Even in an explosive and increasingly competitive housing market, there are opportunities for real estate investors—and I think one of the most enticing areas for growth right now is in the rental market.
The rising cost of real estate in the United States has made it more challenging than ever for young people to break into traditional home ownership. Indeed, for many millennials and Gen Zers, this once-unquestioned centerpiece of the American dream is no longer the goal. Today, younger people are looking for both housing and more attainable ways to invest their money that better align with their lifestyle.
These generations had already embraced flexible and mobile work arrangements, long before the Covid-19 pandemic made them a necessity. Add to that a less-is-more mindset and growing anxiety about climate change. Accordingly, rooting down in a house with a 30-year mortgage doesn’t seem as appealing as it once did.
Benefits Of Rental Investments
In my work with real estate investors, I’ve seen how the benefits of investing in rental properties are wide-ranging. For one thing, rental properties are in very high demand right now—especially for single family homes. Lower priced rentals rose 7.1% between August 2020 and August of 2021, and higher priced rentals climbed up 10.5% in the same period. Even many older Americans are cashing out of the equity in their mortgages by selling their homes and opting to rent.
Investors can enjoy a steady passive income stream as well as tax benefits. Given the predictability of the rental market, I think it’s more than reasonable to anticipate steady appreciation. Zillow expects home values to grow 13.2% over the 12 months ending in June 2022.
Finally, it’s relatively easy to get in and out of the rental game. Investors can use leverage to make their initial purchase(s). They can later refinance the property into a long-term mortgage, which can be cashed out when the property is sold.
Drawbacks Of Rental Investments
Of course, rental investments have their drawbacks. These are long-term investments that won’t see profits for at least seven to ten years in my experience. Any real estate investor knows that this can be a risky proposition, particularly as we face down anxieties about the current market bubble bursting. However, I anticipate more pockets of price correction than any major crisis. Nevertheless, property value swings can be a bit of a white-knuckle ride.
Rentals are also a capital intensive investment—it’s not just your buy cost, but the hold cost, the finance cost and the selling cost that you will need to anticipate with plenty of capital. That means rental investing is not necessarily a good fit for everyone.
For those who are willing and able to get into the rental game, it’s important to prepare before jumping in:
1. Research widely. Read up on rental laws in your area, as well as the applicable tax laws and benefits. It’s critical to know what kind of deductions you can file.
2. Partner smartly. Many investors will need contractors to help them either rehab or maintain the property. Will you also need a partner to help you manage it? Tap into local networks to find well-reputed, reliable property managers and contractors.
3. Look closely. Determine what neighborhoods would be most desirable for you and your renters, including the most convenient and safe locations. Emerging neighborhoods may offer more tax incentives. Some other factors to consider are desirability of schools, amenities, access to public transport, walkability and nearby green space.
4. Borrow wisely. Some investors prefer to pay all in cash upfront. Even if you can purchase your property with cash, you may still choose to finance it as in some cases there may be higher returns. Find a lending institution that offers some flexibility on down payments. (Disclosure: I am the president of a private money lender.) Typically, a 20% down payment is required, but some lenders may allow you to fully finance the mortgage and even the repair funds. Customer service is equally paramount. Look for a lender who is responsive and communicative.
5. Plan accordingly. Whether or not you choose to work with a management partner, you will need a management plan for the property. Many investors would rather not be responsible for hands-on repairs, but hiring a manager will typically reduce your profits unless you have multiple properties.
6. Update judiciously. I’ve found the key to successful rehab is to neither overdo nor underdo any upgrades to the property. The home should be attractive, clean and up to date, but money spent on fancy fixtures or materials will be wasted. Give a realistic budget and timeline for any repairs or construction.
7. Prepare thoroughly. Get your financial affairs in order to make a sound investment. It’s important to have other income streams in case the property goes unrented for any period of time. There are usually higher rates of default for rental property loans, so most lenders will look very closely at indicators such as credit score, down payment, debt-to-income ratio and savings. It can also be a good idea to purchase landlord insurance to cover any property damage, liability or lost rental revenue. Finally, I suggest any property owner should keep a savings account for emergency and unexpected expenses, setting aside at least 20% of rental income or more.
8. Wait patiently. The returns on rental properties are not immediate. This is a long-term investment and will require long-term patience before you see a profit. At the same time, it’s important to have an exit strategy to mitigate any potential financial risk.
If you choose to wade into rental property investments, do your due diligence and watch closely for the right time to strike. Start small—you have plenty of time to build a portfolio. A rental investment can be rewarding for the patient investor who’s in it for the long haul.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.