I bought my first rental property in 2010 when the market was much different! I bought a single-family home for $97k that rented for $1,050 a month. I know many people would love to go back to those days but the reality is prices will most likely never be that low again in most markets. While I bought a single-family home for my first rental, there are many other types of rentals and I have since bought multifamily, commercial, and mixed-use rental properties. The type of property that is best for beginners in today’s market with high-interest rates and high prices will depend on many factors.
What was my first rental property?
The first property I bought was a 3 bedroom, 2 bath, 2 story house with a 2 car attached garage. The home was built in 2005 and did not need a lot of work. I bought it in Greeley, Colorado and while prices were much lower back then, I still got a great deal. I took my time looking for properties and this was an estate sale. The home needed some paint and that was about it. It was a fantastic property for my first rental. I used Bank of America to get a 25% down investor loan which was not easy but luckily the seller was patient! While properties were cheaper then, it was much tougher to finance them and there were much fewer options for investors.
I later sold that property for $275,000 in 2019 and used a 1031 exchange to buy a commercial property for $600,000. I think buying a single-family rental was an awesome choice for me at that time. However, this property would not be a very good rental now as it is worth around $350,000 and would only rent for $1,700 to $1,800.
Are single-family rentals good for beginning investors?
I think single-family rentals are great for beginners if the numbers work out. However, with high rates and high prices, the numbers simply don’t work in many areas. There are areas of the country that have cheaper houses that are great for single-family rentals but we aren’t all in those places. Here are some of the pros and cons of single-family rentals:
- Large buyer pool if you need to sell: Single-family homes are attractive to investors and owner-occupants. When buying a rental as a beginner it is smart to have an exit strategy. Maybe the property is not as good as you thought it was or you decide you hate rentals. Can you sell the property? If you need to sell a single-family home you can sell to other investors or owner-occupants. Owner-occupants will often pay more than investors and they are always buying homes even when interest rates are high. Investors may slow down their buying when rates are high.
- Easy to rent and manage: Single-family homes appeal to many renters and are usually easy to rent. Tenants also have a tendency to stay in the property longer and take care of it. I have had the same renters for 10 years in some of my single-family rentals. Many tenants will even make minor repairs themselves (not always a good thing) and maintain the yards, perform snow removal, etc.
- Easier to find a good deal: In most areas, there are more single-family homes than other types of rentals. Because there are more of them there are usually more for sale and you might be able to get a better deal than on multifamily or commercial where there are much fewer properties.
- Easier to finance: Lenders love to finance houses, even as rentals. It is much easier to get a loan on a house than a commercial property, multifamily, or mixed-used property.
- More diversification: If your plan is to buy a lot of houses, like my plan to buy 100, it can be a little safer than buying a few big properties. Each house will be in a different area, with different tenants, and one horrible situation won’t destroy all your houses.
- You can house hack a single-family home which means you buy as an owner-occupant and rent out part of it while you live there or live there a year and then rent out the whole thing. Owner-occupants get much cheaper loans with less money down.
- Harder to cash flow: The big con with single-family rentals, especially right now is they can be very expensive compared to the rent they bring in. The more expensive the property, the worse the rent-to-value ratio tends to be.
- Houses are expensive right now: Most properties are expensive but in some markets, houses are very expensive, and the higher the price, the more money you will need to invest in them.
- Tougher to scale: It is tougher to scale when you need to buy a lot of houses to meet your goals. Each purchase takes work to find the deal, finance it, and possibly make repairs. If you buy larger multifamily or commercial it can be easier to scale.
- More expensive to repair: It might be more expensive to repair single-family homes than a larger building because a larger building has one roof, possibly one heating system, etc. However, that roof and heating system on the big property will be much more expensive to repair and you will need a lot more money at once, than if you are repairing houses here and there.
Are small multifamily rentals good for beginning investors?
Multifamily rentals have more than one unit. You could invest in a duplex or a fourplex or a 100 unit property. Multifamily properties can make it easier to scale because you have more units under one roof and the rent-to-value ratios may be better. These pros and cons are for smaller 2 to 4-unit multifamily properties.
- Can have much better cash flow: Multifamily properties are usually valued based on the income they produce. The prices are not driven up by owner-occupants who do not care what a property will rent for.
- Somewhat easy to sell: 2 to 4-unit properties are fairly easy to sell still although not as easy as single-family homes. You can still house hack a 2 to 4-unit property which means owner-occupants can buy them. There are not a lot of people looking to house hack but you can still sell to investors and owner-occupants.
- Easy to finance: Again, 2 to 4-unit properties are fairly easy to finance but not quite as easy as single-family homes. You can buy as an owner-occupant or get an investor loan with many banks.
- Easy to get a good deal on: There are a lot of 2 to 4-unit properties in most markets although not as many as there are single-family homes. It can be easier to get a great deal, although not as easy as houses.
- Harder to manage and rent: 2 to 4-unit properties take more management and usually have more tenant turnover than single-family homes. Tenants tend to move more often, the rents are usually lower, and tenants rarely think of a multifamily as a permanent place to live.
- More risk of major loss of income: If you have a few houses and one tenant decides to cook meth in the house it can destroy the house and cause major problems as well as lost rent for months. You still have the other houses to bring in income. If you have a multifamily property and that happens the whole property may need to be vacated for an extended period of time. If you have just one of each, then the risk is about the same.
- More expenses: The tenant usually pays all of the utilities and performs the yard maintenance and snow removal on single-family homes. On multifamily homes, the landlord often pays for the maintenance and some of the utilities if not all of them. You may be able to charge higher rent since the landlord is paying those expenses but make sure you account for them.
