Which is Better: Multi-Family Real Estate or Storage Units?
One of the most consistent questions I am asked is which is a better investment: multi-family real estate or storage units? Today I’m going to answer that question and talk about how good my storage units are doing. We are going to talk about all the reasons why my friend Garrett and I have really enjoyed owning storage units. We’ll cover the pros and cons of residential real estate.
First, I want to give you an update on how these storage units have done. The expenses and management have been substantially lower than what we had guessed they would be. Another great thing is that we were able to bump rents up to market on nearly all of these properties. Originally I was hoping to get rents to $9,500. After expenses every month, we are getting $9,650. There was even one month where we had $10,200. Gross rents are now up to over $11,000. Some months we pay more expenses and some less, but it’s been incredible. Now what we’re netting on these properties has ended up being more than we planned on grossing. Granted, this is before our mortgage. The mortgage is in kind of a cool situation. We did an interest only loan for a 4 year period with the sellers. The seller financed it so we’re only paying $4,300 - $4,400 a month and we’re netting $9,600 after all expenses. This property pays both of our mortgages.
We have that loan for 4 years. Currently we are looking to refinance in the next year, especially with the Fed scaring everybody saying that interest rates are going to go up. This is going to impact our cash flow but that’s okay because we’ve been cash flowing like crazy on this property. We’ll just have that money going toward principal paydown on a standard loan with lower interest rates than we have right now. We should be able to get this refinanced at 3.5%.
With our equity in this property, because we’ve added so much value to it, when we refinance we hope we are able to pull all our money out of the deal so we will have none of our own money in the deal. It’s cash flowing extremely well, and it’s going to be a win-win.
So these storage units have gone way better than what we expected, and they’ve been a blast. With that being said, we also both own residential real estate that in the current market has done way better than we expected as well. Now let’s jump into the pros and cons of both.
Storage Unit Pros
- For this particular property, the maintenance has been extremely low. Issues are nonexistent. There’s just not a lot of expense that goes into these storage units. You are not dealing with clogged toilets, etc.
- Minimal risk. In this market, everybody needs a storage unit. We probably should have raised the rents even more because there is such a huge demand for storage units right now. There is still risk, but it is minimal because most people just set up recurring payments for their storage units on a credit card and then you never hear from them again. The lower price point goes under people’s radar so they don't think about it every month. A $65 or $125 bill every month just doesn’t matter as much to people.
- We got ours in a good location, which I think matters a lot.
- Value-add and growth opportunities. This area is being developed right now. There is a Costco a few minutes away. We thought we could do some signage and advertising. We are thinking about building out some bigger, shop-style units on this land too. We’ve got room for more units and a lot of money just sitting in the account that we both agreed to just leave there, but our account on this property is already built up to $50,000 already. So maybe on the docket for this year will be adding units and pushing through that refinance.
This combination of factors makes our storage units an incredible investment.
Storage Unit Cons
- If you have to evict someone out of these, it is more difficult than going through the process with a tenant. There is a whole long process that I still don’t completely understand. Luckily we have a management company that deals with those as they come. We haven’t had to go all the way through that process yet. Usually when we’ve had to get someone out we have bought them out or done something to get them out so we can get someone else in. When we do have those issues, I’m sure we’ll complain about it. But again we have the management company that takes care of it.
- Another negative is it’s hard to get a lot of cost segregation here. Especially when we don’t have pavement, we’ve just got rocks. You just have the building. There’s not a lot to depreciate or to speed up depreciation-wise. Even though we paid over $1,000,000 for these properties, when I looked at doing cost segregation, it didn’t make sense. We’re just going to depreciate them over an extended period of time. I found that to be a big negative because I love accelerating my depreciation that I can use against my income so that I don’t have to pay as much in taxes right now. I’m pushing it down the road, but I hope to defer the majority of my taxes until the day that I die, and then I can leave my kids and family with all these depreciated assets that are making them lots of money.
What is Cost Segregation?
Cost segregation speeds up the depreciation that you can take on your properties. For example: on a standard property, I believe it’s a 27.5 year schedule. So if you bought a property for $1,000,000, and let’s say $250,000 of that was land, you can’t depreciate the land, but the other $750,000 you can depreciate. To the government, that depreciation looks like an expense going against your income so you’re not paying taxes on what that eats up from your income. So if you’re dragging it out over 27.5 years, you’re just getting a little bit of that $750,000. What cost segregation does is it lets you speed it up to take it in 3 or 5 years, and some things in 1 year, where portions of the property are evaluated and then given an accelerated depreciation schedule so that you can take a larger chunk of that depreciation.
