Why Condos and Single-Family Homes Make Bad Investment Properties

Just because you can invest in something doesn’t mean you should.

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Many real estate investors cut their teeth on rental houses and condos. Maybe they own their own home and figure owning a rental home can’t be much more complicated. But unfortunately, many homeowners become “accidental landlords,” unable to sell their home before they move and renting it out to cover the mortgage until the market turns in their favor. 

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But the smart investors graduate to bigger deals as quickly as possible. So here’s why you shouldn’t look at a condo or rental house as a worthy investment property.

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1. Low ROI

A single-family house or condo just doesn’t have the economies of scale it takes to push the ROI to excellent levels or comparable to professional levels.

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There are many reasons for this. Here are just a few:

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• You have to pay MSRP for supplies and appliances. No bulk discounts on the purchase of 20 fridges, for example. 

• For repairs, you will have to pay inflated contractor fees on a job-by-job basis. With larger buildings, you can save a bundle by hiring a full-time handyman.

• What if the roof breaks? Wouldn’t it be nice if ten tenants were paying rent into that repair fund instead of just one?

• Without multiple units generating income to cover expenses, an extended vacancy or eviction can kill your cash flow and even threaten your ability to pay the mortgage.

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If you do the cap rate math (Purchase Price ÷ NOI = Cap Rate), you will find that rental houses and condos have much lower cap rates than larger buildings — meaning less ROI. Condos also have the added problem of appreciating slower than other property types. 

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Bottom line — all things being equal, a person who invests $50,000 to become part-owner of a multifamily building will be much wealthier five years from now than a person who invested that same $50,000 into a rental house or condo.

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2. HOA Woes

Some houses these days often belong to homeowner’s associations (HOA), and condos always belong to condominium associations (which is the HOA of the condo building).

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It hurts to watch HOA dues eat away at your cash flow. HOA fees can also change with little notice, destroying your income projections. They can even file special assessments. Don’t even think about not paying up — they can put a lien on your property and foreclose if you stiff them.

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Theoretically, these dues go towards maintenance and improvement of the shared spaces, but HOAs are notoriously irresponsible with their dues income. 

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To make matters worse, HOA officers are notorious busybodies eager to get into the business of other members. As a result, your HOA president may try to dictate maintenance tasks and even restrict you from approving certain tenants. It’s a headache worth avoiding at all costs.

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3. You Can’t Force Appreciation

With commercial property (including residential apartment buildings), its value is directly correlated with the net operating income (NOI). Put simply, if you increase the NOI, your property becomes more valuable. 

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If you spend $20,000 to perform property upgrades that increase the potential rent or reduce operating expenses, your property could increase in paper value by $50,000 or more. You can use this higher NOI to justify a higher sale price or refinance.

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By contrast, the market dictates the value of houses and condos to a much higher degree. That means the value of your property depends mainly on how much the guy down the street (or two floors down) sold his property for last month. It doesn’t matter how many upgrades or improvements you make, no matter how much you increase the NOI — comparable sales trump everything in the single-family and condominium market. 

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Compared to a multifamily building, with a rental house or condo, you’re giving up a lot of power to control your financial destiny.

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4. You Probably Won’t Accelerate Depreciation

Real estate investors are allowed to deduct a depreciation expense every year to account for wear and tear on the property. It’s a neat way to reduce your tax liability without incurring any extra expenses.

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The IRS requires you to spread that depreciation out over decades. Still, with larger commercial buildings like apartment complexes, it often makes sense to commission an independent report called a Cost-Segregation Analysis, which allows you to take more depreciation much sooner. This is called accelerated depreciation. 

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The NOI from a rental house or condo doesn’t usually justify the cost of this report, but on a commercial building, the tax savings over the life of a 5-10 year investment cycle can be substantial.

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5. It’s Not What They’re For

In real estate, we often talk about the “highest, best use” of a property. Unfortunately, it simply isn’t the highest, best use of a condo or single-family home to buy it as an investment and rent it out. That’s not what they were designed for.

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Single-family homes and condos are designed to be autonomous dwellings and lifelong projects for an owner-occupant, usually a family or multi-person household. The occupants can make a low down payment, build equity by paying down the mortgage, customize the house to their personality, and enjoy a lifestyle of autonomy and privacy. 

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Every aspect of a single-family home or condo is designed for this use — not for use as an economically-viable rental unit. So it’s an inherently flawed strategy. By renting it out, you are putting that property to a lower, worse use — and you can see it in the diminished ROI.

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By now, it should be clear that condos and single-family homes are far from ideal as long-term investment properties. However, if you think a condo or house is all you can afford based on your savings, you’re wrong. 

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By becoming a part-owner of a multifamily complex or other commercial property, you can access the advantages of larger investment properties even if you don’t have deep pockets. 

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Questions? Want to get started investing in apartment buildings? Reach out to our team at invest@infinity9.com.