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Pros And Cons Of Single Family Home Investing
Dated: August 31 2015
Greetings, fellow investors! Today we are going to talk about single family homes as buy and hold investments. We got started with SFHs and still own some today. We also own small multi-families, apartment buildings, mixed use and office spaces, so I have gotten to know the things that make SFHs a great investment and areas where they can fall short.
I will talk out of both sides of my mouth for a moment. There is simply no better investment from a cash flow perspective than a single family home, bought at the right price, with a solid long term tenant who pays their rent on time. And there is no worse of a suck-hole than a single family home that is sitting vacant with damage done by the tenant who far exceeds their security deposit — as well as a leaky roof and a broken furnace.
Investments in SFHs are not bad and should not be viewed that way. Nor should they be the end all be all to wealth building. There are, however, ways that they shine as investments and ways that they can miss the mark. In this article, I am going to go over the pros and cons of SFH investments.
Single Family Home Pros
Pro #1: Expenses
In my estimation the thing that makes SFHs so great is that when the property is leased, the expenses are low and predictable. Tenants typically pay all utilities, including water. If your lease agreement is structured well, the tenant will be responsible for the landscaping and the snow removal. There are no common areas to clean as you would have in a multi-family. And if your tenant are really great, they will do some minor repairs themselves without you even knowing about it. As long as there are no major maintenance issues, your only out-of-pocket expenses will be debt service, real estate tax, insurance, and management.
Pro #2: Tenants
Not all tenants pay their rent on time, and of course, not all tenants take good care of their rentals. That being said, I have seen more tenants treat their rented house like a home than those who are renting an apartment. They put up lights on the house at Christmas, they cut the grass, and one even paid to have some of the windows replaced. You would think they owned the house themselves the way they treat it. I have SFH tenants who have been in place for many years, and will stay in the house for as long as we let them stay. As long as we don’t increase the rent beyond their means and take care of a repair when it’s needed, they will stay forever.
Pro #3: Market Comparisons
So, I know that this is a hotly debated topic among real estate investors. Apartment buildings are valued on cap rate, which is determined by looking at the Net Operating Income. If you increase your rents or reduce expenses, your NOI goes up, so your value goes up too based on the same cap rate. I know the story. The other side of that conversation is that apartment buildings will only be compared to other apartment buildings. The acceptable cap rate for the market will be what it is and will stay that way until the market changes.
The one investment that is a bit of a chameleon is the single family home. It can be compared to other SFH investments and should be when you are evaluating a purchase. But because it’s still a single family home, it can also be compared to homes that people live in, which can really affect value if the home ownership market changes in your area. This phenomenon is true only in A and B class neighborhoods, from what I’ve seen.
A and B class neighborhoods have a low concentration of rentals overall, so you have plenty of comps to pull up the value of your rental when the home buyer market gets hot. C and D class areas are primarily landlord owned, so there the homes owned by the occupants will have around the same value as the ones owned by a landlord. In a nutshell, you can buy at an investor price and sell at a home owner price when the market is right.
Single Family Home Cons
Con #1: Vacancy
As I alluded to in the beginning, a SFH can turn on you on a dime when the tenant moves out. In New Jersey, where I invest, you can only charge 1.5 month’s rent in security deposit on any residential unit. That is the case in most states as well. If the tenant leaves you with any rent owed, there is very little money left to get the property rent ready again. This money can get sucked out very quickly if you need repainting, carpet, or other touch ups to get the house rent ready again. And if the tenant left you a ,mess behind as mine have in the past, it can cost you dearly to get the unit turned around.
The second way that vacancies sting on a SFH is that there is only one rent source. Once that source is gone, the property is financially “upside down,” meaning that you have to support the expenses out of your pocket until you have another viable tenant in place. Multi-family doesn’t work that way. You can lose one or even a few tenants in a small multi and not even blink.
Con #2: Personal Guarantees
Financing on SFHs can get interesting, which is why some would put a mark for them in the “Pro” column. You can get owners to hold a mortgage easily on a SFH, and you can get really creative with low money down strategies. That being said, you most always will have to personally guarantee the mortgage with a bank or private lender on a SFH. The reason is that it’s very hard for a lender to be comfortable with the asset being enough collateral for their loan. There are too many “what ifs” that could come up. You only see the PG get removed on much larger deals, where the main value is in the property, not the other holdings of the guarantor.
Having too many personal guarantees out there can slow down your growth over time, as you should be disclosing those to lenders as “contingent liabilities.” Banks don’t want to see too many of these, as it dilutes the value of a PG to them. Bottom line, there is only so much personal guaranteeing you can do, so be careful!
Con #3: Capital Expenses
This is the one that comes back around and bites some investors in the butt. For any real estate rental, you should be budgeting and setting aside cash each year for major capital expenses. These are anything that are not regular maintenance items and can include roof repair or replacement, heater repair or replacement, windows, kitchen and bath upgrades, and even carpeting. The list goes on and on. These items cost big money.
On a SFH that cash flows $300 to $400 per month, a $5,000 roof replacement can knock you out of the box. What makes SFHs difficult is that you only have one unit to contribute to that capital expense budget. If a major repair hits before you have time to set aside some cash, you will be going into your own pocket to keep things moving. Multi-families are different. You have a few units that can kick towards the cap ex budget, and things like roof replacements will typically be less per unit than a single family home in comparison.
In conclusion, SFHs are a double edged sword. With the right planning and implementation, you can do very well with them. Just be sure to think about the long term before you buy. How will this investment affect your ability to finance more deals in the future? Are you able to set aside some “rainy day” money for big expenses and potential tenant move outs?
Do you see more pros or more cons when it comes to single family home investing? What would you add to my list?