Why more units are better than fewer

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Once you’re sold on the idea of buying an apartment building, the next question is: “What to buy?”

One of the important principles to keep in mind is that it’s usually better to buy more units than fewer for a given amount of money.

To see why, let’s compare two different deals on the same street:

Duplex (two units)

  • Each unit rents for $2,000 / month
  • Total rent of $4,000 per month
  • Expenses (not including mortgage) of $1,000 / month
  • Net operating income of $3,000 / month
  • Price of $500,000
  • Mortgage for 80% of price, or $400,000, at 4%
  • Monthly mortgage payments of $1,910
  • Free cash flow of $3,000 – $1,910 = $1,090

Fourplex (four units)

  • Each rents for $1,000 / month
  • Total rent of $4,000 per month
  • Expenses (not including mortgage) of $1,000 / month
  • Net operating income of $3,000 / month
  • Price of $500,000
  • Mortgage for 80% of price, or $400,000, at 4%
  • Monthly mortgage payments of $1,910
  • Free cash flow of $3,000 – $1,910 = $1,090

Both of these deals look similar on paper. They’re both 7.2% caps at 10.4x gross rents. They’re both returning $1,090 x 12 = $13,080 per year in free cash, which is 13% per year on your $100,000 down payment.

So, why is the fourplex a better deal than the duplex, everything else being equal? Well, imagine you have a vacancy in one unit. For the duplex, this means that, until the vacancy if filled, your income is $2,000 / month. This means that you can cover your expenses of $1,000 per month but you’re going to have to come out of pocket to cover $910 of the mortgage. That’s no fun.

Now consider the fourplex. Until you fill the vacancy, your income is $3,000 / month. You are still able to cover the $1,000 in expenses. You can also cover the mortgage of $1,910 and still have $90 left over. Obviously, that’s not great. But you didn’t have to part with any of your own money. And that’s why, all things being equal, the fourplex beats the duplex – the income stream is less dependent upon any single tenant.

A caveat. In real life, all things are not equal!! Sometimes fourplexes are bid up and pricing for duplexes is just better.

And sometimes, you’re not a perfectly rational, economic buyer. By this I mean, sometimes you actually care about how the property feels to live in, because you’re going to be living there. It’s hard to resist the lure of making your first purchase a single family home. There’s no shame in making the first one a duplex instead of a fourplex. You’re still doing way, way better than if you bought the single family.

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