The ultimate guide to buying your first single family rental

TL;DR: Single family rentals are one of the simplest most accessible ways to invest directly in real estate and generate cashflow and compelling returns. The best way to do this passively is through working with a turnkey provider, or finding a good real estate broker / property management outfit in your target market. They will be able to help your source, remodel, rent, and manage the properties you buy. Some people advocate the buy, rehab, rent, refinance (BRRR) model, but that’s a lot of work. If you’re like me, you have a day job and don’t want to become a contractor or a landlord, you want to be an investor. Focus on your day job, and get the right team to help you with your investments.

If you read my write up on the full financial details of a single family rental (SFR), then you might be wondering how you can get access to those 15-20% returns yourself. Let me tell you now that it is very achievable. I am not special or uniquely gifted at real estate investing. I consider this something available to anyone with decent credit and a strong interest in reaching Ramen Retirement. All you have to do is purchase a decent property in a decent neighborhood at the right price, then get the right team to manage it for you. But where to start?

Finding the right sub-market

Before you go looking at specific properties, you want to figure out which market and sub-market you’ll focus on. Which neighborhoods will you consider or exclude from your search? I outline a good approach for this in my post on real estate market selection. Find a market that fits your investment goals – yield or growth? Then find the right neighborhoods within that market that are a good bet. Look for positive economic prospects, low crime, and good schools.

What type of SFR?

Next, get clear on exactly what type of property you’re looking for. Single family homes can range from small 2 bed 1 bath bungalows, to large 5 bed, 5 bath McMansions. From what I’ve seen, the sweet spot for SFRs is the 3 bed, 1 or 2 bath home, with 1,000-1,500 square feet. Aim for something that is finished well, but not super high end. That type of property will find the greatest demand from renters, because people renting a single family home typically have a family and want enough space to accommodate that. At the same time, they’re not looking to blow the budget on a massive home. They are renting because they want to save money or can only afford so much.

A typical 3 bed, 2 bath home should rent for $1,000 or more. At those price points the management fees won’t eat unduly into your total rent collected. As you look at smaller properties, you can typically find better ‘rent to price’ ratios, but those returns might prove illusory because the management fee will typically be a higher percent of rent, and the expenses to maintain the property will also be higher (as a percent of rent).

How to make it happen?

Once you know the sub-market and property type you’re interested in, there are three broad strategies to go about acquiring your first property:

  • Turnkey – Buy a fully remodeled and leased property from a turnkey operator
  • Direct buy and hold – Buy a property that is basically rent ready on day one
  • Buy, rehab, rent, refinance (BRRR) – Buy a rundown property to rehab, then rent

Each strategy offers varying levels of risk, complexity, and return. Generally, the more risk or complexity involved, the greater potential for return.

Turnkey

Working with a turnkey provider is the simplest and easiest approach, though it likely offers the lowest potential returns. But the lowest returns aren’t bad! The 15-20% returns I reference here came from a turnkey property. Think of it this way: with a turnkey provider you’re buying a fully remodeled, leased, and managed property that is basically hands off from day one. All you need to do is review the deals they offer and bid on the ones you like. Lower effort, lower risk, generally means slightly lower returns. The turnkey provider needs to charge for their value add somehow, which means you’ll be buying a property that is closer to market price. You won’t be getting a great deal. But you can certainly get a good one, particularly if you’ve got a day job, and you don’t want to be spending all your time planning and executing your own deals.

Turnkey providers basically run a giant flipping operation, where they flip the homes to investors instead of owner occupants. They usually perform the following activities:

  • Source discounted properties – either from MLS or auction, they will find rundown properties that are in need of some remodel or rehab repairs
  • Plan and execute the remodel – they will often have multiple construction crews ready to remodel a property as soon as they buy it, and they have a lot of experience around what improvements generate the best rental rates, and how to do that most cost effectively
  • Sell to investors – with a remodeled property in hand (or in progress) they’ll sell it to an investor
  • Lease up the property – once they complete the remodel, they will get a quality tenant in there
  • Manage the property – usually they will also manage the property post renovation and rental (some providers will outsource this to a local property manager)

This is the best entry level approach to direct real estate investment. My advice is to figure out which market you want to invest in, then find all the turnkey operators working there. Do some diligence on those providers (read up on Bigger Pockets, ask for contacts of other investors they’ve worked with) to catch any red flags, get on their mailing lists, and then spend a month or two reviewing the properties they offer. Most turnkey operators will have at least 2-3 new properties per week. With each property that roughly fits your criteria, run it through my investment comparison and screening sheet to assess the true expected returns. Don’t take the turnkey operators numbers as gospel. They will provide their expected rent, expense and financing figures, but they will often present a very ‘rosy’ picture. Run your own analysis to be sure.

