How to Generate Rental Income Without Owning a Home
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You’ll never buy that casa on the playa by cherry-picking the right stonk. When 95% of professional money managers can’t beat a simple benchmark, your Saturday afternoon due diligence sessions aren’t going to put you in the top 5% that can. Accumulating wealth is a slow boring process that takes lots of time and sacrifice. Start saving as early as possible, live below your means, and make sure you’re diversifying across asset classes. By that we mean you shouldn’t just buy stocks, you should also invest in realty.
Owning a house is great until it’s not. There’s always a list of things that need tending to – gutters need cleaning, water furnace is broke, sprinkler system needs winterizing, and the list goes on. Even renters are expected to participate in home upkeep tasks such as mowing the lawn. Only in an Airbnb do you get to escape all the extra bills and chores with a single fixed fee. Being a landlord does have its perks though, as you get to enjoy capital appreciation and rental income. If only you could own a house without having to own a house. Finally, such a value proposition has Arrived.
About Arrived
Founded in 2019, Seattle startup Arrived Homes has raised $137 million so far to build a platform that allows investors to become landlords without actually having to own a home. Well, that’s not entirely true. Arrived lets investors own a small piece of a home with as little as $100. Once a target home is identified and investors commit the required capital, Arrived then facilitates the purchase which consists of two components: a traditional mortgage and a pool of funds provided by investors on the platform. Here are the components of “total cost” for a random property we pulled up on the platform:
- Property Purchase Price – The final purchase settled on between buyer and seller
- Property Improvements & Cash Reserves – A slush fund for things that may come up such as a new water heater, plumbing, repairs to the house, gutter cleaning, etc. – typically averages around 2% of the total home value.
- Closing Costs, Offering Costs & Holding Costs – What it says on the tin
- Arrived service fee (one-time) – One of the ways the company makes money
Once the properties are purchased using interest-only loans, Arrived then seeks to sign two-year leases with tenants. The longer duration helps provide consistency in rental income while not depleting cash reserves since the rental payments can cover any unexpected costs that arise. Property cash flow payments are made to investors on a quarterly basis and oversight is conducted by Arrived’s property management partners at 8% of rent income.
Historically, rental properties on the platform have paid cash dividends from rental income that translate to 3.2% – 7.2% annual returns on investment. Investors are allowed to redeem their shares and liquidate their investments on a quarterly basis after an initial 6-month hold period. If a property starts to incur negative cash flows, then Arrived says they’ll make a short-term loan from their corporate entity to the individual home and then repay the loan with future rental payments.
To better understand how the process works, let’s take a look at a random property on the Arrived platform – The Lovejoy in Atlanta, Georgia.
The Lovejoy
Logging into the Arrived platform takes seconds, and you don’t need to be an accredited investor, which means anyone with a U.S. bank account can invest. Once logged in, we found two houses available to invest in (they seem to go fast). We’ll look at one located in Atlanta called The Lovejoy, a 1,834 square foot house that was built in 2020 and has a purchase price of $293,000.
The 3-bedroom 2.5-bath home is currently seeking a tenant for $1,895 a month so that works out to a gross yield of 7.76% which is almost exactly what the national average is. Arrived’s one-time annual fee when the property is purchased works out to about 5.4% of the property price and their asset-management fee works out to about 0.44%. Overall, the arrangement seems fair, and if you’re able to spend the time allocating money across multiple properties, then this is probably a reasonable alternative asset class to consider.
Arrived produces quarterly financial reports which contain key metrics investors should be paying attention to. For any investor with time on their hands, the platform is an engaging way to invest in rental properties. As with any asset, you’ll want to diversify your money across multiple houses in multiple regions to ensure diversification. In the future, we hope Arrived Homes chooses to bundle houses together into a “collection” which would make the investment process easier. If you’re looking for similar exposure but don’t have the time to navigate the Arrived platform, there are some real estate investment trusts (REITs) to check out. For example, Mid America (MAA) offers investors exposure to large apartment complexes across the United States. With a $25 billion valuation and steady revenue growth, the yield is dismal at around 2%. There’s safety in numbers though, and you’re getting a diversified investment vehicle that’s managed by experts with diversified exposure to 300 apartment communities containing 100,490 apartment units.
