I have a confession. I love real estate and I think everyone should own some. My dear friend Craig, a commercial real estate guru, would admit that it took him about three years to realize that I’m not a “stocks guy,” but rather a comprehensive financial planner who recommends that income-producing real estate be a sizeable portion of one’s portfolio. We just have slightly different views on the “how” and “how much” parts. What we can agree on: As far as investments go, the single-family home idea rarely adds up.
Why It Usually Happens
1. You own and live in a home, want to move, and you see the easy opportunity to just convert the house to a rental property instead of selling it outright.
2. You inherit a home from a loved one and decide it would make more sense to rent it out than to sell it.
Why Owning Real Estate Feels Safer Than Owning Businesses
For many, the appeal of a rental property has to do with the appetite for owning an investment that can be physically touched and understood with no stressful daily reminder of its worth. There’s no ticker symbol for your rental property that you can stick on your smartphone (at least not yet). A recurring rent check also delivers a level of satisfaction that most of us don’t feel from receiving a mutual fund’s quarterly dividend payments or appreciation on paper. For others, it’s often the “I tried the stock market once and got killed” syndrome (naturally, they didn’t hire us).
“But I’m Cash Flow Positive”
We all have our little peeves in life. With the typical rental property owner, mine comes in the form of the line, “As long as I’m cash flow positive, I’m satisfied.” Ugh. Being cash flow positive means that one’s expenses are covered by the rents, with no regard to the quality of the actual investment experience or total return.
The biggest driver of this outcome is the mortgage expense. It’s quite easy to be cash flow positive when the only major expenses are taxes, repairs and insurance. If there’s no mortgage, a whole lot of cash was likely used to buy a building, cash that would have been freed up for other investment opportunities. If there is a mortgage on the property, it may enhance the total return over time, but it can also exacerbate losses if real estate has a downturn. One can lose his entire investment if he puts 20% down on a mortgage and the property drops by 20%. The mortgage should not be what drives the perception of the rental property as a good or bad investment any more than a margin account should be a factor in judging the return from owning a business (stock).
My Top 3 Issues with the Single-Family Rental Investment
Energy: With a single-family home, the burden tends to fall to the owner to collect the rent, find new tenants, and take the call about a broken toilet at 11 p.m. With investment properties such as apartment buildings, retail shopping centers, or office properties, professional property management is generally built in, saving the owner lots of time and frustration. The net cash flows to the owners are typically higher than in single-family investments as well.
Diversification: Every investment should properly reward an investor for the risk they take. At Abacus Wealth Partners, we attempt to own thousands of businesses for the sake of broad diversification. Like the cables on a bridge, if one breaks, the bridge still stands. When you own one rental house, you’re relying 100% on one occupant for 100% of your income, and crossing your fingers that your tenant is low-maintenance and always agrees to the rent hikes. Even if you have a strong appetite for owning one building, I think you’re better off owning a 10-unit building with nine other investors than a single-family house on your own.
Emotional interference: In my experience, owners of a single-family home are more likely to charge an artificially low rent because the tenant is a friend or family member or just “really nice.” In some cases, the owner simply doesn’t know what the market rate should be. Putting a real estate expert between you and the property raises the chances that you will get the return you deserve.
Let Other People Handle the Details
If a property owner gets lucky, he has a perfectly wonderful pay-on-time tenant who never complains, rarely has repair requests and is happy to pay higher rents as the market demands it. In the real world, buildings don’t always appreciate, stuff can break, and tenants can complain, move and fight rent increases. The workaround: Own enough units so you can justify having real estate professionals between you and the rent checks, go to Bora Bora, and let others worry about broken toilets and screen doors. Check please.
Happy Real Estate Investing,
The opinions expressed are those of the author and are subject to change without notice in reaction to shifting market conditions. This blog is provided for informational purposes, and it is not to be construed as an offer, solicitation, recommendation or endorsement of any particular security, products, or services.