Buying single- family homes as an investment is challenging because the potential income and additional expenses have to be considered. Additionally, you have to evaluate the investment potential of the home.
An investor considering income property either buys primarily for cash flow or appreciation, although, all investments have elements of both. If the home will also be used by the owner for personal use and enjoyment, then weighing and considering the investment attributes and personal benefits of a prospective home becomes more challenging.
Single-family homes generally are not good cash-flow investments because the relationship between the value/purchase price and the income the property can generate is not as favorable as a multi-unit property. As an example, a single-family home with a purchase price of $400,000 could generate $24,000 in annual income (6 percent of the cost), while a four-unit property valued at $600,000 could generate $60,000 in annual income (10 percent of the cost). A large down-payment is necessary for the rent on a single-family home just to cover the expenses.
Single-family homes normally appreciate at a higher rate than multi-unit properties, so what you lose in cash flow may be made up with a larger gain when the property is sold. This is particularly true if the home is bought at the bottom of a “down market.” If the real estate market is flat or declines, the lack of cash flow could quickly erode the performance of the property as an investment and be a drain on the owner’s income from other sources. In most market cycles, single-occupant properties make the most sense for buyers who intend to use a home for their personal enjoyment and/or convert the home to their primary residence in the future.
Buyers of homes have two rental options: rent for a long term or offer the home as a vacation rental. The advantage of a long-term rental is steady income, lower maintenance costs and lower management fees, which are typically about 10 percent. The disadvantage is that the owner cannot use the property for long periods of time. Annual gross vacation rents can be higher than long-term rental income, particularly if the home is in a desirable location. The income is higher during peak demand periods and lower when demand is lower. Additionally, the maintenance and management costs are higher, typically 35 percent, which could fully or partially erode the additional gross income.
If you are thinking about buying investment property, you should talk with more than one agent who has extensive experience with income property. You should also discuss any homes that you are considering with a property manager to get a realistic idea of what you can expect to generate in income and pay in expenses before you make an offer to buy. I recommend that the most conservative numbers be used in the evaluation process.
Steve Setka is an exclusive buyer’s agent with Keller Williams Realty in Durango and a licensed mortgage originator. He can be reached at 903-7782 or firstname.lastname@example.org.