Are Rental Properties Good Investments?
Updated: Sep 21, 2021
It's no secret that we love real estate in our house. At the time of this writing (mid-2021) we own six multifamily investment properties with a total of 20 rental units between them, and we are two-for-two on selling primary residences for profit.
Throughout our short investing career, we have realized significant benefits in the form of profits, appreciation, amortization and industry experience. That said, we have always taken a very active role in all of our properties and projects, managing our rentals, serving as general contractor on remodels and even picking up the occasional hammer or paintbrush.
So what about those who are unable or unwilling to dedicate as much time and effort to investing as we have? Is real estate investing right for people who may have a demanding job, for example?
To me the answer (as with any good finance-related answer) is "it depends."
First, you have to decide what your goals are, as there are countless ways to invest in real estate or make money in the industry.
For the sake of this post, we will focus on rental properties. Specifically single family houses and small multifamily properties.
I view rental properties as being on a spectrum between cashflow oriented and appreciation oriented.
Take a condominium in a predominantly investor-owned complex as an example. It is not uncommon to see condos trading today at similar prices as 10 or 15 years ago, but oftentimes their rent-to-purchase-price ratio can be significantly higher than a single family house.
Real world example: there is a condo in Baton Rouge listed for $110,000 that sold in 2015 for $115,000. Negative appreciation - ouch. BUT that unit should rent for $1400-1500/month which could yield a halfway decent cashflow if the association dues aren't too high (though they often are, so be careful). Dividing the monthly rent by the purchase price gives you a 1.3% rent-to-purchase price ratio - this property sits closer to the cashflow end of the spectrum.
Also on the pure cashflow side of the spectrum would be the "D Class" properties. These are the rent houses that you can pick up for $50-75k that rent in the $1000-1200 range (hitting the mythical "2% rule" rent-to-purchase price ratio target often mentioned in online real estate forums - we will likely do a post on this sometime down the road). Cashflow is crazy good for these properties, on paper anyway. Unfortunately these properties tend to be much more maintenance intensive, come with a higher turnover and vacancy rate and are less likely to appreciate.
At the other end of the spectrum are the "A Class" properties. These are likely to be found in newly constructed or well established neighborhoods. When purchasing these properties, investors must compete with retail buyers who are looking for primary residences. This means increased demand, which leads to increased purchase prices.
Higher purchase prices mean lower returns. However, the competitive nature of these markets mean prices are typically rising, a.k.a. appreciation.
Real world example: there is a cute little cottage in an excellent part of Baton Rouge listed for sale at $275,000 (2 bedroom/1 bathroom, 1,184 sqare feet). It last sold for $234k in 2020, and before that it sold for $215k in 2017. This house would most likely rent in the $1,400-1,500 per month ballpark.
With a 0.5% rent-to-purchase price ratio, this property is definitely on the appreciation end of the spectrum and may not produce any real cashflow at all, depending on financing terms, vacancy, etc. However, assuming it sells within $15k of asking price, the seller is looking at a $26k increase in the past year, or a $45k increase over the past four years - appreciation in action.
So where on the cashflow-appreciation spectrum should you invest? It all depends on your goals, how much risk you are willing to take on and how hands-on you want to be in your investing.
A younger investor with less capital (and more time to rebuild should things go bust) may set a goal to maximize cashflow so he or she can generate additional income to continue reinvesting each month. This investor may want to focus on the cashflow end of the spectrum.
A more seasoned, well capitalized investor may have a goal of preserving capital, especially if he or she has sold a property and is looking to defer capital gains taxes with what is known as a 1031 exchange. This investor will probably want to focus on the appreciation end of the spectrum.
As with any investment class, there is no single "right" way of doing things, only the way that fits your particular goals and situation.
As far as the time commitment goes, that can be solved by building a team. The right property manager will take all of the stress and headache out of owning a rental property, but they will come at a cost in the form of a percentage of collected rent.
You will need to weigh the pros and cons of professional vs. self management and decide if it is worth the cost. Hint: a good manager is worth it 99% of the time, and if you are in the Baton Rouge area, check out Cornerstone Management Group for property management services.
To hopefully bring this to a close, I firmly believe that real estate in general is an excellent investment strategy from a return on investment perspective, inflationary hedge perspective and a tax advantage perspective.
There are numerous ways to play the real estate investing game. Just be sure you determine which one works for your unique situation and be sure to work with advisors and a team that you trust.
Also, keep in mind that real estate investing (as with any fundamentals-based investment vehicle, as opposed to speculation) is a marathon and not a sprint. Yes, you hear about folks making a mint overnight on a deal here and there, but the overwhelming majority of investors in real estate build wealth over time - as in decades.
The important thing is to have patience and perseverance, and you will have success in your real estate venture. It is very hard to lose with a real estate investment over the long term, so don't be afraid to jump in once you have the right team of advisors in place to assist you.
We will definitely drill down more into some of the concepts we covered in this post, and we will take a look at some deals we have done (and some we did not do) in future posts.
In the meantime, if you would like help buying or selling your next home or investment property, get in touch with Sally or check our SoldWithSalBR on Facebook. Or if you'd like to talk to us about real estate questions, renovations, Baton Rouge or pretty much anything else, feel free to reach out at firstname.lastname@example.org.