In the realm of real estate investing, many so-called experts and coaches tout single-family rentals as the golden ticket to wealth. They paint a picture of passive income, highlight the numerous tax advantages, and emphasize the potential for equity appreciation. These experts often charge hefty fees for their coaching and seminars, promising financial freedom through property ownership. But how accurate are these claims, and what are the real returns on single-family rentals? In this post, we’ll delve into the pros and cons of owning single-family rental properties to provide a more realistic perspective on their profitability.
The Cons of Owning Rental Property:
- The Search for Cash-Flowing Properties: Finding the right single-family rental properties that will generate positive cash flow can be a challenging endeavor. It often requires significant time and effort, and the market is highly competitive. Property hunting becomes a full-time job in itself. Properties listed on the Multiple Listing Service (MLS) are frequently targeted by buyers intending to owner-occupy, making it difficult, if not impossible, to identify rental properties that will cash flow. The competition can drive prices up, further eroding potential profits.
- Average ROI: A good single-family rental property, once acquired, typically yields a return on investment (ROI) ranging from 4% to 7%. This estimate is based on a substantial dataset of approximately 1,000 properties our company has managed over the years. It takes into account actual expenses and accounts for the significant cost of maintenance and depreciation of major structural systems like HVAC and roofs.
- Active Management: Contrary to the notion of passive income, owning a rental property demands ongoing involvement, even with a professional property manager. Maintenance issues, tenant turnover, and property-related decisions can be time-consuming and require active management.
- Alternative Investments: As of the date of this post, there are alternative investment options that offer competitive returns without the active involvement and risk required for rental properties. Risk-free Treasury Bills currently yield about 5.5%, 10-Year US Treasury Notes offer around 4%, and the historical return on US equities averages 11-12%.
- Interest Rate Dependency: The recent appreciation in rental property values has been partly driven by historically low interest rates over the last two decades. There are no guarantees this appreciation will continue.Â
The Pros of Owning Rental Properties:
- Illiquid Asset Benefits: Unlike stocks that can be easily traded on an exchange and display price fluctuations by the minute, rental property valuations are less apparent and therefore, create less temptation for make impulsive investment decisions. This can be particularly beneficial for investors who struggle with discipline, as long term returns on equities only hold true for investors that stay fully invested and continue to invest in down markets.Â
- Structured Savings: Rental properties force property owners into a structured savings plan. Renters pay their monthly rent, and landlords must pay the mortgage. This monthly obligation encourages long-term savings through the gradual reduction of the mortgage balance and the accumulation of equity.
- Tangible Cash Flow: Rental properties offer the allure of tangible cash flow, even during market downturns. While the value of other investments may fluctuate wildly, rental income provides a consistent source of cash flow, which can be reassuring to investors, especially during challenging economic times.
In the world of real estate investing, single-family rentals come with their own set of pros and cons. While equities may offer better long-term returns for disciplined investors, not everyone has the patience or temperament to navigate the stock market’s volatility. Single-family rentals can provide stability, structured savings, and consistent cash flow, making them an attractive choice for those seeking an alternative path to building wealth.
Ultimately, the decision to invest in single-family rentals should align with your financial goals, risk tolerance, and investment strategy. It’s essential to weigh the potential returns against the time and effort required for active management and consider the broader economic factors that can impact the rental property market. In the end, there’s no one-size-fits-all answer, and the profitability of single-family rentals depends on your unique circumstances and investment preferences.