Is SFR investing worth the return? An IRR analysis

[Dave Vona]

Hi, I'm trying to decide whether I continue to actively invest in single-family (or small multifamily) long-term rentals or invest with a multifamily syndication. I decided to run IRR (Internal Rate of Return) calculations for the SFR (single-family residence) investing in order compare with the IRR targets I see proposed by syndication operators.

The target rate I often see on syndication sites is around 15-18% IRR (and sometimes higher for new development projects). This includes some amount of cash flow and then a larger payout once the property is sold or refinanced after X number of years. My intention was to see how this rate compared to the IRR of a SFR investment using several property assumptions and different purchase models.

Based on my calculation, I was surprised to find that the IRR on a SFR was not as high as I expected, especially if held for the longer-term.

I realize there is more to an investment than just the return. Most investors will also take into consideration risk, time invested, control over the asset, the ability to do a cash-out refinance, and other factors. However, I wanted to focus on just IRR for this analysis.

Please note, I did not include the tax benefits from deprecation. From my understanding the 15-18% IRR promoted by syndicators generally does not include these tax benefits either, so it is still a fair comparison.

Assumptions
I had to make a few assumptions about the property and mortgage interest rate:
Property value = $180,000
Rent = $1680
Mortgage Interest Rate = 6%

I also made assumptions related to other costs such insurance, taxes, property management, maintenance, capital expenses and vacancy. Both rent and expense growth was set at 2%. For simplicity, I did not include closing costs or loan points in the purchase price numbers, but did include a fee of 10% of the sale price to cover closing costs, commissions, and minor repairs.

Models
Below are two tables showing the IRR for the traditional rental, using a 20% down payment, and the BRRRR models using a 75% LTV loan. My models only go down to 80% market value (i.e. a 20% discount) since this seems like a reasonable goal for the "average" investor in 2024. I compared a 2.5% and 5% property appreciation rate at 5-, 10-, 15- and 20-year intervals. The IRR is assuming there was an initial investment amount, some cash flow each year, and then a sale of the property in the year indicated.

Traditional SFR rental using 20% down

BRRRR using 75% LTV loan

Observations:

1. In nearly every case, the IRR continues to decrease the longer the property is held even though the cash flow is increasing. This is because the earlier years see a large jump in IRR due to the leverage used, however this effect diminishes in later years.

2. After 20 years, the 5% appreciation rate use-cases only make a difference of roughly 2-2.5% in the IRR.

3. After 20 years, only the 80% BRRRR use-cases offer greater than a 20% IRR.

Questions

1. Is it worth investing in SFRs for a part-time, non-professional investor? Unless you're able to consistently purchase properties at a 20% or more discount using the BRRRR strategy, the longer-term IRR is going to be under 20%. A consistently higher appreciation can make up for a lower purchase price discount, but 5%+ appreciation for 5-10 years is typically not the case in markets that offer some amount of cash flow.

2. If you do invest in SFRs, is it better to hold the properties for a shorter period (less than 10 years) to increase your IRR?

3. If the IRR is not greater than 20-25%, which applies to most of the above models over the long-term, are you better off investing in a syndication which is much more passive than buying and managing a portfolio of SFRs?

Please let me know your thoughts on my analysis and any comments you have on the SFR vs syndication investing questions. Thank you.

[Ian Ippolito]

Quote from @Dave Vona:

Hi, I'm trying to decide whether I continue to actively invest in single-family (or small multifamily) long-term rentals or invest with a multifamily syndication. I decided to run IRR (Internal Rate of Return) calculations for the SFR (single-family residence) investing in order compare with the IRR targets I see proposed by syndication operators.

The target rate I often see on syndication sites is around 15-18% IRR (and sometimes higher for new development projects). This includes some amount of cash flow and then a larger payout once the property is sold or refinanced after X number of years. My intention was to see how this rate compared to the IRR of a SFR investment using several property assumptions and different purchase models.

Based on my calculation, I was surprised to find that the IRR on a SFR was not as high as I expected, especially if held for the longer-term.

I realize there is more to an investment than just the return. Most investors will also take into consideration risk, time invested, control over the asset, the ability to do a cash-out refinance, and other factors. However, I wanted to focus on just IRR for this analysis.

Please note, I did not include the tax benefits from deprecation. From my understanding the 15-18% IRR promoted by syndicators generally does not include these tax benefits either, so it is still a fair comparison.

Assumptions
I had to make a few assumptions about the property and mortgage interest rate:
Property value = $180,000
Rent = $1680
Mortgage Interest Rate = 6%

I also made assumptions related to other costs such insurance, taxes, property management, maintenance, capital expenses and vacancy. Both rent and expense growth was set at 2%. For simplicity, I did not include closing costs or loan points in the purchase price numbers, but did include a fee of 10% of the sale price to cover closing costs, commissions, and minor repairs.

Models
Below are two tables showing the IRR for the traditional rental, using a 20% down payment, and the BRRRR models using a 75% LTV loan. My models only go down to 80% market value (i.e. a 20% discount) since this seems like a reasonable goal for the "average" investor in 2024. I compared a 2.5% and 5% property appreciation rate at 5-, 10-, 15- and 20-year intervals. The IRR is assuming there was an initial investment amount, some cash flow each year, and then a sale of the property in the year indicated.

Traditional SFR rental using 20% down

BRRRR using 75% LTV loan

Observations:

1. In nearly every case, the IRR continues to decrease the longer the property is held even though the cash flow is increasing. This is because the earlier years see a large jump in IRR due to the leverage used, however this effect diminishes in later years.

2. After 20 years, the 5% appreciation rate use-cases only make a difference of roughly 2-2.5% in the IRR.

3. After 20 years, only the 80% BRRRR use-cases offer greater than a 20% IRR.

Questions

1. Is it worth investing in SFRs for a part-time, non-professional investor? Unless you're able to consistently purchase properties at a 20% or more discount using the BRRRR strategy, the longer-term IRR is going to be under 20%. A consistently higher appreciation can make up for a lower purchase price discount, but 5%+ appreciation for 5-10 years is typically not the case in markets that offer some amount of cash flow.

2. If you do invest in SFRs, is it better to hold the properties for a shorter period (less than 10 years) to increase your IRR?

3. If the IRR is not greater than 20-25%, which applies to most of the above models over the long-term, are you better off investing in a syndication which is much more passive than buying and managing a portfolio of SFRs?

Please let me know your thoughts on my analysis and any comments you have on the SFR vs syndication investing questions. Thank you.

Dave,

First, I have 7 figures invested in both single family rentals and syndications (i.e. crowdfunding).  And I personally believe both have their pros and cons and neither is the 100% superior to the other (and I like having both in my portfolio).

Having said that, there are some issues/problems with your comparison. 

The range of IRR's syndication/crowdfunding deals is much wider than just 15-18%.

Generally there is a higher projected return for taking higher risk. And generally there is a lower projected return for taking lower risk.

So for example if you were investing in a core real estate strategy ( one of the safest) it would be nowhere near as high as 15 to 18% IRR (and closer to 5-8%). And as you mentioned, you can also pick higher risk deals that have higher IRR.

So you're not really comparing apples to apples here.

Also, most likely the syndication/crowdfunding deal you are comparing to is a completely different real-estate asset class than single family (i.e. probably multi-family,office, self storage,mobile home parks or something else).

If so then  each real estate asset class has different risks.  And if that's not taken into account, then it's also not an apples to apples comparison.