Before I could find my first rental property, I had to figure out what I was looking for. It took me over a year to save up the 20% down payment for the investment. So I had plenty of time to narrow down the type of property that best suited my goals.
Initially, I focused on multi family properties ranging from duplexes to 8-plexes. While in theory these properties may cash flow easier than a single family home, I was fearful of higher vacancy rates and turnover costs. Also, since I planned to self manage the property, I figured one tenant paying $800/month would require half as much time to manage than two tenants paying $400/month each.
Benefits of Single Family Homes
After reading several books and countless hours on the bigger pockets forums, I narrowed my search down to single family homes. Several benefits to this asset class caused me to determine it was the most viable investment for me. These included lower entry costs, lower vacancy rates and easier resale.
With this being my first investment in a rental property, I wanted to focus on lessening my risk as much as possible. When purchasing a single family home I could find numerous suitable properties for between $60,000-$90,000. If I invested in multi family properties, the prices for available properties ranged from $140,000 to $250,000. I would much rather make a mistake on a $60K investment than a $250K investment. Also, I could spread my investment over four separate communities with four $60K homes rather than one community with a $240K quadplex.
The second reason for focusing on single family homes, was my focus on minimizing vacancy rates. For the first couple years of investing I will only have one property. Which means if it is empty I will have a 0% occupancy rate. I wanted a home that would have the shortest turn around time between tenants. In my area, like most cities, single family homes have the highest occupancy rates. I called multiple property managers, who said single family homes averaged being 95% occupied for the area. While multi-family rentals were closer to 90%. On a property renting for $800/month that is a difference in income of $480/year. Not to mention having additional turnover costs that could be in the thousands.
Another benefit of single family homes is the liquidity in the market. When purchasing a single family you have literally hundreds to chose from at every price range and condition. You are also normally buying from inexperienced sellers who really want the process to be over with. When buying a multi-family home your most likely buying from a professional investor. This makes it much harder to find a good deal below market value.
When you go to sell the home down the road you will encounter the same issue. Those looking to buy a single family home is likely to be someone buying their first or second property, versus a professional investor for the multi-family home. Also, the value of a single family home is not linked to it’s income potential. If you have issues keeping a single family home rented, the value of the home is not affected nearly as much as with a multi-family. This decreases the down side risk of the investment.
What to Look For in a Single Family Home
My next step was narrowing the search with the single family asset class. Prices range from $20,000 to $500,000, and conditions range from a complete remodel to move in ready. Each form of investment has it’s own pros and cons, I simply had to find what was best for my needs.
While I am not completely useless at home repairs, I am definitely not a professional handy man. I may have been able to find a home that essentially needed gutted and picked it up for well under market value. But, I have no experience rehabbing a property nor do I have connections to a contractor I trusted enough to give me accurate and honest rehab quotes. The risk in taking this strategy for me would be greater than to others with those connections. Instead, I decided to look for homes that needed minor to no work done. I can paint, have carpets clean, repair a fence and even repair damaged dry wall… Repairing wiring from flood damage… No thank you.
The next step was determining a price point that would be most profitable for me. There are properties available in Lexington for $35K – $45K, that rent for $700 a month. On paper these investments have wonderful cash flow. The downside is they are in the rougher(higher crime) areas. If I was a professional property manager and had experience with these areas. Or if I had multiple cash flowing properties in my portfolio and could take on extra risk on a single investment. I would have entertained the idea of purchasing a home in those communities. But, I do not have either and needed to lessen risk by purchasing in a lower crime “nicer” area.
After crossing off the lowest priced homes in Lexington, I then decided to cross off the higher priced homes as well. The main issue with increased prices for homes in Lexington and most areas, is that rental prices do not increase at the same rate as purchase price. More expensive homes simply do not cash flow as easily as homes under $100K. With cash flow being the most important factor in my search, I quickly ignored homes above this price point.
My Ideal First Rental Property
My search for my first investment had now been narrowed down. I decided to look for a single family home. With a price ranging from $50,000 to $100,000. The home would need to be in a lower crime area. Also, the home would need to have only minor to no work done before it would be move in ready. Most importantly the investment would have to cash flow with a comfortable margin for error. Meaning if forced to rent below market value by 15%, I would not need to put cash in to pay the bills.
I had narrowed my search down enough that available options were not overwhelming in number. However, I had plenty of choices to look at in order to find a property that met my personal needs. Now I needed to do the leg work and find my first real estate investment.