With low interest rates, a lot of people are parking their assets in rental homes — and why not? Hands down, it’s a great investment (if you pick the right one).
With ROI (return on investment) as the ultimate goal, potential investors can use a property’s “cap rate” (a.k.a. Capitalization Rate – the amount of rent they’ll receive every year compared to the amount of money they’ll spend) to find the best opportunity.
For example, if you purchase a house for $100,000 and have a yearly return of $10,000 after expenses, that’s a 10% cap rate. On the surface, this would appear to be a no-brainer investment.
But what about the hidden costs of the property?
A $100,000 home is most likely going to be an older structure that needs some work. You may have to spend a lot of money bringing the house up to code…; what if the furnace blows out during the first snowstorm or a dead tree in the backyard comes crashing through the roof at any given moment?
In other words, your great deal could very well end up being a money pit.
Don’t Overlook New Homes
Real estate investors can see a much better ROI by renting out brand-new homes.
Consider this scenario: You purchase a brand-new $200,000 home and decide to rent it out, having a return of $1,500 after expenses. That’s a 7.5% cap rate. Compared to the cheaper home in the above example, this rate isn’t all that exciting.
However, the beauty of this investment is that you escape the endless costs that come with old houses, and you get to reap the following benefits:
1. Location, Location, Location
The huge value of new construction is that you’re getting A-area homes in up-and-coming areas. You can’t pay enough for low crime rates, good roads and schools, nice sidewalks, and nice local parks. The people looking to rent in these neighborhoods tend to be ideal tenants — they’ll mow their lawns, they won’t start collecting cars in their yards, they won’t throw huge parties, and, most importantly, they’ll pay their rent in full and on time more often than not.
2. Warranties and New Appliances
With new homes, builders will often put warranties on the property. Typically, they’ll cover anything that gets damaged within the first year. Some provide warranties for as long as 10 years. You won’t need to waste time hunting down bids from foundation specialists or putting the plumber on speed dial. If part of the house breaks, it’s the builder’s problem — not yours. Further, the home’s appliances have never been used. The water heater won’t conk out, the roof won’t leak, the windows fit — everything is brand-spanking-new. You likely won’t be answering tenant calls in the middle of the night for quite some time.
3. You Can Stick to the Basics
Before the house is even built, you can get in on the ground floor and work with the builder to customize the property. Keep your costs down by sticking to the basics. Nix the jetted tub, high-end fridge, granite counter tops, and fancy window treatments — this could cut $20,000-$40,000 off of the home’s price tag, translating to an even better equity position right out of the gate.
New Construction Is a Different Beast
Purchasing a brand-new home presents a different set of quirks than purchasing an old one. Here are three tips to help you make the best investment possible:
1. Buy on the 31st of the month.
Buy on the last day of the month or at the end of a fiscal quarter or calendar year. Builders will discount everything. It’s strange but true. At the end of every month — from the 29th to the 31st — there’s a crazy incentive to sell that disappears on the first of the next month. Why? Because bonuses are based on monthly and quarterly goals.
2. Buy immediate inventory.
Builders report that on average, one in five home closings get cancelled. What does this mean for you? Chances are that you can get a better price on a completed home. The builders want to sell, and if you can close tomorrow, they’re probably willing to give you a discount. Just ask!
3. Work with the builder’s people.
Consider writing your contract with the builder’s mortgage company. This will help the builder feel more comfortable with the contract process. He or she wants to see that you really are pre-approved and that you’re going to close on time. Further, because builders already have relationships with title companies, mortgage companies, and appraisers, you may reap some discounts by using their preferred people. Consider it a potential gain for both of you.
Like any investment, it’s wise to consider both the apparent and not-so-apparent costs you might face. Don’t let a lofty cap rate on a fixer-upper cloud your judgment. In many cases, a new home can ultimately prove to be a smarter investment in the long run.
You can choose your location, you can customize the amenities, and, best of all, everything is new. For real estate investors, that peace of mind is priceless.
Mike Kalis is the CEO at MarketplaceHomes, a Detroit-based brokerage that specializes in new construction sales and property management. Marketplace has sold more than $1.5 billion in new construction homes, gained a controlling interest in more than 2,000 single-family properties, and been a four-time Inc. 5000 list awardee. In addition to his managing partner role at MarketplaceHomes, Mike is a venture capitalist and investor in ZipTours. The startup helps homebuyers and renters see a home with an agent streaming live to their smartphone. It has conducted tens of thousands of tours since March 2015.