SINGLE FAMILY HOMES AS BUY AND HOLD INVESTMENTS

It’s Friday and we are back with a great topic to discuss “Single Family Homes as Buy and Hold Investments”. If a person is looking for a cash flow perspective in terms of investment than Single family homes are the best option to go for.

But today we will see in detail both the sides of this investment that is its advantages and its disadvantages as well.

ADVANTAGES:

1.       Expenses: When a Single family home is leased out the expenses are low and predictable. We all know the tenants will pay all utilities including water. If the lease agreement is well laid out, the tenant will be responsible for landscaping and snow removal. As long as there are no major expenses, you as a landlord will be only payable for debt service, real estate tax, insurance and management.

2.       Tenants: Most tenants treat the rented house as their home as compared to a rented condo. They put up lights on Christmas, they cut the grass etc. They treat and live in the house as if it’s their own home which makes it more safe and maintained. As long as the rent is not increased above their means, the tenants will stay there forever and also take care of your house.

3.       Market Comparisons: 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. We 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.

DISADVANTAGES:

1.       Vacant Home: If the tenant moves out, and the single family house stays vacant for a long time, the money can slip away very quickly. And if the tenant left the house in a bad condition, then it can cost you a lot of money to get the house back to its shape.

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 dilute the value of a PG to them. Bottom line, there is only so much personal guaranteeing you can do, so be careful!

3.       Capital expenses:  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.  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.

                 

In conclusion, Single family Homes with the right planning and implementation, can do very well but just be sure to think about the long term before you buy.

Editor: Neha Charan