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May 31st, 2016 by David Campbell
Single-family homes have the widest market appeal.
In a softening marketplace, real estate that houses jobs (retail, office, etc.) will generally show rental weakness before the real estate that houses people (single family homes). Changes in job indicators give investors in single-family homes opportunities to re-position faster than investors in commercial property can.
Single-family homes have lower rates of vacancy (downtime) than commercial property because there are more potential renters for a single family home than there are for a gas station or a big box store. Single family homes have the most attractive financing terms available. Single family homes will never become technologically obsolete. What technology could replace the need and desire for a place with four walls and a roof where humans sleep at night?
Contrast this with an investor who buys a retail center and then internet shopping and a slow economy make this retail center obsolete. Corner video stores are being replaced by Netflix and streaming movie downloads. Movie theaters are being replaced by home entertainment systems. Soon you may see gas stations becoming technologically obsolete because of major changes in the ways we travel and fuel our vehicles. At the very least, gas stations of the future will require expensive retooling that will erode years of profits for the owner.
Although real estate is relatively illiquid, single family homes typically sell faster and have more liberal access to financing than any other type of real estate. Single family homes can be purchased with cheap, fixed rate financing, with a thirty year amortization and a 20-25% down payment.
Apartments will usually be financed at a higher interest rate and require 30% down, plus you’ll pay a large premium to get an interest rate that is fixed longer than 5 years, and you’ll have an amortization period of 20 – 25 years. If a house and an apartment unit generate an equivalent net operating income, the house will provide a superior cash on cash return due to the better financing available for single family homes.
Single family homes can be purchased in ‘bite size’ portions. If you have the capacity to buy $1,000,000 of real estate you are generally better off buying ten single-family houses for $100,000 each than to buy a single apartment building with sixteen units of $62,500 each.
8 Single Family Homes
16 Unit Apartment Building
Using the ‘bite size’ investment strategy with single family homes gives you flexibility in your tax and estate planning as well as making it easier to harvest equity. If you want to cash out some of the equity in your real estate portfolio, you can sell or refinance one or two single family homes rather than liquidate an entire apartment building. The same ‘bite size’ concept applies to income taxes. For example, offsetting a stock loss with a real estate gain could result in ‘tax free’ real estate profits. Please note, income taxes are a very specialized subject. I am not a tax professional. Always consult your tax advisor.
The income tax benefit from depreciation strongly favors single family homes over commercial property. Single family homes can be depreciated over 27.5 years while commercial property is depreciated over 39 years. The shorter depreciation schedule of single family homes can be a great boost to an investor’s initial cash flow.
Avoid all vacant land investments! These take specialized skill to manage, are difficult and expensive to finance, and are very hard to sell. I know many people who have made huge profits buying and selling vacant land, but vacant land is not hassle-free and it definitely does not cash flow! Making money investing in vacant land requires a lot of skill or a lot of luck. Vacant land takes money out of your pocket for taxes, maintenance, and liability insurance while it produces no revenue. If you are a new or part-time investor, just avoid vacant land. Many people call vacant land “the alligator” of real estate investing because it slowly eats away all of your savings.
A word on buying condominiums: Don’t! While a condo may give you cash flow, it is never a hassle-free investment. I’ve spent years of my life developing, owning and managing condominiums. I HATE THEM! The only winner in the world of condominiums is the developer who originally sells the condo to the general public.
Condos come with the huge, wasteful expense of a Home Owners’ Association (HOA). These collective management groups have different names depending on the location of the property and are sometimes called Property Owners’ Association (POA) or the ominous-sounding Horizontal Property Regime. Cooperatives (co-ops) are legally very different beasts than condominiums, but they are all hideous investments.
These negative factors apply to all types of condos: retail condos, office condos, storage condos, residential condos, but none of these factors apply to my favorite cash flow investment… single family homes!
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