The Pros and Cons of Investing in Stabilized Portfolios of Residential Rental Properties
Published on: Wednesday, December 16th, 2015
By Anthony Cazazian, Senior Vice President, B2R Finance
Investing in stabilized rental properties offers several benefits for the residential real estate investor. A property is considered to be stabilized if it is in lease-ready condition and is occupied by a rent-paying tenant.
Before purchasing a residential investment property, investors need to determine their risk tolerance and whether they are better suited to buy stabilized or non-stabilized (which typically require renovation and lease-up) properties.
Why would a residential investor want a stabilized asset? Here are just a few of the potential benefits:
1. Cash flow has been established. Your property will be producing cash from day one of your closing, and you’ll already know what to expect in terms of cash flow. How sweet is that?
When you buy a non-stabilized asset, the financial outcome is much less certain as there can be changes to renovation budgets, delays in renovation and leasing, and uncertainty with respect to initial rents. Even though rental demand is strong in many parts of the country, finding the right tenant can take time, especially after an ownership change.
2. Lenders will look kindly on you. A residential real estate investor is likely to get more favorable financing terms (e.g. lower rate) if he or she is buying a stabilized asset. Lenders such as B2R who lend based on cash flow often consider it favorable that the property is already generating cash, which will make it easier for all parties to determine if the rent will cover the debt service for a loan.
3. You just need to focus on asset management. If the property does not require any renovation and is already leased, the only thing an investor needs to focus on initially is asset management. This can be done by the investor or a third-party professional. Either way, the investor has a lot less to do at the outset.
Of course, one must consider some of the potential downsides of investing in a stabilized asset as well:
1. It is unlikely you will be able to purchase at a large market discount. The seller of a stabilized asset is not as likely to sell below market as a seller of a non-stabilized asset, which can have an impact on potential profitability. Many investors who are confident in their ability to renovate and lease-up properties prefer to acquire non-stabilized assets so they can capture this potential upside. Of course, this comes with additional risks as well.
2. The existing renovations or lease agreement may not be to your liking. A stabilized property has likely gone through some renovation and is subject to an existing lease agreement. Both of these items may not match exactly with the investor’s preferences and likely cannot be changed immediately.
Despite a few potential drawbacks, investing in well-stabilized assets makes a lot of sense for investors who do not have the expertise in renovating and leasing individual properties, or for those who want immediate cash flow. Above all, though, it is very important to do your own due diligence before making any investment decision.