Single Family Rental Homes: Asset Class with 8.5% Historical Returns

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How about this housing market? A few weeks ago, the CEO of Redfin shared a viral Twitter thread about what he was seeing. Here’s just a snippet:

It has been hard to convey, through anecdotes or data, how bizarre the U.S. housing market has become. For example, a Bethesda, Maryland homebuyer working with @Redfin included in her written offer a pledge to name her first-born child after the seller. She lost.

Inventory is down 37% year over year to a record low. The typical home sells in 17 days, a record low. Home prices are up a record amount, 24% year over year, to a record high. And still homes sell on average for 1.7% higher than the asking price, another record.

What about single-family homes as an investment asset class? Larry Swedroe points to a recent academic study about the historical total returns of single family rentals. Here are some highlights from the paper:

  • The study covers the nearly 30-year period from 1986 to 2014, including zip codes across the largest 15 US metro areas.
  • Total return is broken down into two components: rental income (net of expenses) and house price appreciation, similar to the dividend income and price appreciation of stocks.
  • Across all cities, the total returns were approximately the same: 8.5% total annualized return. On average, this broke down to 4.2% rental income + 4.3% price appreciation.
  • In higher-priced cities, the total returns were composed of lower rental yields but higher price appreciation.
  • In lower-priced cities, the total returns were composed of higher rental yields but lower price appreciation.
  • On average, they found that net rental income is about 60% of gross rental income. In other words, for every $1,000 of gross rent, $400 was eaten up by operating expenses like maintenance, repairs, property taxes, etc.
  • Single family rentals represent 35% of all rented housing units in the US, and have a market value of approximately $2.3 trillion.

According to Swedroe, during the same period the S&P 500 returned 10.7% annualized but with more volatility.

I definitely acknowledge rental properties are the way that many people have built wealth. As individuals can combine cheap leverage from government-subsidized mortgages along with that 8.5% annualized return, that could make the overall return even better than stocks.

I’ve thought about purchasing a rental property (or four) as well, but I’ve always ended up using my time and life energy in other ways. In the end, I look at managing rental properties as more similar to running your own business. If you have the right personality and skillset, then managing rental properties is a great business and a great way to build wealth in terms of return on invested time. But for me, I’d much rather work on online businesses, what I call “digital real estate”. With excess cash from work, I invest in completely passive shares of businesses (stocks) and REITs which require zero ongoing work. When I am fully retired, the dividend checks will simply show up in my brokerage account. I don’t need to screen tenants, hassle them about late rent, argue about security deposits, or worry about evicting a family during hard times.

What about simply buying an REIT that owns single-family rentals? It appears the two biggest are Invitation Homes (INVH) with 80,000 single-family homes and American Homes 4 Rent (AMH) with 50,000 single-family homes. As you might expect, their recent returns have also been quite hot. The 5-year average return for AMH is 17.45%, per Morningstar, but it’s too young to have a 10-year return history. However, the current forward dividend yields of 1.80% (INVH) and 1.02% (AMH) aren’t terribly exciting.

Here’s a 5-year historical performance chart of American Homes 4 Rent alongside some other REITs and the S&P 500, from YCharts. Buying a specific REIT, even if it owns thousands of properties, can still result in a wide range of results.

If you own the broad Vanguard Real Estate ETF (VNQ), you’ll find that 14% of its portfolio is invested in residential REITs. This includes apartments, student housing, manufactured homes, and single-family homes. INVH is about 1.2% and AMH is about 0.65% portfolio weight in VNQ. The mutual fund version of VNQ is VGSLX, and has a 10.5% annualized average return since inception in 2001. That’s not too bad, either, and I’ve been pretty satisfied with my VNQ holding.

But again, single-family real estate is one of the original “side hustles” that helped folks build their own wealth over time. Sometimes, I wonder if I should work on building the required skills and knowledge base, just to keep my future options open and have something to teach my children.

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  1. Active real estating / land-lording is another part to full-time job. Can definitely be lucrative, but requires work and focus from you when you’re not doing your day job, though maybe a solid property management company can help. For me, it’s always been anything but ‘passive’ income.

    Certainly a skill and can be enjoyable, but not for everyone.

  2. Mark Czerniel says

    I’ve always wanted to invest in rentals, but the real estate market is white hot right now where I live (Upstate, NY). Right now, I can’t help but feel I’m caught “holding the bag” if I were to buy now at these high prices, and I would have huge regrets should there be a market slump this year and I could have invested that money) and time commitment) elsewhere.

  3. This is a great post – thanks Jonathan! I live in NYC where buying is prohibitively expensive but all my midwestern friends (where I grew up) own houses. It’s nice to put some % gains perspective behind owning vs. renting and investing elsewhere. The “american dream” doesn’t have to be owning property – you can just as easily retire early with disciplined long term investing in non-properties 🙂

  4. During the aftermath of the housing crisis, I bought several rentals. Average about 15-20% returns on cash invested. I just purchased my latest one 2 months ago with a disappointing 11% COC /s. I believe if you took out the extremely high end markets of California/west coast and higher east coast markets, that 8.5% would be double or triple.
    It’s much harder now, but buying a Class A or Class B property, which are the only ones I’ve bought, can be extremely passive. I self manage and even do 80-90% of repairs myself. There are times where I get calls from multiple tenants and need to fix this or that or call a plumber, but really it’s hands off most of the year. The key is screening for good tenants.

