BiggerPockets Real Estate Podcast - The Ultimate Underrated Rental Property of 2025 (for Small Investors)

Starting point is 00:00:04 Hey, everyone, I'm Dave Meyer, and this is the Bigger Pockets Real Estate podcast, where we teach you how to achieve financial freedom through real estate investing. Just recently, I was on a panel for the Bigger Pockets Momentum virtual investing summit with our friend Brian Burke. And he said something really interesting. He thinks the sweet spot in real estate right now is properties with five to 25 units. And if you don't know, Brian, he's been investing for a long time. He's been in the game for 30 years. He's been contributing to Bigger Pockets since 2013. So he's one of the most successful investors in the entire BP community. He's also just one of those people who's been right so many times that every time he says something like this, I pay close attention. Now, if you've

Starting point is 00:00:51 heard him on the show before, you know that he's not shy about telling you all the things that he's not investing in. So when I heard Brian say he is interested in this asset class of five to 25 unit properties, I wanted to find out more, and that's what we're doing on the show today. On this show, we talk almost every episode about residential real estate, which is properties from single-family homes up to four units. And we sometimes talk about the other end of the spectrum, commercial multifamily real estate, mostly in the context of syndications that raise millions of dollars to go by very large apartment buildings or housing developments.

Starting point is 00:01:30 This middle ground, though, of five to 25-25-year-old. unit properties sometimes gets lost in the shuffle. So I want to ask Brian, what makes those properties attractive, whether we've hit the point in the market cycle where investors should be jumping on deals in this category. And then I'm going to ask him his advice on how investors can analyze, purchase, and operate this type of property. Let's bring on Brian Burke. Brian, welcome back to the Bigger Pockets podcast. Thanks for being here. It's great to be back again, even so soon. Yeah, well, this is what you get for saying interesting things when we're talking in different venues. Brian and I were talking on the

Starting point is 00:02:07 Momentum Summit. And you said something that really intrigued me about five to 12 unit properties. Can you just tell me and everyone why you think that's kind of a sweet spot right now? You have this kind of like imperfect market in the small multifamily space, right? So you get into large multifamily, you know, 100 units and up. It's a very efficient market. It's dominated by professionals to do it for a living. There's not a lot. lot of like quote unquote great deals to be found. But the small multifamily space, that's where your mom and pop landlords live. That's where you have tired landlords. That's where you have deaths that lead to state sales and just all the kinds of things that happen in human life all

Starting point is 00:02:48 happens in that smaller multifamily space. And, you know, as they say that chaos and dislocation breeds opportunity. So I think there's opportunity in that smaller space. And do you think it doesn't apply to even smaller multifamilies, or does this also apply to two, three, and four units? I think it applies to those two to four unit as well as it does, you know, the kind of that five to, really, I'd say five to 25 unit space really kind of fits into this bucket. All of that applies. When you get down to the smaller like two to four unit space, there you have a little bit more competition from like, you know, live in like house hackers. You have some of that in that space. And I think you don't have the economy of scale that you have with kind of that five to 25 unit space.

Starting point is 00:03:35 So while the rules still apply there, I think that you get a little bit even sweeter spot. If you're in this as a real multifamily investor to be in that slightly larger space. Yeah, I've noticed that a lot. And honestly, why my personal interest has peaked to go into sort of this commercial area is less about the economies of scale that you mentioned. But two to four units just seems super competitive. And I think it's bigger pockets fault. I don't know. But we've been preaching how valuable they are.

Starting point is 00:04:05 And they are. But you see now pricing on duplexes, for example, is just kind of crazy unless you're an owner-occupant. And it's because house hackers rightfully can pay more and still make those deals pencil. Whereas if you're trying to scale a portfolio, you obviously can't live in every property and you can't pay as much as the person who's going to house hack that property. So I totally agree with you on that. At the same time, I'm like a little bit, for some reason, nervous to go beyond four units.

Starting point is 00:04:36 Like, is it really all that different? There's nothing to be afraid of. You brought up a good point about the smaller ones having, you know, like maybe it's bigger pockets fault because you have all the house hackers coming in, right? But it's also part of the reason that that space is so competitive is you can get Fannie Mae loans with, you know, lower down payments. You can get FHA. You know, there's regular conventional real estate. state lending that's available to like a single family home buyer, the same types of financing are available in that two to four unit space. And that does create a different competitive landscape.

