Introduction
In this article, we will discuss the wonderful world of Single Family Rentals (SFR’s). As an overview of the topics we will cover:
- The Benefits of SFR’s
- Historical Returns of SFR’s
- Management & Operating a SFR
Real estate is a time-intensive and capital-intensive investment, and understanding the below is crucial for investing in rental properties on your own.
While this may seem daunting, the Players Company has partnered with mogul, a real estate investment platform founded by Wall Street alumni to start your investment journey without the headache. They have received an average annual return of 18.8%, and you can invest into funds or properties vetted by industry professionals. To get started, you can head over to mogul and invest in real estate in less than 30 seconds.
Benefits of Single Family Rentals
When analyzing Single Family Rentals (SFR’s), it is important to understand the ways in which they return on your investment:
#1 Rental Income (Yield)
As a property owner, you have the option to rent out your home to tenants. The tenants pay you rent, and you can take the rent to pay any expenses necessary to own the property (taxes, insurance, interest, etc) and maintain the properties (sink is leaking, AC is not working correctly, etc).
The rent minus the expenses is your “yield”, which means the amount you take home. Because the tenant does not require daily check-ins, the income you receive is “passive” in nature.
#2 Value Increase (Appreciation)
On average, home prices have increased 4.3% on a yearly basis since 1991. Because of the mixture of equity upside (home price increase) and passive income, investing in real estate is typically thought of as the perfect mix between stocks and bonds.
#3 Mortgages (Leverage / Debt)
You may be thinking 4.3% is not that much to increase on a yearly basis, especially given the S&P 500 have increased roughly 9% on the same basis. You would be correct in thinking that, but for real estate, you have the benefit of long term debt or “leverage” (mortgages).
A simple way to show the benefit of leverage is on a $1mm property:
Assume you purchase a $1mm property with an 80% Loan-to-value (LTV) mortgage. This means you used an $800k mortgage and $200k of your own capital. The $200k represents your “equity” in the property.
Now, let’s say the property increases the average of 4.3% in a year. The home price has gone from $1mm to $1,043,000 (increased by $43k) and you decide to sell.
If you had purchased the home without debt: you would receive $1,043,000 back when you invested $1,000,000 (4.3% unlevered return).
If you had purchased using the $800k mortgage: you invested $200k, and when you sold, you received $243k ($1,043,000 – $800k debt paydown).
You just received a 21.5% levered return ($243k / $200k – 1) = 21.5% investment return compared to the 4.3% without using debt.
Comparably, you just returned 21.5% vs. 9% you could have received from the S&P 500.
Real estate benefits tremendously from long term debt, as the rental income pays the “debt service” (interest expense, principal expense, etc.), while you benefit from the debt on appreciation and rental income.
#4 Tax Benefits
The IRS wrote the US tax code to incentivize 2 things: procreation and homeownership. We cannot help with the first, but we at mogul can most definitely help with the 2nd.
The IRS allows you to deduct several expenses related to real estate, including mortgage interest, operating expenses, insurance, property taxes, and depreciation. To calculate taxable income, use this formula:
Taxable Income = Rental Income – (Interest + Operating Expenses + Insurance + Property Taxes + Depreciation)
However, for your bank account, the calculation is:
Net Income = Rental Income – (Interest + Operating Expenses + Insurance + Property Taxes)
Depreciation is considered a “ghost expense,” as it reflects the property’s aging over time (27.5 years for residential and 39 years for commercial properties) without an actual cash outflow.
For example, if you buy a $1 million property with 80% loan-to-value (LTV), you have $200,000 in equity. If your rental income after expenses is 8% of your equity, that’s $16,000 annually. You can also deduct 60% of the property’s value as depreciation over 27.5 years, resulting in a yearly depreciation expense of $21,818 ($600,000 / 27.5 years).
So, while you receive $16,000 from rental income to your bank account, you report a depreciation of $21,818, resulting in a tax loss of $5,818 ($16,000 – $21,818). This loss can offset passive income from other investments.
In comparison, with a REIT, your post-tax return is about 4%. With us at mogul, your return remains at 8%, and you may have a passive loss for tax reporting.
