“Smart people learn from their mistakes. Wise ones learn from other people’s mistakes”.
They look really good...on paper
In this article I’ll explain why you should NOT invest in affordable single family home rentals - which I define as properties under $125,000 USD. The tantalizing 9% yields, apparent benefits of leverage, and the familiarity we have with owning something “residential” make these properties seem attractive at first glance. Having owned over 20 such properties, I can confidently say it’s not worth it.
Trust me. I’ve got a lot of experience in real estate...for example, I have developed: RV Parks, Single family homes (from scratch), Single family homes (high end fix and flip), Subdivisions, and Mobile home parks.
Also, I've owned: Raw land, Billboards, Apartment buildings, Office buildings, and Industrial warehouses.
And sadly…Affordable single family homes
What makes this asset class so difficult?
You most likely have to own remotely, which adds a lot of complexity
Most of my blog readers live in cities with high home prices: London, New York, San Francisco, Boston, Toronto, etc. You simply cannot find affordable homes near any of these major cities. “Entry level” homes are often over $400,000, and boast diminutive yields — as low as 3%.
By contrast, cities like Pittsburgh, Memphis, and Cleveland have homes priced below $100,000, and yields over 8%…or at least that’s what’s quoted. It’s no wonder people are interested in going remote, giving rise to investment websites like Roofstock and HomeUnion.
Unfortunately remote ownership of a residential property comes with a lot of complexity. Even if you are lucky enough to find a great property manager, you won’t be up to date as things change like: zoning codes, new developments, rent control laws, and more.
Residential investing is a personal and on the ground business; unlike owning a commercial property, it’s very hard to conduct everything over the phone.
They are difficult to finance
At one time I considered buying 100–200 single family homes and having them all managed collectively. The problem was that none of the banks I spoke with were willing to finance such a purchase. Each home needs to be separately secured, so either end up with 100 sets of paperwork, or working with a company that specializes in blanket loans with complex release clauses. If you do that, you should plan on paying rates 1%-3% higher than you would on an equivalent residential or commercial loan.
Tenants for these homes tend not to pay their bills on time (or at all)
Yes, a Google employee in a San Francisco condo will probably pay their rent on time. But you will not find many 700+ credit score tenants in small town PA. Chances are they aren’t just late on their utility bills. You will spend loads of money and energy trying to track down your rent, get them evicted, and so on.
They will do all kinds of crazy stuff in and to your homes
One of our tenants blacked out windows and grew weed, resulting in a front-page article in the local paper naming my property when they got busted. Another kept finding dead dogs on their property that we paid to get monitored and removed. A third got in a huge fight, broke several windows and doors, and then disappeared leaving more damage than rent paid. Finally, one of our properties simply burned down.
That 9% cap rate gets chewed up really quickly when tenants start breaking stuff. Or burning things.
Even then, you can get stuck with a terrible neighbor
Even if your property manager selects a wonderful and responsible tenant, you have to live with your property’s neighbors. Multiply your chances of problems by at least 3 (one for each side).
One property we owned became impossible to rent when the neighbor, who shared a porch, sat outside all day yelling at every potential tenant. Another neighbor claimed that a shingle fell off our roof and damaged his car, and he promptly sued us.
What to do instead
Residential investing (such as single family homes) might be a fit for people who are local, have a great sense of how to add value cheaply, and want to self-manage. I am NONE of those things. Over time I have gravitated towards the biggest possible properties I can afford, with the most professional tenants I can afford. Most of these commercial properties take less than 2 hours per year of management.
If you still insist on doing residential rental, you can try:
1) Roofstock ONE: a collection of homes that Roofstock manages on its own. You get the benefits of diversification and avoid the hassles of direct ownership.
2) High end rental properties in your own neighborhood. Quality tenants lead to quality outcomes. If you can hand select the tenants and keep an eye out on the property directly, you have a fighting chance of making it work, especially if you are in a booming area like Boulder, Austin, or similarly growing cities, where the price appreciation will offset the lower rent.
3) Fix and flips where no tenant ever takes possession. We’ve had moderate success at adding value to homes, WITHOUT ever dealing with a tenant.
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