Starting point is 00:05:08 Once you're five units and up, it's considered commercial. That means the lending guidelines are different. It means down payment requirements are different. But operationally, it's basically still the same thing. Now, the larger you get, kind of in some respects, the easier it gets, too. So I had a 540 unit apartment complex. It was easier for me to manage than my 11 unit. And that's just kind of part of the way it is as you grow and scale and get teams. But when you're starting out and trying to build a portfolio, this smaller multifamily space is a great place to learn. It's a great place to build a portfolio.

Starting point is 00:05:46 And believe me, you'll learn more than you want to learn. But that'll be really useful. And so don't be afraid of it. The other thing that intrigues me is, like, I personally got into real estate buying small multifamilies that were in Denver and there's kind of these, you know, cut up old mansions and Victorians. And recently I've only been trying to buy purpose-built small multifamilies because the organization of them, the consistency between units does, in my opinion, make a really big difference. Whereas all these old buildings that weren't meant to be multifamilies that you cut up are just such a pain in the same. the butt to manage and to fix. Whereas, you know, you buy 540 unit. Every unit is a carbon copy of each other. Maybe there's a couple of layouts. But, you know, the systems, the appliances you need,

Starting point is 00:06:35 they're repeatable, they're knowable in a way that some of these small multifamilies aren't. So that part of it definitely appeals to me. Yeah, they can get a little crazy, especially when you get into these modified buildings. And, you know, there's a lot of those. Actually, there's a lot of them in Buffalo when I was out there looking and bought this 11 unit, we looked at a lot of properties that were like two-story single-family homes that got repurposed into duplexes where the lower floor is one unit and the upper floor is another unit. And there's all kinds of oddities that you find in that. And man, it runs the gamut. I mean, between shared utilities and just a lot of those buildings are older and then their systems are really, really tough shape. So there can be a lot

Starting point is 00:07:17 of challenges. But there's also, you know, again, anytime there's challenges opportunity. Totally agree. I just, when you're reaching scale and, you know, when I'm trying to buy units in this part of my portfolio, I'm looking for ease of maintenance. So it just seems like this five to 25 unit area could be good. But I want to bring up sort of the elephant in the room, which is, is it a good time in the market to actually pursue these types of commercial deals? But first, Brian, And we do have to take a quick break. We'll be right back. Most investors spend more time chasing deals than reviewing their insurance. But a quick coverage check can be fast, easy, and one of these smartest ways to protect

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Starting point is 00:10:54 Do you think we are approaching a good time to buy for this subset of the multifamily asset class? Well, that depends, Dave. Do you like to buy things at the top or the bottom? Bottom. Well, then, I think this might be the time for you then. It might not be the time for everybody. The challenge of doing that, though, is the best time to buy anything is when it's most uncomfortable to do so. I have a mentor of mine in stock investing. He says, the stock market is the only market where buyers fear a sale. Yeah. And I think the real estate market also kind of fits into that category. You know, when times are tough, people get scared and they don't want to get in. That means it's a good time to get in. Now, I can't say that today is the precise bottom of the market. But I can tell you, that it topped out in the second quarter of 2022, and it's been on a downslide ever since. And if we're

Starting point is 00:11:49 not at the bottom, we're close enough to it, where if you make a move now on a really well-priced property because you found some needle in a haystack, then I don't think you'll be sad that you did. This to me is a good time to buy. New inventory is starting to decline. Rents will come back when new deliveries start to decline in the second half of this year. So I think this is a really compelling opportunity in the small multifamily space. I love hearing that because I am very interested in buying these right now. So that's very good news. I really do think this is a really interesting sweet spot for people.

Starting point is 00:12:26 So hopefully everyone is also considering this because, as Brian said, commercial real estate has been on sale for the last couple of years. But Brian, we are starting to see the residential. market slow down right now. I've said that I think we're going to have relatively flat prices this year. I think you sort of agreed when we were talking a couple of weeks ago. So can you maybe help our audience understand how and why the commercial space and the presidential space don't necessarily move in lockstep? Yeah, people always like to talk about the real estate market, as if there is such a thing that, you know, all real estate does the same thing at the same time.

