Real Estate Finance Alerts

In my Blog Article on February 12 titled “Why You Should Buy Investment Property Now¹,” I identified what I referred to as a perfect storm for rental property that would provide a tailwind for residential investors for years to come. In summary, I argued that the rising cost of home ownership would increase the demand for rental property. As more buyers and owners became renters, rent rates and profits for investors would increase. Now, five months later, I verify my predictions and evaluate the continuation of these trends. Finally, I identify the significance of these changes for both investors looking to purchase rental properties and homeowners looking to upgrade to a new home.

Reason 1: The Cost of Ownership Continues to Increase. The cost of home ownership increased much more than I thought possible. Recent loan changes eliminated most stated loan programs, increased down payment requirements, and raised minimum credit score requirements. Most flexible loan programs including Subprime loans are no longer available or significantly more restrictive. Additionally, interest rates for flexible loans increased several percent compared to regular loans because fewer lenders offer these loans and those that do are charging a lot to offer them. As the cost of ownership continues to increase, more buyers are becoming renters. With more renters, the rental market continues to improve.

Reason 2: There is Less Competition in a Buyer’s Market. The loan program changes affected two groups of borrowers differently. Investors, as I define them, have strong credit, income, and assets, and purchase homes with down payments of 20% or more. Investors buy properties that have positive cash flow and keep realistic expectations of property appreciation based on historical trends. Contrast this with Speculators who, as I define them, typically buy houses based solely on price appreciation with little down payment and no consideration for rental income and cash flow. Most speculators exited the market because of falling/flat home values and the increasing cost of ownership. With fewer homeowners and speculators in the market, there is less demand resulting in a buyers’ market. Investors can be selective and wait for the right deal at the right price on a property that with the right monthly rent.

Reason 3: Rising Rent Rates. While the strength of real estate markets across the country varies greatly², many rental markets are stabilizing and strengthening. A recent article³ in the Denver Business Journal reported vacancy rates for single-family homes at multi-years lows while rent rates increased 5% year over year for every. Another article⁴ reported the same trends for apartments in Colorado further supporting the rental market. Higher rent rates and lower prices are causing homeowners to take homes off the market and investors to buy homes as rental properties. In fact, recent sales data indicate this is already occurring.

Reason 4: Rising Home Values. Nationwide existing home sales stabilized over the last 6 months⁵. Both median and average⁶ home prices actually rose each of the last 3 months⁷. Even though inventory of unsold homes remains a concern, new home starts continue to fall and are now below the level of household creation. Builders are building fewer homes⁸ than are needed each month by new households. New households will purchase existing homes, which will gradually decrease the inventory of unsold homes. The inventory of existing homes fell below 11 months and will continue to fall in the coming months further improving real estate markets. Rising home values not only increase the return for investors, but they also raise the cost of home ownership which further support rent rates and investor profits. Investors know that they do not need to time the market bottom to be profitable.

Reason 5: A Market Bottom. The impact of a housing bottom is significant for investors because the resulting positive impact to the entire U.S. economy should further improve rent rates and home values. The buyer’s market also benefits homeowners looking to buy a new home. Owners can upgrade to a new home when prices are lower and rent out their existing home until prices increase further and then sell into a stronger market or keep the home as a long-term rental property. However, the improving real estate market also signals that best time to buy is nearing an end. If you try to time the bottom of the market, you will likely miss the bottom and end up paying more as buyers waiting for the bottom reenter the market and the market shifts to a sellers’ market. Additionally, even if you are a very qualified buyer with strong credit and down payment, interest rates are rising as expectations of FED rate hikes increase with the improving economy. Therefore, if you are interested in investment property, you should immediately complete a financial and market analysis to determine if investment property is appropriate for you.

So, is it a Perfect Storm? The market conditions I expected exist and even exceed my initial expectations. The rising cost of ownership, reduced competition, rising rent rates and home values, and an impending real estate bottom all contribute to the strength of the rental market and are reasons to buy rental property now. If you are an investor looking for a residential rental property or a homeowner looking to upgrade to a new home and rent your existing home, the perfect storm for rental property should provide a strong tailwind for your investment for years to come.