Investing in single-family homes is often a good way to build wealth and generate monthly cash flow.
Real estate has proven to be an economic bellwether even when stocks and bonds experience downturns. Of course 2020 and 2021 saw a housing boom unlike any in decades, and Redfin reported that home prices were up nearly 8% year-over-year in late 2022, despite rising interest rates.
Single-family rental homes have lots of upsides for an investor, but there are also a few reasons to look before you leap.
What Is a Single-Family Home?
The popular image of a single-family home is a stand-alone, one-dwelling structure with its own utilities, entrance, exit, and access to the street. The owners own both the building and land it sits on, so condos do not count.
Some government agencies expand this definition to include properties of up to four units, such as duplexes and townhouses.
First-time homebuyers can
prequalify for a SoFi mortgage loan,
with as little as 3% down.
Why Invest in Single-Family Homes?
Buying investment property offers two key benefits to long-term investors:
• the potential for capital appreciation
• immediate cash flow
Let’s walk through some of the key motivators for investing in single-family homes.
Single-family homes are typically easier to obtain financing for than multifamily homes of five or more units.
A multifamily property meeting that criterion requires a commercial loan, which usually has a higher interest rate and shorter term than a residential mortgage.
Lenders often require at least 20% down for an investment property. It could be higher, depending on the borrower’s credit score and savings. Then again, there are creative ways to buy a multifamily property with no money down.
The market for single-family homes is relatively stable and tends to grow more smoothly over the long run compared with other types of homes.
Unlike commercial real estate and apartments, the demand for single-family homes tends to remain relatively strong at all stages of the economic cycle.
Single-family homes may be rented out for longer terms than apartments and usually sit vacant for less time thanks to the steady demand for single-family housing.
Some contend that single-family rentals feel more like proper homes for tenants and therefore are better cared for than apartments.
You’re also more likely to find more families renting single-family homes than individuals. Families may be more likely to extend the lease if they end up loving the neighborhood and schools, as in a coveted suburb.
Many people seek to diversify portfolios with different types of investments. Unlike stocks and bonds, which represent shares of ownership and rights to debt payments from a company, real estate is a tangible asset.
The tangible factor gives you something physical to hold on to that’s unlikely to disintegrate over the long term. Stocks, bonds, and other intangible investments require the underlying company to remain a going concern.
Inflation is the creeping impact of price increases, and when there are concentrated bouts of it over a short period of time, it can rapidly erode the purchasing power of your assets.
Housing has often been touted as an inflation hedge because it has historically held its real value during inflationary markets. This could be because of the following reasons:
1. Most homebuyers lock in their purchase price through a mortgage.
2. Rental agreements typically last one or two years, which allows homeowners to gradually raise rents to keep pace with inflation.
3. Home values typically appreciate over the long run thanks to the intrinsic value of the house and land.
Return on Investment
Thanks to steady demand, single-family homes can match or even exceed the return on investment (ROI) of bigger multifamily properties, with lower volatility than stocks or bonds.
Potential ROI across different real estate properties can be compared using a capitalization rate (cap rate) calculation: net operating income divided by current market value.
Net operating income is your gross annual income from the property minus operating expenses (like repair costs, groundskeeping, property taxes, insurance, utilities not paid by tenants, and any property management fees). Home mortgage loan payments are not included in the net operating income formula.
Single-family homes could be a good addition to a portfolio of stocks and bonds, but why does portfolio diversification matter anyway? Because by diversifying assets, you may offset a certain amount of risk and improve returns.
When stocks or bonds fall, real estate prices can take much longer to follow.
Things to Know Before Investing in Single-Family Rentals
Because of the high acquisition cost of single-family homes, you’ll want to conduct proper due diligence on your local housing market and target property before you buy.
As with all investments, be cautious when investing a significant portion of your cash in one place.
While the projected rental income on a property looks attractive at a glance, bear in mind that maintenance costs and surprises should be factored in.
Vacancy rates, legal issues with tenants, and unexpected repairs can sap your returns over time.
It’s smart to factor in a cash buffer to ensure that money is available on short notice.