Our Take on Arrived
Investing in alternative assets doesn’t have to be boring. We were early participants in Lending Club and enjoyed vetting consumer loans to build a portfolio over time, though we no longer use the platform. If you love wine, Vinovest is probably one of the best things going right now. The same holds true for art lovers and Masterworks. Actively participating in investment decisions is fun. While the selection on Arrived is limited, that shows demand is there for their service. Over the last 20 years, single-family homes in the United States have appreciated an average of 3.9% per year which is an additional benefit on top of the yield. But investors need to understand that the property market can also have significant volatility. Just look how rapidly prices have been appreciating in the same zip code as The Lovejoy house we looked at earlier.
When property prices jump 28% in a single year – on average – there’s every reason to believe they can exhibit similar volatility on the downside. An obvious concern would be the short holding period that Arrived Homes proposes of 5-7 years. Should the property market crash as it has in the past, it may take some time to recover and selling for a loss might be the reality. Perhaps Arrived would then extend the holding period so as not to incur losses when selling properties. Since they’re using interest-only loans taken out for 70% of the property value, that means the principal never decreases. Should the price of a property fall 30%, the value of the property will not be able to cover the loan.
Our own exposure to realty comes from several commercial property REITs we’ve invested as part of our dividend growth investing strategy. These three companies have all paid a dividend – and increased it – for more than 25 years in a row. We find these investments adequate for the time being given we believe the U.S. residential property market seems a bit overheated right now. If you’re someone who thinks otherwise, you can sign up to Arrived using this link.
Conclusion
Property is a unique asset class to hold because it isn’t correlated to stocks and bonds. Even REITs which trade like stocks become less correlated to the stock market the longer you hold them. An argument could be made that owning a property on Arrived for rental income is better than owning a rental property in real life because you’re reducing property-specific risk. But the added risk is the Arrived platform itself. Given that properties are backing these loans and the company has leeway on their hold period, the risk seems manageable.
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Let me make sure I understand this. Net yield for Arrived, exclusive of rising property values that may not materialize, is 7.76 – 5.4 – 0.44 = 1.92 percent? MidAmerica seems to offer a trifle more, and you describe their yield as “dismal.” It is, of course, when inflation means you lose money in real terms.
Okay, so we are hoping that home prices will continue to appreciate. Last year, they went up about 10 percent after inflation. Sounds good.
Unfortunately, we are in a period of rising interest rates. The average rate for 30-year mortgages this morning was 4.601 percent with an APR of 4.695 percent. There seems little chance it will remain under 5 percent for the rest of the year. That means monthly payments will head upward. The most credible estimate I have seen is 40 percent.
This leaves two possibilities. Banks will prop up home prices by playing a better-hidden version of the games that led to the crash of 2007/’08. Or the average price of homes will drop about 10 percent. What won’t happen is a continued rise in home prices at anything like the rate seen in recent years.
That eliminates the other prop supporting Arrived’s value proposition. I don’t understand why anyone would put money into it. Maybe someday, but definitely not now.
Good question. The yield estimates do not include property price appreciation. Direct from the horse’s mouth:
Returns are earned from rental income dividends and appreciation driven by changes in property values. Arrived properties paid cash dividends in Q2 2021 that translate to an annualized 5.21% – 6.42% per year. As for appreciation, we have several resources to help you estimate investment performance, including an investment calculator that allows you to model returns.
We agree with your take on rising interest rates. We’re currently holding some great commercial property REITs and don’t see the need to change that up right now. We would opt for a REIT over a platform like Arrived though the latter is certainly more “fun” to use for someone with time on their hands. As you have said, we do not believe the rapid appreciation of property prices in the USA is sustainable and therefore wouldn’t put money into a platform like Arrived based on that assumption alone.