Starting point is 00:13:04 And there's a market cycle slide that you'll often see people put up when they're talking about real estate market cycles where the cycle goes up and it peaks out and then it comes down and then it troughs out and then it goes back up again. But I have a slide that's way better than that. And it has a bunch of lines that are crisscrossing, you know, in all kind of different like ways because that's really what the real estate market looks like. It looks like total chaos because you could have home prices in a slide while multifamily is increasing. industrial could be going up while offices going down and hotels are trading sideways. All these things can be happening. And what is also interesting is even within the same type of real estate, it can be moving in two different directions in two different locations in two different locations. I mean, it might be where multifamily in Buffalo is on a tear, but multifamily in Los Angeles is on a downside.

Starting point is 00:13:54 These could be happening at the same time. So we always have to keep that in mind. But, you know, there's a lot of bad news that's been coming out about commercial real estate. multi-family, office especially, has been in a really bad spot. What you have to look at is where in the cycle are we? And what are the chances that that cycle is going to bottom out and then start to move in the opposite direction? Now, if you're talking about going out and buying office buildings, yeah, it's really bad out there. Will they come back? That's debatable. You know, maybe they will, maybe they won't. But on the multi-side, you know, you see new delivery.

Starting point is 00:14:32 is coming down. You see rent growth starting to flatten. It was negative for a while. Now it's flattening. When I look at rent growth forecasts for the future, they're trending up in most markets, starting later half of this year and into next year. So if you can buy before that's already happened, you know, what do they say like buy on the rumor and sell on the news? You know, this is kind of we're in that rumor stage. So I think that this, you know, despite the fact that there's been a lot of turmoil, I just think that that's what creates opportunity. All right. Well, now you're giving me phomo and anxiety that I need to go buy something immediately. How long do you think this opportunity last? Do you think we're just starting and there's going to be opportunity for years to come?

Starting point is 00:15:11 Or is this kind of like a right here, right now kind of opportunity? I think that we have a little bit of time. There's no sense to rush anything. You know, you can let this play out. I don't think that we're looking at a V-shaped recovery where all of a sudden we're going to have this immediate, massive bounce. I think that this recovery is going to be a process. And I think over the course of the next couple years, you're going to have some really sharp buying opportunities. And I think over the subsequent couple of years, you're going to see the market start to mature. You know, I've made up a few sayings. I might have said them on one of your podcast before. I don't remember which one. But people used to say, you know, about the multifamily market,

Starting point is 00:15:48 survive till 25. These were the owners who were trying to just hang on. Well, they got to 25, but they're still in a lot of distress. Yeah, nothing got better. Nothing got better. Their interest rates are still high. Their loans are still coming due. you know, and I had come up with a bunch of new sayings, end the dive in 25 was my first one. And that meant that, you know, the market's going to stop going down. I mean, before it goes up, it first has to stop coming down. And I think we're going to reach that point this year. And then I think it gets fixed in 26, meaning that I think next year we're going to start to see some of this work itself out. The market's going to get legs under it. I think you're going to be an investor heaven in 27, meaning there's going to be deals out there. You're going to see, you know, the stuff that you bought. you're going to get rent growth. You're going to start to see price growth. And I think if you wait until 28, you're going to be too late. Those are my sayings for the day. So I like this. All right. Take it for what it's worth. So Brian, I want to ask you about property class within this space. Like, do you recommend people invest in class A, really nice polished spaces, class B, class C? How do you see

Starting point is 00:16:54 that tradeoff in this particular subset of the market? It really has to match to your risk profile and the amount of work you really want to put in. If you have a high tolerance for risk, and let's say, you know, you're like a really young go-getter, like, I'm going to kill it in the real estate business, and I'm going to go find this really super like below market deal, put in a ton of work and really turn it around. Buying Classy properties might be for you because there's some people that just won't touch them because they're really management intensive. It's really difficult to pull that off. It takes a lot of energy and a lot of time and it's a lot of risk. If you have that in you, that's a really great place to start. And I guarantee you will learn 10 times more about this

