 80% loan to value.

Now Fannie and Freddie will differentiate between stabilized and non-stabilized apartment projects, and they require them to have that stabilized occupancy.

Big is not always better; the numbers, your comfort zone, diversification and flexibility are the keys to successful investing.