Is There a House in Your Retirement Plan?

Single-family homes can offer an easy entry into property investment and help you diversify your portfolio. But even experienced real estate pros have to take care to ensure they get the most from this type of nest egg.

Thinking of adding investment property to your reserve fund? You’re not alone. When investing site asked Americans in a 2016 survey what they felt would be the best way to invest money they wouldn’t need for more than 10 years, the most popular answer was real estate.

But while you surely understand the benefits of real estate as an investment — equity, ownership of a tangible asset, and appreciation, just to name a few — when it comes to taking the leap, you might feel stuck. Even for real estate professionals, it’s difficult to know where to start. It’s one thing to help your clients with property investments; if you’re going to take that leap yourself, you first need to gather a sizable amount of your own money. Then you need to make sure you play your cards right and end up with a winning property.

While there’s no one-size-fits-all property investing strategy that will always outperform the rest, rental properties — and particularly the humble single-family residence — have been performing exceptionally well in recent years. Over 36 percent of U.S. households were renting in 2015, according to a report by the Joint Center for Housing Studies of Harvard University, which is the largest share since the 1960s. And 40 percent of the nation’s renters are in single-family housing, up from 34 percent in 2005. We’re experiencing an unprecedented demand for this type of housing, and that’s fueling surging rental prices across the country.

One of the great advantages to investing in single-family homes is the relatively low entry point. As any residential real estate practitioner can confirm, this type of property is by far the easiest to start with. Compared to condos or multifamily residences, the required down payments and outgoing expenses are often significantly lower. Meanwhile, you can expect steady returns on a single-family home investment. According to RealtyTrac, the average annual gross rental yield for properties purchased in the first seven months of 2016 was 8.7 percent.

Why the Single-Family Rental?

Nationally, rents for single-family properties are on the rise. According to a recent report released by Morningstar Credit Ratings LLC, increasing rents on single-family properties throughout the U.S. suggest that tenant demand remains robust. And while many investment options struggled to provide substantial returns throughout 2015, another recent Morningstar analysis found single-family rental investments outperformed expectations in terms of both rental income and appreciation in a number of markets throughout the country.

What’s driving this demand? Steve Hovland, manager of research services at HomeUnion, says more favorable views about renting among millennials and seniors is one catalyst behind the increasing occupancy rates and higher rents. Additionally, Harvard’s Joint Center for Housing Studies predicts the steady decline in homeownership will continue to fuel demand for rental housing into the foreseeable future.

So these market conditions make rental property investment more enticing, but why are single-family rentals particularly attractive? In my experience with Renters Warehouse, I’ve noticed that these properties tend to attract high-quality, low-maintenance tenants. Maybe that’s because occupants of single-family rentals tend to stay longer than apartment dwellers do; one Oakland-based company specializing in single-family rentals finds that on average, their tenants stay in a rental for about three years and that tenancies of five or six years are not uncommon. Not only does this tend to lead to more stability, but it also helps investors such as yourself cut back on the need for tenant sourcing and screening.

Making the Most of Your Investment

While the market for single-family residential property is hot, it’s important to note that not all units are created equal. Some properties naturally perform better as rentals than others.

For this reason, it’s important to run the numbers and pay attention to your projected net yield. Don’t assume that a great price or an outstanding property will automatically equate to higher profits. At the end of the day, finding success with single-family rentals comes down to two very simple things: finding a winning property and ensuring that it’s managed as profitably as possible. Here are some key steps to follow:

Know Where to Look

While it’s true that there are fewer bargains today than there were immediately after the recession, there are still good deals to be found if you’re patient and know where to look. It’s always a good idea to start local, since you’re already familiar with the local housing market and your area’s economic conditions. Pay attention to whether a property is a power-of-sale property or a foreclosure. With foreclosures — which have the lending institution on the title — you’ll often be able to get a better deal, since banks prefer to offload properties fairly quickly.

Find the Right Property

Next, it’s important to choose a property that will perform well as a rental. While there are exceptions, many investors find that the most profitable rentals are the ones that fall in the middle of the scale. Look for properties that are in nice, middle-class areas, near jobs and good schools; this will increase your chances of attracting long-term tenants while avoiding the costs that are often associated with rentals that are located in more exclusive neighborhoods. You’ll also want to carefully consider whether you want a fixer-upper or a turnkey property that’s ready to go. While some investors make it their strategy to purchase homes that are in need of repairs, this method can be risky and costly if you don’t know what you’re doing. No matter which option you choose, it’s important to go into it with an airtight plan and a timeline for any repairs.

Run the Numbers

Don’t operate on assumptions alone. It’s important to do your homework and determine how much a property will cost you to operate each year; this includes taxes, insurance, maintenance, repairs, and unexpected vacancies. Next, subtract this figure from your projected annual rental income. While low property prices or estimated high gross yields can be tempting, remember: a cheap property doesn’t necessarily mean that it’s a good deal. Similarly, more expensive properties that promise high returns will make a poor investment if the annual taxes end up eating up most of your profit. What matters most is how well the property will perform in the long-term.

Manage Your Property Profitably

Once you’ve acquired a property, you must manage it in a way that will ensure maximum profitability. Keep in mind that your tenants can make or break the success of your rental, so it’s important to implement comprehensive policies, a solid rental agreement, and a thorough screening process for vetting potential renters. Run background checks, call references, and perform credit checks for all potential tenants. Finally, it’s important to ensure you are operating in compliance with anti-discrimination laws. Always provide your screening procedure in writing. Run it by an attorney to ensure that your questions don’t discriminate against any protected classes. Many investors choose to use property managers, allowing them to offload the work of tenant sourcing and screening as well as the day-to-day tasks associated with property management. This is an especially good idea for those who want a more hands-off experience once they reach retirement.

The single-family residence is still a hot item that can make an excellent addition to your retirement portfolio. Just remember that, as with any investment, it’s important to assess potential properties on a case-by-case basis, ensuring you weigh projected profit and loss.