Starting point is 00:17:39 business than you will if you want to just go by Class A property. And more than you want to, like you said. More than you want to. Yeah, 100% more than you want to. But if you're kind of like moderately risk averse, going into that Class B space is probably a good place to be. And if you're just absolutely like hands-off person like, I don't want to mess with anything. I want no risk. I don't want bad tenants. I don't want it to deal with any of that stuff. Class A properties is probably the best place for you. Now, you'll probably find that it's the least amount of return, but on a risk adjusted basis, it's a very good return. So, you know, you've got to match your personality and your risk tolerance and the amount of work you're willing to put in and then decide from there which

Starting point is 00:18:23 class is right for you. And I'm going to ask you a question you're absolutely going to hate, but I'm going to ask it to you anyway. You know, what is a good deal in this market, right? Because I know that cap rates are going to be very different in different property classes, different markets, but can you just maybe give us a little bit of a guideline for like how you would look for and spot a good deal in today's day and age? Yeah, I mean, a lot of people want to focus on cap rate and say, oh, a good deal means it's this cap rate or that cap rate. Forget about cap rate. I know you hate that. I just hate cap rate.

Starting point is 00:18:55 It's just such a useless metric. What you really want to think about is the cash flow and replacement costs. I mean, if you can buy a property for a price that's less than you can build it for, you're already starting off on solid footing. But remember, this isn't only called multifamily. This is also called income property. It's another way that this is referred to as income property. You don't go buy it.

Starting point is 00:19:23 a 20-unit apartment complex because it's a nice place for you to live. I mean, sure, you could live in it, but that's generally not why people buy 20-unit apartment buildings. They buy it because it's income property. That means you've got to look at what is the income. And if it doesn't have income, it's not a good deal. So when you're underwriting, you know, you're going to look at your rent minus vacancy, minus operating costs, minus property taxes, insurance, minus interest, what's left. And don't forget about capital improvements. you're going to have water heaters that break. You're going to have parking lots that need to be resurfaced.

Starting point is 00:19:58 You're going to have roofs that need to be replaced. Amortize the cost of those big ticket items over their lifespans and adjust for that as part of your cash flow question. And are you in positive cash flow territory? And is the cash flow that you're going to receive enough to make the investment worthwhile? There's another old saying that I really liked that says all investments have risk, but not every risk is worth the investment. If you are going and buying a property that you have to put $200,000 a year cash into and you're going to get $100,000 a month of positive cash flow, you've got to really consider whether or not this is a smart investment if you could go invest

Starting point is 00:20:39 in a mutual fund, stock, or whatever, and get a much better return. You want to get a return on your capital. So look at it from a return on capital basis, not a cap rate basis, return on capital basis. Brian, I have more questions for you about these medium-sized, multifamily properties, but first, we do need to take a quick break. If you own a short-term rental, here's something worth knowing. Not all landlord policies are built for your type of property. And with holiday bookings, chilly weather, and higher guest turnover,

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Starting point is 00:23:46 We're back. Here's the rest of my conversation with Brian Burke. Now, just totally asking for a friend and for our audience, not for myself. But if you were to be interested in this kind of deal, how does the underwriting and deal analysis process differ from either single family rentals or smaller two to four units? In this five to 25 arena, it's very similar to underwriting a fourplex. You're going to look at your rent. You're going to look at vacancy factor.

Starting point is 00:24:17 And here's something that I think is really important that people miss. If you own a fourplex, you can probably fill. fill that foreplex up and have almost no vacancies for long stretches of time. But when you get into this 5 to 25 unit space, your property is going to follow the market. So if the market has 10% vacancy, you're going to find yourself 10% vacant. If you're 100% full, you're doing something wrong. So really look at economic vacancy factors. Be respectful of what the market data is telling you about vacancy, about rent growth,

Starting point is 00:24:53 about rental rates because you're going to be, you know, a byproduct of the greater overall market. It's really tough to beat it when you get into these larger properties. The other thing to think about is like the utilities who's paying for them, who pays for what, make sure you're quantifying that. And you've got a good management fee in there to pay a really good management company to help you with it. I'm not really a big fan of the DIY approach. I know some people really like to do it that way, but I'd much rather have a really strong, competent manager in there and overseeing what they're doing. So make sure that you're accounting for those expenses. Those are the big things to look forward underwriting in this space.

