The Pros and Cons of Investing in Higher-end Rental Properties
By Kerry Curry, Contributing Writer
Residential real estate investors often wonder whether it makes sense to invest in a couple of expensive properties rather than several lower-priced ones, with the biggest question often being: “Is it worth it?”
To help us look at the pros and cons of investing in higher-priced rental properties, we tapped the expertise of Chris Clothier, partner and vice president of sales and marketing at Memphis Invest, a turnkey investment firm.
First, we’ll look at the reasons why you might want to consider buying higher-end investment properties:
- The quality of the product. “The pros of investing in the upper half or upper third of the market is that you tend to get a higher quality home; that is why it is priced there in the first place,” Clothier said.
- Maintenance costs. The house may be built better and require less maintenance than a cheaper property. (Maintenance can also be viewed as a ‘con.’ – see below)
- Tenant quality. You’ll be able to attract tenants who can afford to pay more, who have higher incomes and more stable jobs. They may stay in the property longer and may put less wear-and-tear on the home.
- Additional exit strategies. Higher-end tenants may view the property as a potential future purchase — an exit strategy for the real estate investor that may not be available in the lower third of properties where likely buyers will be other investors. Be sure to check with your lender if this is your exit strategy, though. Many asset-based lenders do not allow lease-purchase options, so that may limit your ability to finance the property.
Now let’s consider the cons to buying more expensive investment properties:
- Barrier to entry. There’s a higher hurdle to get over to acquiring the property as it costs more.
- Maintenance costs. Higher-priced housing comes with nicer finishes and higher-end appliances, which will cost more to replace and repair when the time comes to do that.
- Vacancy costs. If the property sits vacant, the cost to hold a higher-priced property will be more than a less expensive property.
- Lack of diversity. You won’t have the ability to spread your money across as many assets if you are buying at the higher end.
Real estate investors and risk tolerance
Clothier said that one of the most important aspects of considering whether to invest in cheaper properties versus more expensive properties is an investor’s appetite for risk.
More expensive properties typically mean less risk and also less reward.
The actual return on investment for a higher-priced residential property typically will be lower than on a cheaper property, but the dollars spent will be more secure, Clothier said.
“A lot of times people will say ‘I can buy 10 homes for $30,000 or I can buy one $300,000 home,” he said. “They justify buying the cheaper homes by saying if you have one vacancy you are in big trouble on the $300,000 home. If you have one (vacancy) on a $30,000 home, you are in less trouble.”
But investors don’t always take into account that the turnover rate and maintenance costs on a cheaper property may be higher and that type of property may come with higher risks. Therefore, the advantages of mitigating risk in the above scenario by having more diversification across 10 less expensive properties is lost because the risk is so much greater, Clothier said.
“That’s why I’m a big believer in owning at the higher-end of the market because the advantage of having a higher quality tenant and more exit strategies far outweigh the diversification of buying more assets,” Clothier said.
Conclusions: Find the middle ground
The best route may be somewhere in the middle where there’s a bigger pool of potential renters and also a bigger pool of potential properties for investors to acquire, he said.
Investors will only earn a rate of return once on the capital they deploy, whether it is deployed across 30 homes or just one or two, Clothier notes.
“You are looking for a way to mitigate risk and get the highest return. How can I get a good return without having to take too much risk? It ties into the middle ground house. It’s not inexpensive, but it’s not so expensive that you can’t diversify.”
B2R Finance offers rental investors innovative lending products to help unlock equity from existing portfolios and provide the cash needed to build rental portfolios nationwide. For more information about how B2R can help you obtain rental property financing, just call 800-227-8107 or visit http://www.b2rfinance.com/apply-now and follow us on Twitter @B2RFinance.
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