Return of Single Family Rentals Historically
When comparing Single Family Rentals historically against other asset classes, you can see the benefits in action.
We took home price data, stock index data, baskets of bonds, and other public market data to compare returns from 1993 to 2023, and we found that Single Family Rentals on average returned ~40% higher annually than the S&P 500.
Additionally, portfolio theory used to be dominated by the Traditional allocation method of 60% stocks / 40% bonds. In 1985, a Yale economist & endowment Chief Investment Officer took a radically different approach, allocating 50% stocks / 30% bonds / 20% REAL ESTATE.
From 1985 to 2021, the Yale endowment outperformed the Traditional method by 41% on a yearly basis and became the de facto portfolio model, coined the “Yale Method.”
Management & Operating an SFR
Property managers can make or break a real estate investment. After all, the return is generated from the cash flow and appreciation, and without a good property manager, the rental income might not be sufficient to cover costs.
Typically, property managers can operate a property in one of the following ways:
Long Term Rental (“LTR”)
Definition: A residential property that is rented for a term of 1 year or more. When thinking of SFR’s, this is the typical operational strategy.
Pro’s:
- Higher occupancy rates and lower turnover rates, with a longer term tenant the typical time the property sits on the market is the time it takes to turnover
- Lower maintenance costs
- Utilities are paid for by the tenant
- Extensive background checks on the tenant prior to signing
- Lower touch investment, set it and forget it
- Leases typically auto-renew at the end of the year with a markup, you will have notice well in advance by the tenant whether or not they intend to stay
- Security deposit in the event of damage
Cons:
- Lower yields, longer leases typically lead to lower rental rates than your typical STR or MTR
- Tenant vs. Landlord rules typically only apply to this type of lease
- In today’s interest rate environment, it is incredibly difficult to find a rental yield that will meet and surpass debt service, so long term rentals typically lead to either less leverage or a rental loss, if you can keep in place the debt from previous years, the rental income will yield in a LTR
Medium Term Rental (“MTR”)
Definition: A residential property that is rented for a term of 1 month to 1 year (typically 3 month or 6 month stays).
Pro’s:
- Higher yields than a LTR but lower than a STR
- Higher occupancy capabilities than STR with rent premiums
- Less turnover than a STR
- Way to mitigate higher interest rates
Cons:
- Only works in certain areas where people stay for medium terms at a time, think a city with a transient population (DC, Houston, etc.) and a focus on a certain profession (traveling nurses, government officials, etc)
- Not quite as high a yield as a STR
Short Term Rental (“STR”)
Definition: A residential property that is rented for a term of less than 1 month. This is typically thought of as an Airbnb rental or vacation rental.
Pro’s:
- Highest yields of all SFR strategies
- In some cases, only need 50% occupancy to meet debt service, so anything beyond is yield directly to end user
- Cleaning fees can be included in the property
- Way to mitigate higher interest rates
Cons:
- Higher furnishing cost than the others
- Higher maintenance costs
- More turnover
- Highest risk of the strategy, but also highest reward – that being said, the minimal amount of occupancy needed to meet debt service is a massive risk mitigant
Partnership to Access
In this article, we highlighted the main points to consider when investing in real estate. If you are looking to try real estate investing before committing a massive amount of time and capital, head over to mogul and invest alongside the Players Company into high quality properties or funds.
Sources:
- Federal Reserve Economic Data (FRED). “Economic Data.” https://fred.stlouisfed.org
- World Bank. “World Bank Commodity Price Data (The Pink Sheet).”
- Federal Reserve Economic Data (ALFRED). “Historical Economic Data.” https://alfred.stlouisfed.org
- S&P Dow Jones Indices. “S&P/Case-Shiller U.S. National Home Price Index.” Vintage: 2023-06-27, Index Jan 2000=100, Monthly, Seasonally Adjusted.
- Shiller, Robert J. Irrational Exuberance. Princeton University Press, 2000, 2005, 2015, updated.
- FTSE Nareit. “FTSE Nareit U.S. Real Estate Index Series.”
