Why choose CRE over Single Family Homes as an investment?
I have a hard time justifying to people why CRE is objectively a better investment vehicle than single family homes (more often than not).
My strongest argument is that it allows for scale. With, say $10MM to deploy, it's much harder to identify and transact on rental homes compared to one or a handful of CRE properties. This difficulty is compounded when you factor in 1031 exchanges.
Besides deploying capital, there's also the property management aspect. Assuming one has the expertise (granted, a big assumption, but I'm speaking to a CRE crowd here so...), managing a single $10MM office building is less labor-intensive than managing 100 single family homes. Simply consider the costs of yearly renewals vs. 3, 5, 10-year renewals. The advantages of scale with CRE is more obvious when you take a more apples-to-apples comparison with a multi family property. A 1,000-unit apartment is easier to manage than 100 SFH's, by several multiples (assuming those SFH's don't just make up one entire neighborhood).
However, I can think of some counter-arguments. For one, CRE doesn't benefit from greater tax advantages (though not sure how Opportunity Zones might come into play?). As I understand it, the lengthier depreciation term doesn't add value since investors typically depreciate the entire asset over just a few years.
There's also the risk involved in buying a building with low tenant diversification. Multi family solves this issue, but office, industrial, and retail properties often have one or just a few tenants. So loss of a single tenant could mean a sizeable hit to occupancy and income.
CRE is also capital-intensive, even after you've bought the property.
Finally, regulations are tighter. ADA, fire life safety, and potentially even ESG (like solar) requirements all add risk.
Some aspects are up in the air for me. Does CRE create more value for investors at the level of risk comparable to SFH's? Or is CRE just a vehicle for daring investors to bring in outsized returns for outsized risk (e.g. value-add, development)? Is CRE's appreciation potential higher than that of SFH's, on a relative basis? In terms of acquisitions, is competition stiffer due to well-funded players in the space and fewer buying opportunities?
What do you all think?
I think economies of scale is definitely the biggest advantage of a CRE asset. It's just easier to make deals work in a traditional sense (in my opinion). While I can't speak for say 100 SFH vs an apartment building, I'd rather buy 5% of an apartment building than a SFH. You get much more for your expenses as part of an apartment building. Management fee is the one that stands out to me the most. You pay much more nominally, but you may only end up paying 2-3% of GPR for an apartment, opposed to say 20% for most SFR. Scale allows for risk mitigation. This could be the same as with 100 SFR, but in an apartment building, 1 vacancy means much less than in a SFR where you make 0 cash flow and are losing on the mortgage.
Another strong point for say a CRE as opposed to a collection of SFR would be the land parceling. It's more valuable to have one large, connected land parcel than an equivalent mass of disconnected small parcels. There's more opportunity to recreate the highest and best use.
Honestly, as I went through this answer, I think the differences are minimal. But, it's much easier to deploy $200m at once, as opposed to $200m split between 100 properties - and that's value in it of itself!
If you are looking at it from a portfolio level it shouldn't matter if that individual house is underwater and you're "losing money on the mortgage" since the cashflow from the other properties will be able to make up for it, like how in an apartment building the other units make up for the vacant ones. As long as you don't silo all the houses and fall behind on the mortgage payments and lose it to the bank, it's the same.
I realize my wording was confusing there. Appreciate you pointing it out. I meant what you did, and I also wanted to show the vacancy difference and affliction to an owner comparing a singular SFR and an apartment building. My grammar didn't make that clear lol.
This isn't a counter argument, though. It's a net neutral, not an argument in favor of single family rentals.
Uh... so is a single family home. Frankly, the single family home is far more expensive. My MF building has one roof that covers dozens of apartments. Your dozens of single family rentals has vastly more areas in which major capex could be needed. Sure, replacing a boiler in a large MF building costs 10x what it does to replace a hot water heater in a home, but you've got dozens more heaters, so in aggregate you are paying more.
This is a good point (finally).
For anyone with substantial equity behind them, MF is a far better investment than SFH. More operational efficiencies, more efficient from a transacting/deployment standpoint, and steadier cash flow.
SFH is a great investment play for people starting out, or who don't have access to large pools of capital. You can build a substantial real estate empire by slowly buying, renovating, and renting SFH. It just takes a really long time. Whereas if you get lucky and buy right, owning a couple of MF buildings can catapult you into UHNW status in a very short amount of time (of course you need a lot of luck there in terms of timing the market and being in a rapidly appreciating area).
It’s not better per se just different. If you’re an institutional owner of real estate (PE fund or insurance company) it’s much easier to deal with a giant CRE acquisition and deal with a handful of contract-honoring corporate renters rather than dozens of pain-in-the-ass individuals who want you to fix their toilet and try to skip out on their lease.
The question is, which investment has a better yield. Yield is made up of (i) current income and (ii) residual income.
Commercial real estate has a far better current income. Take a look at a SFH, see what it can rent for, and tell me the cap rate, I bet it's ~2.5% (excluding short-term rental business plan). Commercial real estate cap rates start at ~4.50% and go up to 8%+, depending on the property.
SFH's may perform far better in residual income, but because they are not yield driven it's harder to predict. One gateway city I tracked, homes appreciated ~8% YoY for 30 years. If you bought a home for $250K in 1990 it was worth $2.5M in 2020.
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