Home Rental Property: A Good Investment?
As home prices have soared over the past year and housing inventories have fallen, more and more families are renting rather than owning. Demand for rentals is rising in lock-step with falling home ownership. While rising home prices can be attributed to supply and demand – high demand, in part, sparked by the pandemic and a low inventory on the market – this dynamic has also been fueled by real estate speculation.
More affluent renters are also staying in the rental market longer and driving up the demand for rental housing. Traditionally, the wealthy move on to become homeowners, but tight housing market inventory keeps them in rentals longer. The Nation’s Housing Report report found that most new apartment construction has focused on the higher income earners. Those earning $75,000 and over have contributed the most to rental growth over the past few years.
Lack of available houses for sale driving increased demand for rentals has propelled rental costs upward. In 2020, approximately 10 million families allocated close to half of their income toward rent, according to the annual State of the Nation’s Housing Report from the Joint Center for Housing Studies.
Rental Property Investments on the Rise
Investors are responding to the growing demand for rental properties as potential home buyers get priced out of the housing market. As a result, built-to-rent single-family homes are seen as an emerging investment opportunity. According to real estate research firm Green Street, the expected annual return (risk-adjusted) for built-to-rent investments in the private market is now on average about 8%, with the weighted average return for all property sectors at 6.1%.
Large national home builders like Lennar Corp. and D.R. Horton Inc. have made building rental homes a major component of their business. In addition, investment firms like Blackstone Group are adding more rental housing into their portfolios. “Close to 100,000 built-to-rent homes will have started construction this year, according to estimates from Brad Hunter, founder of the Hunter Housing Economics consulting firm. Investors have poured about $30 billion in debt and equity into the sector in 2021, with many billions more in future commitments,” Mr. Hunter said.
What’s on the Horizon?
The growing investor interest in building homes for rent is pushing land prices way up in certain markets like the sunbelt. However, higher land prices could equate to a compression of investor returns, making this segment less attractive for some investors. In fact, some analysts and builders are reevaluating their investment strategy as they think the rapid growth in the rental sector is unsustainable.
Seattle-based Zillow Group recently announced that it will begin winding down its buying and selling of homes, citing the “unpredictability” of forecasting housing prices. The shuttering of its home-flipping and rentals will result in a 25% reduction in the company’s workforce.
Increased foreclosures could also become an issue. A recent report on Realtor.com showed filings for foreclosure have gone up almost 70%, in part because the eviction moratorium has been lifted. Low-interest rates may help to mitigate foreclosures becoming a crisis. But, with a flood of houses coming to the market due to foreclosure, it could drive down prices.
But, unlike 2008, there is no bubble to burst. Instead, the buying boom this time around is linked primarily to low mortgage rates, and a shift in preference from urban living to suburban living, primarily a reaction to the pandemic. Couple these buying boom links with construction labor shortages and back-ordered materials, and housing prices pushed upward.
As the market moves back to normal, housing prices may retreat from the current highs of panic-buying. And experts predict mortgage rates are likely to rise in the next year or so. As prices stabilize, families will, in all likelihood, move from rentals to home ownership as there will be more accessible buying opportunities. Additionally, as rental prices have been rising faster than wages, losing such a large portion of a paycheck to cover housing means cutting back on other essentials such as food, clothing, and health care. This can be draining on young families trying to save for a down payment on a home purchase. As a result, there will be incentives for young families to move on from rentals.
As always, Madison encourages clients to reach out to our advisors with any questions you may have regarding investments.