Types of Rental Properties

If you’ve been in the market for a home, you know that in addition to single- family homes, you can choose from numerous types of attached or shared housing including apartment buildings, condominiums, townhomes, and co- operatives. In this section, we provide an overview of each of these properties and show how they may make an attractive real estate investment for you.From an investment perspective, our top recommendations are apartment buildings and single-family homes. We generally don’t recommend attached-housing units. If you can afford a smaller single-family home or apartment building rather than a shared-housing unit, buy the single-family home or apartments.Unless you can afford a large down payment (25 percent or more), the early years of rental property ownership may financially challenge you: With all properties, as time goes on, generating a positive cash flow gets easier because your mortgage expense stays fixed (if you use fixed rate financing) while your rents increase faster than your expenses. Regardless of what you choose to buy, make sure that you run the numbers on your rental income and expenses to see if you can afford the negative cash flow that often occurs in the early years of ownership.Single-family homesAs an investment, single-family detached homes generally perform better in the long run than attached or shared housing. In a good real estate market, most housing appreciates, but single-family homes tend to outperform other housing types for the following reasons:Single-family homes tend to attract more potential buyers – most people, when they can afford it, prefer a detached or stand-alone home, especially for the increased privacy.
Attached or shared housing is less expensive and easier to build and to overbuild; because of this surplus potential, such property tends to appreciate more moderately in price.Because so many people prefer to live in detached, single-family homes, market prices for such dwellings can sometimes become inflated beyond what’s justified by the rental income these homes can produce. That’s exactly what happened in some parts of the United States in the mid-2000s and led in part to a significant price correction in the subsequent years. To discover whether you’re buying in such a market, compare the monthly cost (after tax) of owning a home to monthly rent for that same property. Focus on markets where the rent exceeds or comes close to equaling the cost of owning and shun areas where the ownership costs exceed rents.Single-family homes that require just one tenant are simpler to deal with than a multi-unit apartment building that requires the management and maintenance of multiple renters and units. The downside, though, is that a vacancy means you have no income coming in. Look at the effect of 0 percent occupancy for a couple of months on your projected income and expense statement! By contrast, one vacancy in a four-unit apartment building (each with the same rents) means that you’re still taking in 75 percent of the gross potential (maximum total) rent.With a single-family home, you’re responsible for all maintenance. You can hire someone to do the work, but you still have to find the contractors and coordinate and oversee the work. Also recognize that if you purchase a single-family home with many fine features and amenities, you may find it more stressful and difficult to have tenants living in your property who don’t treat it with the same tender loving care that you may yourself.The first rule of being a successful landlord is to let go of any emotional attachment to a home. But that sort of attachment on the tenant’s part is favorable: The more they make your rental property their home, the more likely they are to stay and return it to you in good condition – except for the expected normal wear and tear of day-to-day living.Making a profit in the early years from the monthly cash flow with a single- family home is generally the hardest stage. The reason: Such properties usu- ally sell at a premium price relative to the rent that they can command (you pay extra for the land, which you can’t rent). Also remember that with just one tenant, you have no rental income when you have a vacancy.Attached housingAs the cost of land has climbed over the decades in many areas, packing more housing units that are attached into a given plot of land keeps housing somewhat more affordable. Shared housing makes more sense for investors who don’t want to deal with building maintenance and security issues.In this section, we discuss the investment merits of three forms of attached housing: condominiums, townhomes, and co-ops.CondosCondominiums are typically apartment-style units stacked on top of and/or beside one another and sold to individual owners. When you purchase a con- dominium, you’re actually purchasing the interior of a specific unit as well as a proportionate interest in the common areas – the pool, tennis courts, grounds, hallways, laundry room, and so on. Although you (and your ten- ants) have full use and enjoyment of the common areas, remember that the homeowner’s association actually owns and maintains the common areas as well as the building structures themselves (which typically include the foundation, roof, plumbing, electrical, and other building systems).One