Jump from renter to buyer to landlord
Trying to buy your first house can be a challenge. Moving up from renting to owning requires affording a mortgage and saving up for a down payment. But what if you turned the tables on that renting equation and buy a rental home?
Landlords: If you can’t beat ‘em, join ‘em
What if you could be the landlord for a change? This would mean leasing out your bought home. And it would involve saving up the rent monies paid so you could afford to move in comfortably later.
With the right planning, this strategy can help you buy now and capitalize on today’s low mortgage interest rates. You can earn extra cash while also building equity in the property. New research indicates many people take this path and reap the rewards.
Key facts, one conclusion: buy a rental home
Fresh research by ATTOM Data Solutions suggests that buying a single-family home and renting it out to someone else can be a smart idea. Consider that:
- The 25 top-performing zip codes for buying single-family rental homes all posted year-over-year increases in rental rates, population and home prices.
- All 25 had potential gross rental yields of 10 percent or greater. They also had potential annual cash flow of $10,000 or more for a cash buyer after paying property taxes, maintenance, insurance and other costs.
- All 25 had a vacancy rate of five percent or lower for non-owner occupied homes.
- At least 25 percent of all single-family homes were non-owner occupied within these zip codes.
What these numbers means to you
Daren Blomquist, senior vice president for ATTOM Data Solutions, found the findings fascinating. He says the data show that renting out a single-family home is a popular option in many areas.
“There are still plenty of medium-sized to larger operators out there making plenty of acquisitions,” he notes. “This is especially true in secondary and tertiary markets like Detroit, Philadelphia, Baltimore and Memphis.”
In these markets, buying single-family rentals can provide ample return on investment.
“In some of these markets, like Memphis, large turnkey rental operations are set up. Here, medium-sized operators are buying, rehabbing and leasing homes.
“Then, they’re selling those as turnkey rentals to more passive individual landlords,” says Blomquist.
As a result, non-owner occupants (investors) bought 28 percent of all single-family homes sold in the past year. That’s well above the historic average of just under 25 percent.
Why this can be a worthy plan
Blomquist says it may be smart to buy a single-family property that you rent out, with the hopes of moving into at a later date. The reasons are plentiful.
First, “Macro market housing trends strongly favor landlords,” he says. “Homeownership rates continue to hover at a near 50-year low. They’re well below normal for the under-35 cohort. But this cohort is gradually reaching life milestones that make them to want to live in their own home, such as marriage and kids.”
The ownership rate for Gen Xers is also far below historic averages.
“These are households that typically have kids. And they’re more likely to want to live in a house with a yard,” says Blomquist.
Other good reasons to buy a rental home
Builders are finally starting to construct more homes. Problem is, they’re still playing catch-up from a deficit built up over the last few years compared to household formation.
“This translates into restricted supply and increasing demand for single-family rentals. And that should continue to put upward pressure on rents,” he adds.
“Yes, the rental market could suddenly soften. But that likely means the owner-occupant market has strengthened. That gives a single-family rental owner the option to easily cash out of their investment if needed.”
But there’s a bigger reason to buy a rental property now to live in later.
“It provides an income-producing real estate investment in the short term. It also builds equity wealth in the longer term,” says Blomquist.
“When you later move into the home, you will have instant equity due to rising home values and a paid down mortgage thanks to the rent payments.”
Risks to ruminate
But like all investments, this one isn’t foolproof.
“The biggest risk is that the property’s income-generating potential is not realized. That means the property can become a money pit rather than a cash flow engine,”
Blomquist cautions. “This can happen for a variety of reasons. Often, it’s due to overestimating rental rates. Others underestimate the costs of managing and maintaining the property.”
Blomquist notes that a rent-out-now, move-in-later strategy can also be a bit more costly to finance.
“Your lender will want to know upfront if the property will be owner-occupied or non-owner occupied. The latter is considered at higher risk for default. Hence, the loan will come at a slightly higher interest rate,” he says.
Still, interest rates for investment homes remain near historical lows.
“There is more competition than ever in the lending-to-investors space. You can take advantage of that by shopping around for the very best rate and terms,” says Blomquist.
He adds that a smaller investor can qualify for a regular conforming loan from Fannie Mae or Freddie Mac.
Take a closer look
Leasing out the home you buy requires proper due diligence. Before committing, Blomquist suggests carefully considering:
- The specific property and market. “Not every U.S. market is ideal for buying single-family rentals. Some high-priced markets have very few opportunities and tons of competition. That doesn’t mean there are no good options. It just means they’re tougher to find,” he says.
- The property’s true value and income-making potential based on its condition and area. “Consider real-market rent rates in the neighborhood,” he notes. “And give thought to realistic estimations for costs. These include mortgage payments, property taxes, insurance, property management fees, and maintenance costs.”
- The people you’ll need to trust. This includes your potential tenants and anyone you hire to manage, repair and maintain the home. You’ll need to screen all of them carefully.
Finally, consider buying a multi-unit home (which you can with a low-down-payment government loan) and live in one unit for a little while. You get to finance as a primary residence, and convert it to a rental if you need to move in the future.
What are today’s mortgage rates?
Today’s mortgage rates have not changed much from last week’s. Which means they are still extremely attractive for anyone considering a primary, second or rental home.