Starting point is 00:25:32 You said something that if you don't have vacancy, you're doing something wrong. Does that mean you're just undercharging rent? Yeah, you're undercharging rent. Yeah, you should be at market vacancy. So if you've got 25 units and you're 100% full, your rents are too low. What about the debt side of things? Because for everyone who's listening, just, you know, when you get a residential mortgage, usually you can get 30-year fixed rate debt. That is not typically what you do with commercial loans. They're usually adjustable rate mortgages that have a balloon payment after three, five, seven, ten years. So how does that factor into the underwriting or what should we all be thinking about when we consider commercial debt versus residential? Yeah, commercial debt is a whole different animal. You know, the best financing that you can find out there anywhere is the 30-year fixed, fully amortized loan. And those are great for single-family homes. You can even find them for your duplexes and four-plexes. But that's not a thing in the small commercial multi-family space once you get over five units.

Starting point is 00:26:35 You can sometimes find bank financing, especially if you have a relationship loan. If you've got a relationship with a local community bank, you might find some really attractive financing. I have that 11-unit building I told you about in New York. I had a local bank that financed it for me on a 25-year fixed rate, fully amortizing loan. Wow. And so, you know, in the smaller space, you can find that debt out there. When you get into bigger multifamily, that gets even harder to find, especially when you get over $5 million, you know, those loans are really difficult to find. They usually will have some type of prepayment penalty.

Starting point is 00:27:12 They'll have shorter maturities like five, seven, or ten years. At that point, you have to pay them off for refining. So it does get a little complicated as the loan size goes up. But if you're under that $5 million mark, you can find really compelling financing from local community banks. That's my starting point for that size. All right. That's really good to know. I guess the question is, assuming you can't get one of those great fixed rate debts,

Starting point is 00:27:37 assuming you're getting a more traditional kind of loan, five, seven year, something like that, how do you underwrite that? Because do you just assume that you're going to get a refinance at some point? because that seems to be one of the major problems that operators have been facing over the last couple of years that they weren't able to refinance. So, like, how do you manage that risk? You manage the risk with a longer maturity. And that's the reason that a lot of operators are having that challenge right now is they got too short of a maturity. There was a period right after COVID where a lot of buyers, especially of larger multifamily, were buying with three-year

Starting point is 00:28:14 bridge loans. And these loans were intended to buy a property, fix it up, you know, raise the rents, and then get a new loan. That was the reason that you would get those loans. But they kind of got repurposed where these syndicators were using this debt as a crutch because they couldn't raise enough equity. So they would use these high leverage loans to juice their returns and require them to bring less cash to the table. But the tradeoff was is that they had three-year maturities. And That might work when it works, but if the music stops and there's no place left to sit, that's when things go wrong. So the challenge of that refinance is when rates go up, values fall, that refinance is very

Starting point is 00:28:56 difficult. Outside of that, assuming that rates stay level or maybe they only go up a little bit and values do not fall, the refinance is certainly doable, especially if you've owned the property for a while. And that's why the longer term maturity is really pay off. If you get alone with a 10-year maturity, it's pretty sure that you'll be able to refinance in 10 years. The market should have gone up by then. And if it did go down, it should have had enough time to come back by that point. And if it went down right before it was refy time, it already went up for eight or nine years,

Starting point is 00:29:30 and you should still be in pretty good shape. It's the really short terms that will get you because three to five years is the blink of an eye in this business. It may seem like a long time. But once you buy a property, you'll find three to five years goes by it really quickly. Thank you, Brian. You've really demystified the underwriting process for me a little bit. It really doesn't seem very different from all of the regular presidential underwriting that I've done. And hopefully everyone listening to this sees that this really isn't all that complicated.

