Single Family Rentals – What to know in 2020

One of the best and easiest ways to get started in real estate investing is to purchase single family rental units. Typically, these are detached or semi-detached starter homes or even condos in good areas that you purchase and then rent out to earn income. Benefits include being cash flow positive, build up equity as your tenants pay down your mortgage, tax advantages and you may experience appreciation as well. Let’s take a closer look at the single-family rental property investment.

What is a single-family rental property?

In a nutshell a single-family rental property is any property that is occupied by a single family and can be rented to that single family. Sometimes this will include homes close to a university or college designed for a family but actually rented out to a group of students where each student lives in a single room (with shared common areas).

The home can be detached, semi-detached or even an apartment condo (although these tend to appreciate less than regular homes). The house type is less important than the fact that it was designed for a single tenant.

Benefits of a single-family rental property

There are a host of benefits to owning a single-family rental property but the five main ones are: being cash flow positive, increase your equity over time, taxation advantages, appreciation and security. Oh yeah and it allows you to collect passive income too.

Cash Flow Positive: This is a big one. If your rental property is cash flow positive it means that your expenses are less than the rent you charge. Your fixed expenses will include mortgage payments, property tax, insurance, property management services, regular maintenance, utilities and any home owners association dues. Variable expenses might include unexpected repairs or capital outlays (new roof, furnace, etc) legal fees, loss of rental income and others.

The 2% rule in real estate is a rule of thumb which suggests that a rental property is a good investment if the monthly rental income is equal to or higher than 2% of the investment property price. For example, for a $100,000 rental property, the rental income has to be at least $2,000 to meet the 2% rule. This is an ideal situation (if you can charge 2% of the purchase price) but we don’t always live in an ideal world. I would say that below 1% is not a good situation and you most likely won’t be cash flow positive. Between 1% and 2% and you have a chance of being cash flow positive, but it really depends on the numbers and what rents are going for in the area of your single-family home.

It still might be worth making the investment even if you are not cash flow positive. For example, you might be just breaking even or very slightly negative on the rent of a home in an area where there will soon be a new subway stop going in, or perhaps a new major employer is moving into your area. In these situations, you are banking on rising appreciation which we’ll get to shortly.

One quick way of calculating expenses on a rental unit is to use the 50% rule when calculating the expenses of a single-family investment (rental) property. The rule states that — on average — the total expenses associated with operating a single-family rental unit (not including the mortgage) will be about 50% of the gross rents. Obviously, you need to do your due diligence first but this will let you do a quick calculation to see if a potential property might work for you.

Generally speaking, you want to be cash flow positive as this will give you some float if things turn negative – like during a global pandemic and your tenants move back home to help look after their parents.

Increasing Your Equity Over Time: This one is fairly straight forward. As you use your tenant’s rent payments to pay down your mortgage you are increasing your equity. This is a fantastic way to boost the equity you have, which can then be used as you approach a lender to help you purchase another property.

Taxation Advantages: If you receive rental income from a property that you own the IRS (in the USA) will allow you to make deductions for certain expenses. These include mortgage interest, property tax, operating expenses, depreciation of the property and any repairs that you make to improve the renal unit. Be sure to keep your receipts for all expenses that you incur when earning your rental income. Some of these apply to properties outside the USA as well so it is always a good idea to keep accurate and detailed records for your local tax authority.

Appreciation: Appreciation is the really the increase in value of your property over time. Generally speaking, real estate increases in value the longer you hold it, but it is certainly possible to experience the reverse over a short period of time. We all remember the financial crisis of 2008 where the property values of millions of home owners plunged dramatically. You would not have wanted to be in a position where you had to sell during this time period as you most probably would have taken a loss.

Very often it is the appreciation of the property where you will make the most return on your investment. This is all dependent upon the location of your rental property and how well you have maintained or improved your asset. Just keep in mind that it is not guaranteed. If you evaluate the numbers before looking at appreciation and decide that it make sense – probably because it is cash flow positive – then when you do decide to sell, any appreciation you experience will be an added bonus.

Security: The real estate market is much more stable than the stock or bond markets and are often unconnected with one another. Primarily because in real estate you have a real tangible asset that is backing your investment. Namely the single-family home. If for some reason the situation changes and it no longer become financially viable for you to own the property then you can sell it for a significant sum of money. In the stock market it is very possible to see your asset fall to zero, and this just can’t happen in real estate. This means that you can safely diversify by investing in real estate since the risks are different.

Passive Income:

Not specifically mentioned in the benefits of owning a single-family rental property above is the fact that it can generate a passive income for you. You can still work your regular day job and collect rent from your tenants. This is income for you that you earn whether or not you punch the clock, especially if you employ a management company to handle any tenant issues.

Conclusion:

Single-family rental units can be one of the very best ways to get involved in the real estate investment market. It can generate a passive income when your situation is cash flow positive, boost your equity by having your tenants pay down your mortgage. You can take advantage of the tax situation by keeping track of your expenses and you can set yourself up for a big win when you finally do decide to sell by capturing the appreciation on the property.