Buying a single family home as an investment is the starting point for many real estate investors. Unfortunately, in Los Angeles, most single family homes don’t debt cover when being considered as an investment. The cardinal rule of real estate investing is: cash flow break-even or cash flow positive.
Homes have no correlation between their prices and the amount of income they produce. Therefore, it is common to see houses with 18-20 GRM and 2.5% cap rates or worse.
If the single family home doesn’t cash flow positive, you will have to come out of pocket each month to hold the property. When you lose money each month- that is a bad investment.
The only reason I can think of that an investor would be willing to do this is in the hopes appreciation will increase the value of the property greater than holding cost (4%/yr) + cost of sale (7-8%) expenses.
Single Family homes have a greater vacancy loss risk than multifamily properties because they only have one tenant. If you have a vacancy you will be losing 100% of your gross income every month the house is empty.
Single family houses are more management intensive than multifamily properties because they have multiple roofs, lawns, locations… etc. They don’t scale well.
A perk of single family homes is that utilities are separately metered. If a single family home can be purchased for a 11.5 GRM or less, and a Cap rate of 5% or more- they could make financial sense.
Let’s consider a real world example:
2Br/2Ba Hancock Park Bungalow worth $800,000 and rents for $3,600. Property is purchased with 20% down at an interest rate of 4.38%. The Vacancy reserve is increased from the normal 3-5% to 15% ($6,500 or two months vacancy) because of the high vacancy loss risk. If you were to manage the property yourself, the property would negative cash flow $1,500/mo. (or $18,000 annually).
What does the purchase price of this bungalow have to be to break even? The answer is $480,000!