Multifamily property is a high-flying opportunity according to some gurus but buying note pools might be a better strategy. How do they compare? That’s what we’ll consider in our final installment of the “Notes vs Alternative Investments” series: Notes versus Multifamily.
When compared side by side, there seems to be a clear winner because of the limitations and liability that comes with one of these investments.
Note Pools and Multifamily Real Estate Investing are both about Volume
Since there are more doors with multi-family dwellings, we’ll compare multiple notes versus multiple doors. Now you may be saying, “it seems you’ve already made up your mind”, but as you will soon see and in concert with his series, were looking at the sum of its parts to reach a conclusion. And you’re always free to disagree with us if you have a different outlook or different goals.
The first thing we need to do is calculate the net operating income that multi-family units will produce in order to compare the two. That means calculating the income you’ll receive from all the units based on the number of doors and local area rent averages. Then we’ll deduct the industry average 50% of rents to cover the expenses for upkeep, marketing, and other aspects of managing a multi-family property. Finally, we’ll deduct the expected monthly mortgage amount from what you have left and see how much profit remains.
On a property with a gross income of $120,000 per year, the NOI might come down to around $36,000 with all those expenses.
Using a mid-range cap rate of 7%, your property cost is going to be in the low $500,000 range.
A comparable note pool that brings in $36,000 per year in net income might cost somewhere in the mid $300s, with the collateral properties valued in the low-mid $400s. But each investor can optimize these numbers for their own tastes. For instance, the pool could contain as few as three assets, or ten or more.
Challenges of Multifamily Investing
Multifamily investments often compound some of the challenges of rental homes, and they have some of their own unique issues you’ll want to consider. Let’s look at three things that you will need to know when dealing with multi-family rentals.
One, buying a multifamily property will limit your location options. You’ll need to make sure your property is in a good location in order to keep it rented.
Two, is tax complexity. It would take too long to go too far into this topic, but if you want a bit more information you can investigate the IRS regulations regarding investment properties. There are many factors that would-be investors are unaware of when looking at these types of investments.
Three, financing a multifamily property can be problematic. Even if you live in one door and take the rental income from the other doors into consideration, qualifying is hard. This strategy works if done correctly, but you’ll want good guidance and judgment in order to keep you from losing money.
Of course, there are other factors that you need to consider as well, like dealing with the same “terrible T’s” of rentals, or dealing with the fallout of vacancies and their effect on your cash flow—not to mention the reserve funds needed to get units back into a showable state.
While these are factors are common knowledge when dealing with multifamily properties, the biggest factor in our comparison with notes is that you’re usually buying units at market value with no discount.
What Do Note Pools Offer in Comparison?
First, you can buy notes in pools. Just like at a warehouse store, the more you buy the more you save. In fact, note insiders know that buying in bulk gives us more discount, so buying more doors gives us a higher yield on our investment. If this strategy fits your investment profile, you can buy a mini-pool of notes at a discount and then recoup some of your investment by selling the least attractive notes individually at a profit.
Second, unlike multifamily properties, location isn’t as important. With notes, we’re able to acquire multiple doors but spread out our risk with geographic diversification. With your doors spread across the country in different markets, your portfolio is balanced, and you can compartmentalize any issues that may arise. And since you have a servicer managing your portfolio, it doesn’t mean any extra work for you.
Third, when it comes to comparing tax complexities, notes are considered personal property. This takes the complexity of real estate tax law out of the equation. Again, this topic is far too deep to cover in this article, but on the surface, notes are definitely more streamlined and easier to keep track of.
Fourth, there’s no complicated bank qualification process with notes, making them more accessible to more investors and allowing you to optimize your asset stack with smaller, more controlled investment dollars.
Note Pools Beat Out Multifamily Real Estate Investing
The biggest takeaway from this article should be that investing in a pool of notes provides more capital diversity, precision risk management, increased flexibility, simpler management, and fewer headaches than purchasing multiple doors of multifamily units.
At the end of the day, if a few notes aren’t performing, a note investor has far more options to protect themselves and even profit. An investor with vacant or poorly located multifamily units is often stuck.
Once again, we think there’s a clear winner by investing with notes. We hope you’ve benefited from this educational series of “Notes versus Alternative Investments”. Notes are a powerful tool for building true generational wealth.
Please contact us if you have questions, or if you’d like us to do a comparison with other investments.