Businesses to avoid: Remote, single-family home rentals

Was just reminded by a Curbed article about a mind-bogglingly stupid trend in real estate investment and figured I’d share why I think it’s so dumb.

Here’s the deal:

  • Many people working in big, coastal cities feel locked out of the property market, both for owner-occupancy and also for investment
  • Online platforms have sprung up to allow these people to buy single family homes as investment properties in lower-cost places, where cap rates are higher cashflow (ie prices are lower relative to “forecast” net operating incomes)
  • Supposedly, these are “turn-key” services, where you can do everything from your desk – no need to visit the properties for inspections before buying, no need to meet the management company, etc.

Let me explain why this is a terrible idea:

  • Single family homes (the focus of this model) are very difficult to make work as rentals, because they’re full of idiosyncratic repair risk (each one has its own, particular issues) and the management has negative economies of scale (widely dispersed assets are harder to manage). The SFR REITs have done OK because they got in at such low prices in 2011-2014.
  • Without being on site for inspections, it is very easy for someone to defraud you, by selling you a property with hidden problems. Those high cap rates get much lower when you have to replace a roof or the plumbing unexpectedly
  • Your management company, which is supposed to handle finding tenants, making repairs, etc. has no skin in the game… they literally could not care less about the $300 / month they’re making from your property… if anything goes wrong, they’re gone
  • In investing, risk and reward are generally correlated. If you see a deals advertised on public markets that have what look like unusually high returns, you should be extremely cautious… it is VERY likely there is risk embedded in the deals that you do not see (for example – vacancy risk in a downturn)

This business model, connecting naive capital with remote single family rental homes in tertiary markets, feels like the kind of thing that emerges at the end of a cycle, when valuations are high and the easy money has been made.

I would be absolutely shocked if this story ends well for the investors.