Single-Family Homes as Investments

Although real estate is an illiquid investment that doesn't convert readily to cash, single-family homes are generally considered to be the most liquid of all real property investments. They typically can be sold in a significantly shorter amount of time than other types of real estate, and their equity can commonly be used as collateral for loans and in refinancing. A single-family home is also one of the most easily rentable types of investment real estate, since everyone certainly needs housing. As such, the sheer abundance of homes is an advantage for the potential investor; new opportunities can present themselves weekly, if not daily.

A major benefit offered by single-family homes is in the area of financing. Lower interest rates and higher loan-to-value (LTV) ratios can typically be obtained for single-family homes than for any other type of investment. In many instances, owner-occupied homes can be purchased with little or no cash down payment.

However, a significant disadvantage of single-family homes as investments is that rarely can they be rented for an amount large enough to make the debt service payments, unless a very substantial down payment is made when purchasing. This condition creates a negative cash flow situation, which makes holding the property an economic burden for many investors. But this negative aspect is often unlikely to continue for more than a few years because rents in most areas have typically risen between four- and eight percent annually. Such an increase in gross income coupled with a fixed debt service payment generally mean that, in a relatively short period of time, the negative cash flow would likely turn itself into a positive cash flow.

Furthermore, even if a single-family home has a negative cash flow, that negative condition might be effectively reduced or completely eliminated by the tax benefits of owning the property. Depreciation, for example, is a paper expense that can be used to reduce the owner's overall income tax liability. If the investor can live with the negative cash flow, and the tax benefits along with property value appreciation are sufficiently significant, then what would otherwise be considered a poor rental investment could actually turn out to make a great deal of financial sense.

Some buyers of single-family homes are able to altogether avoid the negative cash flow aspect of this type of investment by offering them for sale on a lease option basis. Using a lease option with a significant portion of the rent going toward the down payment, a higher monthly payment can be commanded.

When searching for candidate properties, the smart investor must keep in mind that no home purchased for resale will be a bargain if a buyer can't be found for it that's willing to pay enough for the investor to make a profit. As such, the investor should be watchful for things such as substandard basic construction, possible building code violations, floor plans that are unlikely to appeal to most buyers, and rapidly declining neighborhoods. However, areas that have been affected by economic recession may be attractive possibilities because homes can likely be purchased there for less than current reproduction costs and will likely realize a considerable increase in value when the overall market recovers.

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