Over time you’ll get a sense for the types of properties and returns available from the different turnkey providers. From speaking with other investors, you should also know what to expect in working with them. Once you get comfortable with a provider, pick out the right property and pull the trigger, then wait until things get settled and you have your first check rolling in. Once you’re comfortable with this approach, you can keep working with these types of providers. But if you’re a little more adventurous, you can consider dialing up the complexity and risk in the hopes of generating even higher returns.

Direct buy and hold

With a direct buy and hold approach, the goal is to source your own properties. In this model you will be looking for a home that is basically rent-ready – i.e. the home is in good enough condition that you only need to do some very modest improvements to get it to a place where you can rent it out to a quality tenant. One approach that works reasonably well is to follow the neighborhoods where you’re seeing lots of turnkey properties, then look for deals coming on the market that might offer better value. This way you’ll have a good idea of what you’re buying and how it compares to other investment properties on the market.

With this approach I recommend working with a real estate agent or broker. They can be your boots on the ground (particularly helpful if you are investing out of state). Ideally, you can find a brokerage that also acts as a property manager, and this way they can help you with the following activities:

  • Sourcing – typical job of a broker, and they’ll be even more helpful for you as they should have an idea of prevailing rental rates for the area
  • Making the property rent ready – because they do property management, they’ll be familiar with the basic repairs that come with turning over a rental home, so helping spruce up your new property will be in their wheel house – they’ll have contacts and preferred pricing with various contractors
  • Leasing – as a property manager, they can help you get it leased up
  • Property management – they’ll manage things for you once everything is complete

So you can see this is very close to the turnkey model. The difference is that you need to identify your own properties and do a little more diligence up front. You’ll be taking on a little more risk with the property as you will be doing some minor repairs, and there won’t there won’t necessarily be a tenant when you buy – you’ll have to ‘carry’ the property until you get it cleaned up and rented out. But that said, if you understand the sub-market well, and you have a good broker and property inspector helping you on the purchase, then there’s no reason you can’t make this work.

The reward will be that you might get a 5-10% discount on the price of a turnkey property. If you know your market, and don’t mind doing a little more work, it could be worth the extra effort. In market where there simply aren’t turnkey providers (smaller markets), this might be the only entry level strategy available.

 

Buy, rehab, rent, refinance (BRRR)

The last approach, typically called the BRRR strategy, is much discussed among real estate investment circles. In this model, you are both an investor and a general contractor. The idea if that you buy a property that needs substantial work, you plan out the remodel, hire and manage contractors, then get it leased up, and ultimately managed by a property manager. By purchasing a fixer upper you can get the property on the cheap, and if you’re a decent general contractor you’ll be able to get it rent ready for a modest investment that would ultimately be less than if you bought it from a turnkey provider. Folks typically talk about ending up with properties that are 15-20% below market rates after the rehab costs are factored in.

This is a perfectly good strategy, but not one I really recommend for anyone who has a day job, or is purchasing out of state. You really want to be on the ground and have the time to see things through. Coordinating contractors and all the other players in the real estate game is complicated and time consuming, and if you have a full time job you enjoy, you’re probably much better off focusing on that, and investing your savings through less demanding strategies (see above).

 

A few other considerations

So that’s it. Not that complicated. SFRs are the simplest way to get into direct real estate investment, with compelling returns, and there a range of options to help you do it. But as you consider jumping into this space, there are a few other things to keep in mind.

