Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to [email protected].
Question from Sally in Southern Cal: Hi Brian. My husband and I want rental properties and have a little over $50,000 to get started. But the high cost means we will be risking almost everything we have in savings. I’ve done some reading and understand the general approach to use for getting into single-family rentals. However, this “new normal” coming out of the pandemic makes me think that some of the old advice might not be the best advice. What do you think has changed for small investors like us?
Answer: Hello Sally. First of all, the goal of single-family rentals is to build wealth and that is going to take time. You’re doing the right thing by asking questions and doing some planning before rushing into this. The good news is that as we inch closer to a post-pandemic world, the single-family rental market looks to be as strong as it has ever been over the past 20 years. So strong that institutional investors are getting into “built-to-rent” homes. Single-family rental investors are accounting for 15-20% of existing home sales and SFRs make up about 35% of the total housing market, including apartments. All indications are that this is a very good time to get in as mom and pop investors. Here are some important tips for the post-pandemic market as well as getting started in general.
1. Understand the millennial market. Because of the sheer numbers, you should expect millennials to continue driving both the rental and homebuyer markets. Most people are talking about how this generation is affecting home purchases, but they are still significantly behind baby boomers when it comes to homeownership. Just as important, millennials are at the age when they very much want to be out of apartments and into single family homes to raise families. COVID-19 also means they want out of high-density housing for social distancing reasons. As long as they are still dealing with student debt, saving massive down payments, and struggling to qualify for a mortgage, SFRs are their best option. Sally, you should always have a target market, so by studying what millennials are willing to pay for in your market, you can expect to keep your rentals fully occupied.
2. Ideal single family investment property. To make your efforts worthwhile, you want a property with at least a 12% gross rental yield. Also known as the 1% rule. Sally, you aren’t likely to find this $100,000 example in southern California, but the simple example is a $100,000 home renting for $1,000 a month ($1,000 X 12 divided by $100,000 = 12%, or $1,000 =1% of $100,000). It should be in a neighborhood where the median home price is below $200,000. Other factors also go into this analysis such as low crime rates and quality of the school district for millennials raising families. Another good alternative in areas with zoning laws that allow it is finding a single family house on a lot that is large enough to build another dwelling or two. This could be a future business expansion plan if you can add a mothers-in-law apartment or a few college student bungalows. For density reasons, this is probably more appropriate in the future post-pandemic world.
3. Rehab for value. This is going to be a balancing act. Many millennials want top quality but at a budget price. A middle-of-the-road rental house doesn’t need granite counters and stainless-steel appliances. When it’s time to upgrade a rental, you want nice and modern but you don’t need the most expensive of anything. Build a budget that works with your return on investment and stick with it. In most cases, you’re going to do fine with middle-of-the-road carpets, counters, and fixtures. Depending on your circumstances, the lower end of middle-of-the-road is fine too. If renters want a high-end lifestyle, they’ll need to rent in a high-end neighborhood.
4. Borrow strategically. Growing your rental business over time is going to require borrowing money. There can be a temptation to grow fast by borrowing too much. No one knows when there might be a slump in the market and houses could go vacant for several months. To build long-term wealth, you want to own some of your rentals free and clear and have some of them financed. Try to avoid the temptation of using free and clear properties as collateral to purchase more properties or you may become mortgaged to the hilt. Your free and clear houses should generate enough cash that when combined with a mortgage only on the new property it is enough to avoid mortgaging properties that you already own free and clear.
5. Start with a simple business plan before investing. Mom and pop investors need a business plan just as much as big institutional investors. Do the math! And not just for the first month that you’ll rent out the house. Do long-term projections that include interest rates, vacancy rates, rent increases, rehabbing, and inflationary costs such as insurance, property taxes, and any utilities that you are responsible for.
6. Stay on top of maintenance. Each property should have its own annual checklist for routine maintenance. Your lease agreement should include you doing a bi-annual walk through to look for problems. Water damage can become a very expensive repair if not caught quickly. Inspect all potential sources of water leaks including tub and shower sealing, all sinks, toilets, and laundry rooms. Encourage renters to report problems promptly rather than later.
7. Anticipate changes in the neighborhood. Change is going to come from many different sources. COVID-19 is driving changes towards work at home as well as social distancing. Millennials are driving changes with a desire for boutique neighborhoods. Online shopping (also part of COVID-19) is killing neighborhoods near shopping malls, but institutional investors are anticipating a comeback in mall neighborhoods as online retailers convert malls into distribution centers that bring employment back to these areas.
Overall, mom and pop rental houses are a business and should be run as a business. Even a two-property portfolio requires planning, execution, and management. Keep good financial books and plan for emergencies. If you want to succeed as mom and pop landlords, then you must run it like a business.
What are you doing in the post-pandemic rental business? Please add your comments.
Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to [email protected].