  5. I am torn on this topic. As a first time home buyer who’s competing against deep pocketed individual investors, hedge funds, pension funds, foreign governments/foreign investors, etc, it’s extremely demoralizing. A few weeks ago after searching for 3 months to buy a home I was finally a top bidder. But I lost out to a 100% cash buyer that offered the same amount and won the house. This was for a $1.6 million “starter” house here in the SF Bay Area.

    Of course this has been going on for over a decade here but this was my first time experiencing it in person. At some point restrictions need to be put in place to limit the deep pocketed investor class from owning everything and forcing others to rent perpetually. In Canada this is already happening. But then again, if I was already a home owner I’d probably be opposed to any restrictions on who could buy my house since it would suppress the market value of the house.

    Being able to buy a house has always been part of the American dream. When that goes away, what then? I’d argue this will perpetuate wealth inequality and further deteriorate this country which is already fraying at the edges.

    My gut tells me that we should restrict institutions (investment companies, corporations, pension funds, hedge funds, etc), from “investing” in single family homes as it artificially inflates home values and contributes to destroying the American dream.

    Interesting read in the WSJ:

    • Problem is geography
      Fact is SF Bay Area is an overpriced place where what you describe will happen. You can’t ask to buy a home when geographically you’re in one of the worst priced places to live. It’s a different game in North Dakota, Utah, etc

      Deep pockets are the only way to possibly live there. Same way goes for NYC, some parts of LA, etc

      It’s sad but true.

  6. Jason Boxman says

    I have family that does this, but another reason is to have a physical asset to pass onto children. In any case, from what I’ve seen, one tenant has been around for years, sends checks, no issues. Another in a different property complained about everything constantly and were a hassle to deal with, but always paid. Prior to that, a tenant was fine, but due to a medical issue abandoned the property in a mess. (Likewise, one property physically is in good shape, the other needed thousands of dollars of repairs, finding contractors this year is extremely hard, as are materials, and so on.)

    Like you, I prefer the simplicity of stocks and funds; and the preferred dividend tax rate. An executive team runs the business and as a part owner you just collect the checks, and bear some risk as well.

    Happy investing!

  7. Other unmentioned positives to owning rental homes – depreciation write-offs against your income, if you actively manage the property yourself. Estate planning – as long as step-up basis exists in the IRS’ tax code, I can depreciate my asset, die, and then my kids can do the same (or can sell the property without tax consequences). Inflation hedge, if that is in your investment thesis. Leverage is the big thing for many, and as long as interest rates remain cheap and can be locked in for a thirty year period, figure out how to take advantage of it in some way.

    I own one rental home – converted prior residence – in addition to my current house, and would like to add to my rental holding in the future. It certainly helps with diversification and plays into my professional experience/knowledge.

  8. It seems across the Country RE risen over 30-40%, and the valuations do not support these levels, aka over the long term how typical home buys are able to sustainably pay given their typically lower wages.

  9. Meant to say: “typical home buyers”

  10. Real estate and rental markets are very local. I can believe 8+% as a long term average return but how it works and the exact #’s will depend on the market.
    I”m not sure if that study counts the owner working to run the property or if they figure you’d use a property manager.
    I’m pretty sure that 8.5% would be based on owning the property with cash 100% without a mortgage. Its easier to get much better returns long run if you’re leveraging your investment with a mortgage.
    Plus the tax treatment of rentals can be pretty favorable too.

  11. Hey Jonathan,
    I been following your blog for quite number of years now and you cover wide variety not just finance and you are similar to my age and love the passion towards financial freedom so keeping up with your blogs..

    Anyway, I LOVE REAL ESTATE and because of the passion and perseverance, I built my business around it and now I will be quitting my 7-4 job end of this Jun. Yes, it’s real. I always want to quit and do my own thing and finally got to the point to do so because of Real Estate. I built my rental portfolio last 5 years with 2 houses every year and have 8 rentals, 1 owner finance property. I do FLIPS here and there and have my own Brokerage firm with 18+ agents now. I have property management company as well with 40+ doors and also build new homes in gentrifying communities in Houston. I just recently added Insurance service as well to my umbrella. We are one stop shop investor friendly service company with passion to service the clients. My rentals are still in mortgage and paying them off through rent and have cashflow of atleast $200/month. It’s all going well knock on wood and trying to get in to commercial a bit soon. I would encourage people to try out rentals and don’t worry about trouble as long you find the right tenant !!!

  12. Have you looked into an option like Arrived that handles all the landlord parts of owning and you just buy into the properties as part owner? I’m curious about them, but haven’t pulled the trigger. I’m a Lending Club IRA refugee and this is one of the options with their new IRA custodian (Alto IRA). The negative seems to be the flat fee from Alto that only makes it worthwhile if you invest a lot in each home. If you’re doing it outside of an IRA, it might make more sense.

  13. Hire a good property manager and you will see that it can be called passive income. The key is getting the good property manager, as good ones are hard to come by.

  14. Useful analysis.

    Jonathan, I recall an article of yours a long time ago that observed that real estate on average tends to mostly track inflation (having trouble finding it now), and wasn’t (I don’t think) suggesting anything like 8% returns even with rental income figured in. This seems like a departure from that conclusion — any thoughts there?

    Obviously there are a lot of factors that play into profitability, real estate markets vary by locality, etc.

    • That’s a good observation. I recall that too, and I’m pretty sure it was the Shiller data that tracked housing prices and did not include (potential or actual) rental income. Here is one source:

      Based on 1950-2000, housing prices only matched inflation. More recently (last 30 years), housing prices have risen faster than inflation.

      This study says the average from 1986-2014 was roughly 4% rent + 4% capital gains. If you assume inflation was 3% then the data sets may still match up. Housing prices increased a little higher than inflation, then you add on the rental income component.

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