Property management

With all of the strategies mentioned above, you’ll note that great property management is key. This is one of the biggest things you should focus on as a passive investor – making sure you have a great property manager. They should handle pretty much everything for you (make rent ready, lease up, collect rent, deal with issues, make repairs, and even process evictions). For this service you’ll need to pay them. I’ve found good property management rates for SFRs start around 8% of collected rent. They will also typically charge a fee for lease up ranging from half to a whole month’s rent. Assuming a tenant stays for 2 years on average, you might assume an all in property management cost of ~12% of rent. This is reasonable and should be part of your deal assumptions. You don’t want to become a landlord, you want to be an investor.

One other thing to note here is that percent of rent is just one way to look at things. If a property is only renting for $500 / month, they might charge a fixed fee of something like $60 / month which is more like 12% of rent. If you add in a month’s rent to lease up, and your blended property management could be from 16-20%. So you can see that as you deal with cheaper properties, or lower rent units, some of the costs like management and maintenance increase as a percent of rent. Keep this in mind as you consider your deals economics.

Insurance

When you own real estate directly, you become a landlord. With that responsibility also comes liability. With SFRs you are ultimately liable if something goes wrong at your property. Given this you’ll want to make sure you have the proper protections in place. You’ll want to get enough liability insurance baked into the insurance policies you get on each property – I typically have at least a couple million of liability coverage on each property. In addition, you’ll want to get an umbrella insurance policy. This is a ‘catch all’ policy that protects you and your spouse should any liabilities emerge that exceed the coverage available on a given property. It’s unlikely that you’ll have to make use of these policies, but if you do, you’ll be glad you have them. Don’t skimp on insurance. It’s a necessary cost of business in this game.

Ownership structures & LLCs

When I first started out with SFRs I wasn’t sure whether I should hold the properties in my name, or under an LLC. I am not a lawyer, and this is not legal advice, but from what I’ve seen and understand, when you are starting out, there is no need to put the properties into an LLC structure. Some people talk about the liability protection offered through an LLC structure, but from what I’ve read, the liability protection may prove illusory or limited at best. As per above, the best protection is actually having the proper insurance in place. So it begs the question, when should someone put a property into an LLC? Well, certainly with larger multifamily properties, or situations where there are multiple investors, it could be useful. But when you’re just starting out with SFRs it’s probably overkill. Wait until you get deeper into the game and see whether it makes sense. There are real costs with establishing and maintaining an LLC, so if you only have a few properties, it probably won’t be worth it.

Mortgage limits

Lastly, you should know that there are limits to the number of SFRs you can buy with conventional mortgage financing. In the past, an individual could only hold four conventional mortgages in their name. That limit has now been expanded to 10 mortgages per person, but you’ll need to find the right bank who will work with you on that. This is a little disappointing, because conventional mortgage financing offers some very generous terms – 30 year fixed rate financing at 4.5% is pretty compelling. What this means for your investing strategy is that you’ll be capped to 10 SFR properties on your own, or potentially 20 properties (if you invest with your spouse). 10-20 properties is a good start, but if you want to go beyond that, you’ll have to explore different financing alternatives, or consider moving into multifamily investing. Once you invest in properties with >4 units, conventional financing isn’t available anyhow, so everyone is forced to work with commercial loans that often have shorter fixed rate guarantees, and potentially higher rates. Consider those first 10-20 properties as an entry level gift into the world of real estate. Part of my investing strategy is to fill up each of those 20 mortgage slots over time. The one thing you’ll want to consider with those 20 mortgage slots is that you might want to aim for slightly higher property prices, so you can maximize the total amount of property value and leverage you are able to apply with conventional loans. In my case, this is why I am looking at duplexes and fourplexes that technically still count as a single conventional mortgage.

The SFR 20 Property Strategy

So to summarize, find the right market, figure out how you want to invest (turnkey, direct invest), pick out the right property and pull the trigger. Get good property management in place, and don’t skimp on insurance. Once you get your first property humming, add another. Repeat once a quarter, and in five years you’ll max out your 20 conventional loans. At that point, with 20 properties, each generating ~3K+ per year in cashflow, you’ll have over $60K in passive income. In many cities in the US you’ll have reached Ramen Retirement. Congratulations.

Now get back to work building the dream!

Ramen-san

Leave a Reply