Is investing in single-family real estate a good idea when prices are sky-high?

Buying single-family homes as rental property has for years been a reasonably safe — and often lucrative — way for investors to make money. This is particularly true in the Southeast where the price of entry to buy a home is lower than in many other parts of the country. 1 However, because housing prices have skyrocketed nationally as a result of the pandemic, it's more difficult to find good deals.

However, it's still possible to make money investing in real estate — including buying single-family homes to rent out. Here's what you need to know before you invest.

Why people are investing in rental properties

While Americans are still investing in the stock market, they're also diversifying investment strategies. Many are increasingly turning to real estate. A 2021 survey found that 28% of investors said real estate was their preferred long-term investing strategy, while only 16% said the stock market was.2 In fact, 55% of Millennials say they are interested in real estate investing, a higher percentage than any other demographic surveyed.3

One popular method is buying rental property. This tangible asset typically weathers any type of housing market, as there are always people who want or need to rent a home. Single-family homes often appreciate or grow in value over time, and while that isn't the goal for owning rental property, it acts as icing on the cake for when the investor might want to sell in the future. Generally, the goal for rental property is earning a steady monthly cash flow.

While apartments have traditionally been a popular choice for renters, in recent years, many renters have been choosing single-family homes instead. This is another reason Millennials are turning to this asset class.

From 2005 to 2015, single-family rentals accounted for over half of the gains in rental housing stock.4 The demand is largely driven by young families who aren't in a position to buy a home, perhaps due to student loan or credit card debt, but who seek to live in a larger space than what an apartment typically offers — namely a house with several bedrooms and a backyard.

Is the price right?

If you're buying during a seller's market with inflated prices, it's more important than ever to determine whether you're paying too much for a property. To do this, you first need to calculate the likely cash flow and the capitalization rate of a rental property. This will help you determine the maximum price you should pay.

These general concepts apply whether you are contemplating purchasing a single-family home, a multifamily apartment, or a commercial property. It's just that the types of expenses might vary a bit depending on the property type.

Cash flow

Cash flow is how much money (if any) you'll have left each month after expenses. Here's how to calculate it:

1. Identify a property you want to buy.

2. Determine the monthly rent for similar homes in the area. You can do this by looking at online rental listings (say on Realtor.com or Zillow) and by using an online rent estimate tool.5 Those methods give you an idea of projected monthly income, which you will use for your calculations.

3. Calculate your monthly expenses. Here's what to include in your list:

• Mortgage payment.
• Property taxes.
• Insurance.
• HOA fees.
• Vacancy rate (about 6% as of Q3 2021).6
• Property management (10%).7
• Utilities. (While tenants of single-family rentals usually pay gas and electric, you might need to cover other expenses, such as trash or water.)
• Maintenance and repair. (You should budget around $150 to $300 per month, depending on the house quality. The higher the house quality the lower the maintenance and repair costs.)8

If your estimated rent is $2,500 per month and your estimated expenses are $2,000 per month, you would have a positive cash flow of $500 a month, or $6,000 a year. If you have several properties, you'll have a nice amount of fairly passive income coming in.