When Planning Your (Multi-) Family, Size Matters

By Pierre-Paul Turgeon

It’s a fact that bigger apartment buildings have better economies of scale, compared to small rental properties of 1 to 4 units, and provide you with a better return on a per unit basis because the per unit operating expenses, namely the fixed costs, decrease with the more suites you have under the same roof. That’s why large institutional landlords such as the REITs (Real Estate Investment Trusts) seek to purchase larger properties. Multi-family properties, however, have additional significant advantages over smaller properties that far outweigh the extra costs of getting into larger income properties. Here are some key advantages:

1.‘Multiplier Effect’: Multi-family properties are valued mostly using the income approach (annual net operating income (NOI) ÷ cap rate), whereas small rental properties of 1 to 4 units use the comparison valuation approach (comparison to similar properties that have recently sold) and, as such, smaller rental properties don’t benefit from the ‘multiplier effect’ the income approach affords. Based on the multiplier effect, every dollar in increased NOI (assuming expenses and cap rates are constant) increases the value of an apartment building by $15 or so.

Accordingly, it does not take long to create significant equity and recover some of your initial costs. With small rental properties, it does not matter how much you increase your rents, the value of the property will not go up. So you get far more financial leverage for your investment with larger buildings. By and large this is the biggest advantage of investing in MF properties.

2. Lower Interest Rates: The larger the loan amount, especially over $1M and if it’s Canadian Mortgage and Housing Corporation (CMHC) insured, the lower the interest rate you’ll be paying. For example, I just got a rate of 2.62% for a 5-year term. If you’re worried about the cost of the CMHC insurance premium, well the good news is that the lender usually amortizes this cost within the loan amount.

In other words you don’t have to come up with additional cash to pay the premium, as the lender will add it to the loan amount. Plus, you generally recover the cost of the premium within the first 5 years of ownership from the property’s own cash flow.

3. Cheaper Management Cost and Less Hassle: Management fees for a professional property manager are much cheaper with bigger properties. Whereas for properties of 1 to 4 units you’ll pay around 10% of the effective gross income, for multifamily properties you may pay around 4% to 5%. Managing a multi-family property is also a lot less hassle because all suites are under the same roof, which means less travel between properties and less requirement of your time.

4. Lower Vacancy Cost: The bigger the property, the less vacancies have an impact on your cash flow. A vacancy in a four-plex will translate into a 25% vacancy rate, whereas a vacancy in a ten-plex amounts to 10% vacancy. This certainly gives you the ability to better withstand the economic downturns.

From 2006 to 2010, Pierre-Paul Turgeon was an underwriter of multi-family properties at Canada Mortgage and Housing Corporation (CMHC), where he worked since 1996. Pierre-Paul is also a lawyer and member in good standing of the Law Society of Upper Canada (Ontario). Pierre-Paul is now the owner of Matterhorn Real Estate Investments Ltd. whose mission is to take advantage of the investment opportunities in Alberta real estate by purchasing income-generating multi-family rental properties.

He will be presenting at the upcoming Multi-Family Bootcamps in Vancouver on May 31, 2014 and in Toronto on June 14, 2014.  For more information on these events and to register, check out the REIN Events Calendar.