- More fluctuations in value: Multifamily properties are valued based on the income of the property and the expenses. If inters rates go up as they have been, they may be harder to sell or sell for less because investors have to pay less to get the same return. However, when rates go up, rents often increase as well so that could offset a decrease in value (rents would go up on houses as well).
Are large multifamily properties good for new investors?
A lot of new investors want to invest in large multifamily properties. Grant Cardone now tells people to only invest in properties with at least 32 units although he used to encourage house hacking with FHA loans. Large multifamily properties can make a lot of money but they can also be very difficult to buy due to their price and lending is much tougher.
- Easy to scale: You can bring in a lot of rent with one property and add a lot of value with the right deal.
- Rent to value ratios: The rent to value ratio may be better on big properties because only investors are buying them and they expect a certain return. The bigger the property the better the numbers may look because very few buyers are looking at those deals.
- The maintenance costs can be lower: The costs versus the rent may be lower because you have large buildings under one roof that share the same systems.
- Much harder to finance: The everyday person cannot get a loan for a large apartment building. One of the factors lenders consider is experience and they are wary of lending to new investors on big deals even if you have the down payment.
- Less diversification: If there is a disaster at a large complex, you may have a huge problem with no rent coming in for months. Again, these are rare but can happen. You also may have chosen the wrong location and the property doesn’t perform as you thought (I did this with an 8-plex).
- Harder to sell: There are few buyers for large complexes and they can take a long time to sell. Interest rates also impact them greatly.
- The expenses come in huge chunks: While the overall maintenance costs may be lower based on the investment, they can be huge when they do come. You could spend hundreds of thousands of dollars on a roof. Having one roof is not always better. There could be more expenses as well like parking lot repaving, landscaping, common areas, etc.
- They are expensive: It takes many people years to save up the money needed for a large complex. The purchase may be worth it, but while you are waiting why not buy smaller deals that build experience and a track record for lenders. The right deals will also bring you cash flow and equity which could make it easier to buy that big deal sooner.
- More headaches: Large multifamily properties tend to have the most turnover, the most repairs needed, and the craziest situations. They take much more management and can have more headaches.
Are commercial properties good for beginner investors?
I bought my first commercial property in 2017 and it cash flowed much better than single-family or multifamily properties in my area and was cheaper. A lot of people see my commercial properties and want to invest in that sector right away. However, they come with more risk and are much more complicated.
- Can be cheaper with better returns: In some areas, commercial properties are cheaper and have better returns but they also could be more expensive depending on the area. Small commercial properties are often cheaper than single-family homes.
- Can add a lot of value: If you can add a tenant on a long term lease it can add a ton of value., I recently bought a commercial property for $865k that was vacant, then added 4 tenants. That property is now worth $1.5 million but it was not for the beginner.
- Long term tenants: Many commercial tenants will stay for years and have leases that run for years. This is great of you have the right tenant but it takes longer to find those tenants. Many of the leases have built in rent increases as well.
- Fewer expenses: Some commercial leases are NNN which means the tenants pay almost every expense. These can be fantastic for the landlord but not every commercial lease is set up this way.
- Less headaches: Commercial tenants tend to be less needy than residential. They often take care of the property themselves and make sure it looks nice for their business. They expect the rent to increase each year and usually don’t get upset about it.
- Owner occupied financing available: Yes you can owner occupy a commercial property. You do not live there, but you run a business out of the property. If you use more than 50% of the space you might be able to get an SBA government loan with 10% down.
- Much more complicated: It takes time top to learn how the lease work, and the differences between NNN and gross. Properties are valued using cap rates which can be difficult to figure out because they vary based on the lease, the tenant, the property, the location, and more.
- Harder to finance: Commercial properties are usually the hardest to finance. They come with risk if you lose a tenant and the lenders know this. They have shorter term loans that must be renewed every five or ten years. The lenders will want to see buyers with experience before they lend them money as well. Even the agents and sellers may not take a buyer serious if they don’t have any experience.
- More expensive costs: If you have to make repairs it can cost a lot more money as rooftop HVAC, roofs, parking lots, and commercial construction often cost more than residential. The city may require more as well like fire sprinkler systems. Appraisals and inspections are more expensive as well.
- Harder to sell: Just like multifamily properties, commercial properties can be much harder to sell because there is a smaller buyer pool.
- Environmental issues: A big concern with commercial properties are past or current environmental issues. You may need to get an environmental report that shows there were no hazardous materials on the property or gas tanks, etc. To clean up problem properties it can takes tens of thousands of dollars or more.
- Tenants might expect TI: TI stands for tenant finishes and many tenants expect the landlord to fix up the space for them. This can cost a lot of money but also add a lot of value.
If you are buying small commercial properties you may be able to avoid many of these issues but it is still good to be aware of them and especially talk to your lender about them! On some of my smaller commercial deals, I am able to get a local bank to finance them without an appraisal which is awesome.
Are mixed-use properties good for beginning investors?
Mixed-use properties can also be put in the commercial category. Mixed-use means the property can be used for residential and commercial or have both at the same time. I have a few mixed-use properties and love them but they can be tough to finance like commercial. The one benefit is you can live in part of it and work out of part of it. You may be able to get low down payment SBA loans because of this.
What is best for a beginning investor?
There are many different options for beginning investors to buy their first rental. I would be wary of jumping into huge projects without a lot of help from someone with experience. It will be almost impossible to do so unless you have a lot of cash. Personally, if single-family homes cash flow, I think those are the safest and best bet, but small multifamily can work as well.