If you’ve got a larger income like we’ve got on these properties where we’ve cash flowed really well, if we would have had cost segregation, we could have eaten up all that income and potentially even used some of that depreciation against some of our other income so that we don’t have to pay tax on that income in a legal way because we are deferring that tax. You’re basically taking individual pieces of the house, and giving them a usable lifespan. The carpet might be 3 years. The roof might be 7 years. Appliances might be 5 years. An accountant will come in that really knows what they are doing. You do have to pay a good fee to have them do this. They’ll break down everything, give it a life, and do it the right way. This way if you do get audited, you’re set because they’ve done everything properly.
Some people will try to accelerate their depreciation by BSing the numbers. If you do it that way, you can get burned if you ever get audited. Many people will say not to accelerate your depreciation, because you’re paying money to speed it up, meaning you’re not milking all that you could because of the money you have to pay. In my opinion, if you’re in the higher tax bracket, you might as well take advantage of it now and eat off some of that higher tax bracket. Rather than paying now hoping that down the road it’ll be beneficial for you. Who knows what’s going to happen down the road? Right now I know I have higher tax brackets that I’d like to use that depreciation against.
If you’re in a lower tax bracket already, it’s probably not worth it. But if you are making great money from your active income, then it really helps if you have enough real estate to offset it. The other idea is to depreciate a property all the way down, sell it, and 1031 Exchange the money into a new property which you then depreciate and sell, etc. etc. That’s why investors are constantly buying and flipping up, because then you can milk a lot of depreciation. If you are one of those people that has a job and aren’t paying a whole lot in tax, accelerated depreciation doesn’t make sense. If you’re in the top tax bracket and you put your money into a property that’s hardly even cash flowing but you’re essentially paying over 40% in taxes, you’ll get a huge return by buying real estate, deferring taxes, and using cost segregation. It just doesn’t make sense if you’re already in one of the lower tax brackets.
That’s one of the biggest advantages of real estate over things like stocks, bonds, things like that. One of the reasons that I prefer residential real estate, if I can get the kind of return that I’m getting with the storage units. Something like this storage unit is just a sheet of metal that is going to last 50 years, you can’t depreciate it over 2-3 years. If we had pavement, that does have a lifespan. That’s something we could accelerate but we’ve just got rocks, and it’s hard to depreciate rocks. We don’t want to put in pavement, that’s expensive.
This is something important to understand. There’s no complete and total life hack for taxes. All that I’m doing with accelerated depreciation is kicking the taxes down the road. What’s really cool about our tax laws, is you can kick them down the road forever. So you can own millions of dollars of real estate and have used all of that depreciation, but if you don’t sell those properties and take that money out, then it’s going to keep sitting there. You’ll defer a lot of taxes in the process.
That’s one of the things that a lot of investors get tripped up on as well. Everybody thinks there’s some magic recipe to real estate. They ask “what’s better, single family or multi-family, commercial or large apartment complexes?” The truth is that each of them has some sort of competitive advantage.
Anything can be good, it’s just a matter of where you can find the best deal or where you can make it work the most for you. It also evolves. Each option has its pros and cons. Financing is always going to be easier with four units or less. It will be better: extended longer, 30 years, better interest rates, more protected as a buyer. You get to the point where it’s really hard to find four units or less because of all the competition there. It’s also hard to place a lot of money. If you get to the place where you’ve built up a good portfolio, you’re limited on loans. If you get to where you really want to maximize your growth, it’s very difficult to find ten different individual four-plexes every year. It can also be hard to find a 40 unit complex. With the 40 unit complex, there’s more money more quickly for less work. Even though your financing won’t be as good, you can go in and pull a million dollars on a deal by adding value and put yourself in a great place.
When you’re trying to decide whether an investment is good for you and you're comparing between storage units, mobile parks, single family, multi-family, whatever you’re doing, just make sure that you figure out your criteria. If you make sure the numbers work, any of those investments can be incredible investments for you. As we’ve gone through the pros and cons lists, yeah there are some cons but there just aren’t many cons with real estate period. As long as you buy right, you’ll be in an incredible spot and that’s my goal is helping you to buy right. Check out my other real estate investing articles to learn more.