Rental properties come in all shapes and sizes and can be found literally anywhere in the U.S. No matter what is going on in the real estate market at large, investors can still find residential rental property with relatively low risk and the potential for high rewards.
The fact is that some types of rental properties can be better for investors than others. In this article we’ll look at some of the pros and cons of different rental properties and explain how to choose the type of rental property that could make the best investment option for you.
Common Types of Rental Properties
When you’re looking for rental property to invest in there are a lot of different types to choose from. The most common types of rental properties include:
- Single-family houses that are detached from neighboring properties
- Luxury property targeted toward the high-end renter
- Vacation homes for short-term stays such as Airbnb or VRBO
- Townhomes or row houses that share a connecting wall, entryway, or front yard
- Condominiums and cooperatives that are privately owned units in a multi-tenant building
- Small multifamily buildings such as a duplex, triplex, or fourplex
- Apartment buildings built as a walk-up, low-rise, mid-rise, or high-rise
These common rental property types can also have sub-types. For example, single-family houses can be located in middle-class areas suitable for workforce tenants, condos can be designed as lofts or small studio units, and apartment rentals can be ground floor units with access to a small garden in an urban setting or a penthouse unit with countless amenities.
Different types of rental properties also have their own unique benefits and drawbacks.
Depending on the market you’re investing in, millennials and families may be willing to pay a higher rent for a single-family house because they see the property as a home that they can live in for several years compared to a small, cramped apartment.
There are also significant differences in the construction and size, cost of ownership and property management, and the investment and exit strategy among the various types of rental property.
The 3 Most Popular Types of Rental Properties
The real estate market – along with the overall economy – moves in normal up and down cycles. In fact, since 1800, the real estate cycle has moved in steady 18-year rhythms, according to the Harvard Extension School.
Some real estate investors enjoy the adrenaline rush of trying to time the market by fixing-and-flipping, at least until they try to flip into a down market. On the other hand, more conservative rental property investors opt for the buy-and-hold strategy, focusing on recurring passive rental income from monthly rents and gradual appreciation in property market value over the long term.
Successful investors understand that when the right type of real estate is purchased at the right price in the right market, risk is minimized and yields are more predictable.
Single-family rental houses
Investing in single-family rentals are a popular choice of many real estate investors for several reasons:
- Asset type that everyone – owners, tenants, property managers, lenders – is most familiar with
- There are more than 70 million single-family houses in the U.S., according to the U.S. Census Bureau, so it’s easy to find a house to buy and rent to a tenant
- Online sources investors use to find good rental property include Zillow, the local MLS, Realtor.com, and the Roofstock Marketplace for turnkey single-family rental houses
- Demand for single-family rental property should continue to see very strong demand from investors and renters
- Financing options for houses are plentiful, including conventional mortgages from Fannie and Freddie, FHA loans, VA loans, self-directed IRAs, along with blanket mortgages and portfolio loans for owning multiple rental properties
- Managing and maintaining a single-family rental home is cost-effective, in part because tenants view living in a house at the top of the “rental food chain” and usually take better care of the property
- When the time comes to sell a rental house, investors have multiple exist strategies such as selling to an owner-occupant, selling to another investor, structuring a rent-to-own agreement with the current tenant, or doing a 1031 tax deferred exchange
Workforce multifamily apartment buildings
The National Association of Realtors (NAR) describes workforce housing as housing that is affordable to workers and close to their jobs. However, workforce housing isn’t the same thing as subsidized housing or Section 8.
In the same report, the NAR notes that the Urban Land Institute defines workforce housing as: “housing that is affordable to households earning 60 to 120 percent of the area median income.” Another way of thinking about workforce housing is that the housing costs are not more than 30-40 percent of the tenant’s household income.
People who rent workforce housing include teachers, police officers, young professionals, construction workers, and tenants employed in service trades such as retail and restaurant. In urban areas or denser suburban submarkets, workforce housing is typically found in “bread and butter” apartment buildings in middle class areas.
However, investing in workforce multifamily apartments can be problematic for a couple of reasons.
First, even for the smallest of buildings, investors often find themselves competing with well-capitalized private equity firms who are willing to pay more while accepting lower cap rates and yields. Secondly, managing a multi tenant property can be difficult because the more units there are the greater the potential for problems.
Of course, single-family houses can also be rented to workforce tenants, depending on the location and market rent. In fact, several years ago, the Urban Institute had the foresight to note that single-family homes could be considered a key part of an affordable housing strategy.
NNN property leased to a single tenant
In the commercial real estate industry, triple-net property (NNN) is often the preferred type of investment for passive income investors.
That’s because NNN property is leased to a single tenant who pays a base rent plus all of the operating expenses in the building. Examples of triple-net properties include freestanding banks and gas stations, car washes, and fast food locations.
NNN property offers some clear advantages to experienced commercial real estate investors, but there are also some big potential drawbacks as well.
The first disadvantage is that business tenants are affected longer and harder during a recession than residential tenants are. When money is tight, people drive less and eat out less frequently, which reduces the commercial tenant’s cash flow and makes it harder for them to pay the rent.
Selling a single tenant NNN investment is also much more difficult. Triple-net properties are usually built for a specific use. For example, a gas station can only be sold to another gas station operator, and a bank building can only be used by a different bank.
Those may be some of the reasons why commercial real estate investors are diversifying their real estate portfolios by investing in single-family rental property. Houses have some of the same investment benefits that NNN commercial property does, and may be more resilient through the different phases of the normal real estate cycle.
Six Factors Help Make a Rental Property Profitable
The words “best” and “good” can be very subjective, with the definition of each varying based on an investor’s strategy and goals. But when everything is said and done, real estate investors want to make a profit.
Here are six important factors that can help make a rental property investment profitable:
Population and job growth have a direct influence on how strong the demand for rental housing is in the marketplace. When more people move to an area to work, housing prices generally rise and the demand for investment property increases.
Supply and demand
On the other hand, an area with a large number of “For Rent” signs could mean the rental market is cycling downward. When vacancies rise, market rents go down. The most qualified renters have more to choose from, forcing landlords to compete for the tenant with incentives and concessions.
Location of property
Factors that make the location of one property better than another include the quality of the neighborhood, how good the local schools are, nearby amenities such as parks and shopping, and the crime rate. The Roofstock Neighborhood Rating makes it easy to find all of this data simply by entering a property address.
Cash flow and appreciation
Recurring cash flow and market value appreciation over the long term are two of the biggest reasons for buying rental real estate. Market rents, property taxes, and growth potential all have a significant impact on how profitable a rental investment is.
If rents in the marketplace aren’t high enough to pay for the mortgage and operating expenses, the value of the property will be less and the growth potential lower.
Landlord tenant laws
Real estate markets can be landlord-friendly, tenant-friendly, or neutral, depending on how the landlord-tenant laws are written for each state and municipality. For example, many markets on the east and west coast where affordable housing is hard to find limit the amount of rent a landlord can charge.
A good property management company can be worth its weight in gold. Even in the same neighborhood, some rental houses have a higher yield than others and generate outstanding returns. The reason why often has to do with the property manager. Experienced professional property managers understand the market, have an established network of cost effective vendors, and know how to get vacancies filled fast.
The best type of rental property depends on your investment strategy and objectives.
Different property types attract different tenants, and some types of rental property are much easier to manage than others.