Investing in Single-Family Homes Isn't as Easy as Many Hope

TheStreet.com

NEW YORK (TheStreet) -- In their eternal hunt for something new and exciting, investors find a few winners and a lot of dogs. A study shows that many would like to dabble in the single-family home rental market -- but it's not easy to do, and the risks are scary.

The survey, by OCR International, a market research and consulting firm, found that 59% of 1,009 adults it polled said they'd be interested in investing in single-family rentals, or SFRs, that have been a hot area in the past few years for professional investors.

"Increasingly, individual investors are following the lead of institutional investors and are looking to real estate investing as an alternative to traditional, low-yielding bond and mutual fund options," said Don Ganguly, CEO of HomeUnion, a real estate management firm that sponsored the research. "These investors are attracted to the potential for income and for asset allocation, not the prospect of a quick gain by house flipping."

Real estate holdings can help diversify a portfolio because housing prices depend on factors different from those driving stocks and bonds. And real estate offers a potential income stream from rents. That can be attractive today given the stingy yields on traditional income producers such as bonds and certificates of deposit.

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Low home prices and fast-rising rental rates have drawn record numbers of professional investors into the SFR market. Ganguly says about one in five homes bought last year was an investment rather than a primary residence. And early this year about 40% of home sales were for cash, which is common in investment purchases.

Unfortunately, it's tough for small, individual investments to break into this market. There has long been a wide selection of real estate investment trusts for ordinary investors, but they typically own commercial properties such as malls, office buildings and apartment buildings. A few single-family rental REITS have been launched recently, but they have yet to show impressive performance.

Many individuals invest in SFRs, but most are hands-on types who find renters themselves and minimize costs by pitching in with upkeep and repairs. That's not what the typical investor has in mind. More than half of those surveyed said they'd want to rely on someone else, such as a management firm, to select and manage the property. That may be unavoidable if the rental property is far away, which may be necessary to get the best mix of purchase price and rental income.

So is this a good idea? That would depend on the property bought, of course. But people who have ventured into this market have learned some tough lessons.

First, buying a home and later selling it for more does not mean the investor made a profit, even if the home is sold for substantially more. Management fees, unexpected repair costs, mortgage interest payments, property taxes and insurance premiums eat away at any gains, and can turn them into losses. Rental properties often operate at a loss for a number of years until rent increases can cover expenses.

The second big issue: This is a "concentrated" investment, meaning there's a lot of money tied up in one place. A promising investment can turn into a money loser over something as simple as a bad neighbor moving in next door or a bad news story about the schools.

Finally, real estate is "illiquid." Unlike a stock, bond or mutual fund, you cannot bail out with few clicks of a mouse. A property that turns into a money pit could be a burden for years.

This is why the most successful individual real estate investors tend to treat it like a second job. They don't rely on expensive outside experts, they know the market and they don't expect an outrageously high return. They typically improve their odds of good returns by minimizing costs. That may involve taking angry calls from renters at 2 a.m., rushing over to snake a clogged drain or oil a squeaky hinge, and breaking out a roller and brush to spruce up between tenants.

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