Starting point is 00:29:58 If you can underwrite a single family home or a duplex, you can make some small adjustments and be able to underwrite these types of deals as well. But I want to sort of just talk about just strategic. basically, Brian, if you think this is a good asset for just regular investors, you know, the average bigger pockets listener is someone who's, you know, going to buy a handful of units over the course of their lives to support their financial freedom. Like, is this a better option than buying a bunch of single families or two or three triplexes or something like that? Why or why not? Well, I think it's a different approach. It's hard to say that one

Starting point is 00:30:36 is necessarily better over the other because it's a lot of this depends on your own individual circumstances. Now, with the larger the properties you get, the more units you have concentrated in one location. Now, that comes with advantages and disadvantages. The advantages are, let's say you have a 20 unit apartment building and you have 20 single family homes. Well, in the 20 unit apartment building, instead of 20 roofs to maintain, you have one roof to maintain. Instead of 20 property managers, because they're all in different places, you have one property manager. of having to hire a landscaper to mow 20 lawns, there's one landscaper mowing, you know, one lawn. So you do get economy to scale. But the tradeoff is you get some operational complexity. You know,

Starting point is 00:31:19 you get big enough. You might have to have an on-site person. You know, in California, if you have more than 15 units in one location, you have to have a quote-unquote on-site manager. So, you know, that adds some complexity to, you know, the business instead of just being really simple. So there's tradeoffs. The financing is a little more complicated in the larger stuff, but I'm a believer in economy of scale. I'm a believer that in, you know, real estate investing, your journey takes you to larger properties. And I don't mean, you know, more square footage on a house. I mean larger properties and others, more units in one location because that economy of scale is what gets you cash on cash return, which eventually gets you retirement and single family

Starting point is 00:32:06 homes can do it, but it's very operationally complex to have a lot of scattered houses in a lot of different places. So I personally advocate for a kind of a balanced hybrid approach where you might have, instead of, you know, a hundred single family homes, maybe you have five, 20 unit buildings. And those could be in different locations. That's fine. You get kind of the best of both worlds by having some geographic and portfolio diversification, yet also some consolidation to capture economy to scale. All right. I like it. I mean, you and I both are, I think, friendly with Chad Carson. I asked him the same question. He said the exact opposite thing, if you all listen to this thing. He was like, go buy 75 single family homes. But I think personally, I'm more of your

Starting point is 00:32:53 belief because I've, I started with small multifamily. I have some single family. And then I went sort of to the opposite where I invest in syndications in like the kind of stuff you do, which is, you know, hundreds of units. But I'm trying to fill out that sort of like middle spot that I don't have diversification and ownership over. So that's pretty interesting. At one point, I had 120 rental houses. And at one point, I had 4,000 apartment units. Wow. I think it was easier to manage the 4,000 apartment units than the 120 rental houses. That's amazing. He might have pulled that off really well, but I don't know. That's just me. I mean, everybody's, everybody's different. I'm curious about timing, though, Brian, because I totally buy the diversification aspect, but is this something new people should consider? Do you

Starting point is 00:33:39 recommend sort of building your way up to it? I recommend building your way up to it as you're scaling to larger properties. I mean, it doesn't mean you have to buy a single family house before you buy a duplex, but if you're going to skip single family homes and go straight into multifamily, I would suggest starting with something that's in the one to four category just because of the ease of finance and just learning and kind of getting your feet wet. And then I would go into that kind of five to 15 unit space. There's not a lot of difference in five to 15 units. You get over 15 units, you know, kind of in that 16 to 25. That starts to get a little bit more complicated. It might, it might behoove you to start in that 5 to 15 beforehand.

Starting point is 00:34:22 I personally, I think I had a duplex first, and then I went straight to a 16 unit. And it was complicated for me to figure out. So I really always recommend climbing the ladder is a much easier way to get on a roof than to jump up on top of it. So, you know, no problem with starting small and working your way up. That's good advice. I like that saying. You're full of good things today, Brian. I like that story.

Starting point is 00:34:47 I'm trying. All right. Well, thanks again, Brian. And thank you all so much for listening to this episode of the Bigger Pockets podcast. If you enjoyed this episode as much as I did, please make sure to give us a five-star rating, either on Spotify, Apple, or wherever you're listening. We'll see you next time. Do you ever notice how every passive investment somehow turns into a very active lifestyle,

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