advantage to a condo as an investment property is that of all the attached housing options, condos are generally the lowest-maintenance properties because most condominium associations deal with issues such as roofing, gardening, and so on for the entire building and receive the benefits of quantity purchasing. Note that you’re still responsible for necessary maintenance inside your unit, such as servicing appliances, interior painting, and so on.Although condos may be somewhat easier to keep up, they tend to appreciate less than single-family homes or apartment buildings unless the condo is located in a desirable urban area.Condominium buildings may start out in life as condos or as apartment complexes that are then converted into condominiums.Be wary of apartments that have been converted to condominiums. Although they’re often the most affordable housing options in many areas of the country and may also be blessed with an excellent urban location that can’t easily be re-created, you may be buying into some not so obvious problems. Our experience is that these converted apartments are typically older properties with a cosmetic makeover (new floors, new appliances, new landscaping, and a fresh coat of paint). However, be forewarned: The cosmetic makeover may look good at first glance, but the property probably still boasts 40-year-old plumbing and electrical systems, poor soundproofing, and a host of economic and functional obsolescence.Within a few years, most of the owner-occupants move on to the traditional single-family home and rent out their condos. You may then find the property is predominantly renter-occupied and has a volunteer board of directors unwilling to levy the monthly assessments necessary to properly maintainthe aging structure. Within 10 to 15 years of the conversion, these properties may well be the worst in the neighborhood.TownhomesTownhomes are essentially attached or row homes – a hybrid between a typical airspace-only condominium and a single-family house. Like condo-miniums, townhomes are generally attached, typically sharing walls and a continuous roof. But townhomes are often two-story buildings that come with a small yard and offer more privacy than a condominium because you don’t have someone living on top of your unit.As with condominiums, you absolutely must review the governing documents before you purchase the property to see exactly what you legally own. Generally, townhomes are organized as planned unit developments (PUDs) in which each owner has a fee simple ownership (no limitations as to transfer- ability of ownership – the most complete ownership rights one can have) of his individual lot that encompasses his dwelling unit and often a small area of immediately adjacent land for a patio or balcony. The common areas are all part of a larger single lot, and each owner holds title to a proportionate share of the common area.Co-opsCo-operatives are a type of shared housing that has elements in common with apartments and condos. When you buy a cooperative, you own a stock certificate that represents your share of the entire building, including usage rights to a specific living space per a separate written occupancy agreement. Unlike a condo, you generally need to get approval from the co-operative association if you want to remodel or rent your unit to a tenant. In someco-ops, you must even gain approval from the association for the sale of your unit to a proposed buyer.Turning a co-op into a rental unit is often severely restricted or even forbid- den and, if allowed, is usually a major headache because you must satisfy not only your tenant but also the other owners in the building. Co-ops are also generally much harder to finance, and a sale requires the approval of the typically finicky association board. Therefore, we highly recommend that you shun co-ops for investment purposes.ApartmentsNot only do apartment buildings generally enjoy healthy long-term appreciation potential, but they also often produce positive cash flow (rental income – expenses) in the early years of ownership. But as with a single-family home, the buck stops with you for maintenance of an apartment building. You may hirea property manager to assist you, but you still have oversight responsibilities(and additional expenses).In the real-estate financing world, apartment buildings are divided into two groups based on the number of units:Four or fewer units: You can obtain more favorable financing options and terms for apartment buildings that have four or fewer units because they’re treated as residential property.
Five or more units: Complexes with five or more units are treated as commercial property and don’t enjoy the extremely favorable loan terms of the one- to four-unit properties.Apartment buildings, particularly those with more units, generally produce a small positive cash flow, even in the early years of rental ownership (unless you’re in an overpriced market where it may take two to four years before you break even on a before-tax basis).One way to add value, if zoning allows, is to convert an apartment building into condominiums. Keep in mind, however, that this metamorphosis requires significant research on the zoning front and with estimating remodeling and construction costs.
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