I’m fairly certain that in the last 14 days and across planet earth, the most commonly said words have been, “these are uncertain times.” Indeed they are. More has changed in the last 14 days than I thought possible in that short time period. With the market decreases and overall uncertainty about the economy, many of us are wondering about the path forward.
I’ve spoken to several people in the past few days who are, for the first time, considering real estate as an investment. They have each expressed their concerns and anxieties about the stock market and its ability to change so quickly (for good and bad), and have wondered if diversifying with real estate, particularly a single-family rental home, made sense for them.
While direct real estate investments (as opposed to investments in publicly-traded REITS and the like) don’t typically experience the extreme lows and highs, they do have their own challenges and risks. The following simple points may be helpful if you’re wondering if single-family residential real estate investment is a good fit for you.
What are the benefits?
There are three primary reasons to invest in real estate:
- Cashflow. Most real estate investments realize monthly income, typically in the form of rent from tenants. This income is dependent on market rental rates, the condition and desirability of the property, and the credit-worthiness of the tenant. Obviously, operating a property will incur expenses as well. Management fees, maintenance, insurance and property taxes are the main expenses. When managed wisely, a single-family rental home can produce positive monthly cash flow. Additionally, there may be tax advantages to operating a rental home. Consult your tax preparer for details.
- Value Appreciation. Over time, the home will likely increase in value. While this increase is not realized in monthly cashflow, it is realized when the property is sold or used as collateral for a loan. Most investors assume a 3-5% annual appreciation, which is fairly consistent with actual market values over time.
- Control. Generally, a direct investment in real estate offers more control over your asset than does an investment in a security. You have direct control over the maintenance of your asset, its rental rate, which tenant occupies it, etc. In a down market you can take direct steps – with your own hands if you choose – to make your asset as marketable as it can be. Sure, you are at the mercy of the local and regional economy, but you don’t have to sit back and watch, powerlessly, as a red down arrow or a green up arrow define your investment. You can take immediate action to manage the valuation of your asset. For instance, you can negotiate with tenants instead of losing them or improve the curb appeal so it’s the best looking house on the block. These things can have an immediate impact on cashflow and value, especially in the worst of times.
There are four considerations before making any decisions:
- Property Taxes. Property taxes will be your single largest expense. They can make or break your cashflow. When considering a potential home for purchase, be certain you understand the property’s appraised value, the municipality’s tax rates and the impact of the loss of any exemptions (homestead) that may increase the property tax for an investment property.
- Maintenance Expenses. What kind of maintenance needs to be done? How are the home’s systems and major appliances? Most of us aren’t experts on these things and it’s wise to have a professional assess the condition of the home so maintenance expenses can be reasonably understood. But remember, things will always come up!
- Management. If you don’t want to worry about personally dealing with maintenance and tenant issues, consider hiring a property management company to take care of it. Usually costing between 5% and 10% of gross monthly rent, a well-chosen manger can make the rental home fairly hands-off for the investor. Of course, you must ensure that the property’s cash flow can support the additional expense.
- Initial Purchase. It’s crucial that you buy the home at the right price. This point cannot be overstated – if you over pay it is very difficult to make it up.
Single-family rental homes can be a great way to diversify your investing. They can provide consistent monthly cashflow (operating income), appreciating value (equity growth) and an opportunity to control your investment in real time.
A competent real estate professional can help you analyze the investment and determine exactly what you are able to pay in order to realize your required returns. Give us a call – we’d love to help!