Your Target Rental and Housing Market
While the rental income streams of New York and California offer much higher revenue potential, keep in mind that the costs of owning real estate in those areas is enormous as well.
Income is only one side of the rate of return calculation, so make sure you have a good handle on the expenses as well. You can only do that by thoroughly investigating your target housing market and relying on the home appraisal.
The local job market, its dominant industries, and the dependability and growth of local businesses also will shed light on how stable a given market will be over time.
Good schools, safe cities, and proximity to workplaces and attractions matter to many renters.
If you’re looking to use the property as a short-term rental, check out the local ordinances, which may prohibit you from doing so.
The 1% and 50% Rules
The 1% rule is a back-of-the-envelope calculation to estimate whether your rental income strategy will be profitable. If the estimated rental income on the property is at least 1% of its purchase price, you should theoretically be able to generate cash flow.
If your purchase price was $300,000, for example, the monthly rent should be at least $3,000, according to the rule.
The 50% rule states that you should expect the expenses on your real estate investment to make up approximately 50% of the gross income generated. That’ll give you a quick and dirty estimate to help you start ballparking your net returns.
Obviously, the exact numbers are more complicated. When you have time, you’ll want to run a full comparison of revenues vs. potential costs of your venture.
This one’s a little more nuanced, as it depends on your goal amount, the time horizon, and your risk tolerance.
Are you looking to build a rental home empire or are you just looking for a little extra income to supplement your retirement?
Do you intend to tap home equity to buy one or more investment properties? Do you plan to flip or hold the home?
How to Invest in Single-Family Homes
If you’re confident that buying a single-family home is the right choice for you, there are a few ways you can invest:
Buy It Yourself
This is the most capital intensive and least liquid route. Buying a single-family home in the neighborhood of your choice will net you reward as well as the risk that comes with any property.
If you’re handy, you can buy a fixer-upper or a HUD home (bidding opens to investors after owner-occupants are given a chance) and renovate it into turnkey condition.
The expense of any contractors or property managers will need to be factored in.
Invest Through a Crowdfunding Platform
If you don’t have copious amounts of capital, you can still fund real estate investment projects through online crowdfunding platforms like Fundrise.
These allow you to diffuse risk while taking part in more aggressive investments than you might have been willing to by yourself.
Keep in mind that you’ll need to share the benefits with all investors who partake in the process. Another shortcoming is that your funds may be tied up for an extended period of time, which varies by project.
Invest in a Real Estate Investment Trust
REITs are corporate entities that specialize in purchasing and financing pools of real estate investments on behalf of their clients. They sell shares that are publicly traded and can specialize in any number of sectors or strategies.
The big benefit of REITs is that they’re one of the most liquid real estate investments out there, as you can buy or sell your shares at almost any time on the open market. However, the market value of each share will fluctuate daily.
In the realm of investment opportunities, REITs often provide better returns than fixed-income assets like bonds, but REITs carry higher risk.
There are REITs that specialize in buying and operating single-family rentals. These REITs pay out a major portion of their cash earnings to shareholders.
Explore SoFi’s Home Financing Options
When done right, your single-family home investment can offer growth and income and diversify your portfolio. You can start with lower levels of capital by investing in REITs or crowdfunding platforms, but the gains will be diluted.
Looking at single-family home rentals or other investment property? SoFi offers financing for one- to four-unit owner-occupied residences, second homes, and investment properties.
Is renting out a single-family home worth it?
It can be. Appreciation and rental income have made single-family homes attractive to investors. Multifamily properties provide more rental income streams but also require more property and tenant management.
How do you value a single-family home rental?
There are a few ways. One is to look at recent comparable sales. Another is to calculate the capitalization rate (net operating income divided by property price or value). A third is to use the gross rent multiplier approach (property price divided by gross rental income).
How fast does the value of single-family homes appreciate?
It depends on the market. Lately, appreciation has decelerated. But the national median single-family existing-home price had risen 8.6% in a year, the National Association of Realtors® reported in late 2022.
Photo credit: iStock/Phynart Studio
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