The Advantages and Disadvantages of Investing in Single Family Residences

The following blog post is the third in a series of posts based on a course that Jan Brzeski and Greg Hebner taught at UCLA Extension in early 2013. The course will be offered again in August, 2013. For more information, please visit their website. The Advantages and Disadvantages of Investing in Single Family Residences

"Acknowledging what you don't know is the dawning of wisdom." -Charlie Munger

Investing in single family residences (SFRs) provides market diversification and can be a good way to balance out an investment portfolio. However, before deciding if single family investing is right for you, it is good to assess the advantages and disadvantages.

Advantages

There is strong rental demand for single family residences. Families who lose their homes frequently want to rent a home in the same area. There is a lot more appreciation potential for SFRs than for commercial properties, in our view. Currently, SFRs in many parts of the U.S. have more attractive pricing than commercial properties (though this is changing as more money floods into the sector).

SFRs have a lot of motivated sellers. Banks need to sell hundreds of thousands of single family homes in the coming few years. Going-in yields (capitalization rates) are frequently 7% or more, which is higher than for apartments in most areas. Additionally, returns of an SFR investment strategy are relatively uncorrelated to public equity markets which hedges against inflation.

Disadvantages

If you are an active investor it requires a substantial amount of expertise and time. Some of the things active investors need to consider are: accurately assessing the value and condition of a home, estimating a realistic range for the costs of renovation, creating a pro forma operating budget, being knowledgeable about the local rental markets, and renovating properties cost effectively. There is an on-going time commitment to managing investment properties. Active investing can be very enjoyable if you can actually execute it. However it is not easy. Oftentimes, investors get sick and tired of looking at a hundred properties and having nothing pencil out: most investments don't make sense, and impatient investors or those with not enough time to devote to searching for property can end up beating their heads in frustration. Because of this, a lot of people end up becoming passive investors.

If you are a passive investor, you have to select a good manager. You have to choose the right investment, and be able to read and understand the investment agreement. Additionally, there are fees involved.

Conclusion

There are many different ways you can invest in real estate. A lot of the decision on what to invest in and how to invest just comes down to what you want to do. What's the reason you want to invest in real estate? Is it retirement income? Do you enjoy it? How much capital do you have? The answers to these questions are different for each person.