The Next Bull Market Could Be Rentals

The great thing about investing is that if you do your homework, you can always find a way to profit in any market. Even when the stock market as a whole is doing poorly, there are always sectors and individual stocks that are doing well, if you are looking for a profitable trade.

Sometimes you have to buy gold or oil stocks, sometimes you have to buy an ETF that is short the DOW, S&P, Nasdaq, or some other index. But the point is there is always something going up.

In real estate, the same thing is true.  It's a cyclical industry and there are times when certain types of properties do better than others. I can remember times when condos were scorching, other times when it was commercial properties, or even land in certain locations that was hot. 

Over the past few years, on the whole, we have had a bear market in real estate. One of the similarities between Real Estate and the stock market is that just like the stock market sectors, you can have some geographical areas where sales begin to lag, while other areas continue to do quite well.  Some cities in the U.S. -- Seattle, Dallas, and Charlotte, for example -- have done fairly well in recent years, even while the overall national market was declining, and formerly bullish areas like Florida, California, and Nevada were hit really hard.

In my own area of Northeast Florida, the number of closed single family home sales reached a peak in June 2006.  There were 1,985 sales that month, and we have been on a slow but steady decline since that time. Just to give you an idea:

Month Year	Number of Closed Sales
June 2006	1985
June 2007	1462
June 2008	1122
August 2008	914

The peak of price and the peak of closed sales do not always correlate immediately, but over time, as sales slow, prices will fall, and that is what we have seen in the past two years. Conversely, during good times, as the number of sales rise, the prices will increase.

Similarly, the condo market in my area has shown a decline in sales since June 2006, and prices have suffered as well. Although the decline isn't straight down, and just like with bear market stocks, we get an occasional "bounce" in the market, the trend has been lower:

Month Year	Number of Closed Sales
June 2006	334
June 2007	210
June 2008	161
August 2008	95

But people have to live somewhere. If they can't afford the down payment and/or closing costs to buy a house, they will rent one. If they lose their home to foreclosure, they will have to rent one they can afford. If their credit is not worthy of the new tighter mortgage standards, they will have to rent. If they are afraid of falling prices, they will choose to rent.

Do you see where I'm going with this? 
Rentals are the new bull market in real estate!

And who will profit from this bull market? 
People who own rental properties!

Now already I hear some groaning from those who have either had bad experiences in the past with tenants or from being a landlord. When I first started to invest in real estate, I heard all of the stories too. "My uncle had a house, and the tenants trashed it. We had a rental one time, and the tenants didn't pay and we had to evict them. Oh boy, Ethan, you're going to get awakened with calls at 2 AM that the water pipes have burst."

I heard them all, and then some. Even my own father tried to dissuade me with his own bad experience at it. But I bought my first rental property anyway. And then my second, and the third. And another and another. Stupid me, right? Yeah, I was stupid all the way to the bank!  

Look, for every guy who says never to  buy rental properties, there's another guy who will tell you not to buy stocks because their grandfather lost a million bucks in the market! And somebody else will tell you to never buy a business because your employees will only lie, cheat, and steal from you. What separates people who live to tell success stories from those who only have horror stories is learning the right way to do things. 

Folks, if you all you do is listen to the "horror stories," you will never invest in anything, and guess what, you will never become wealthy!

Look,  I understand that people are angry as heck right now, because over the past few weeks when I tried to write anything positive about real estate, a number of people just hit me upside the head. Look back at my articles over the past nine months, and you will see plenty of times when I wrote negative pieces about real estate as well.

But folks, I'm not here to become an egomaniac, or with a personal axe to grind related to my own real estate. I'm simply here to write about how YOU can make money. If real estate is not your cup of tea, I understand, and that's fine.

Nor am I going to advise you to sell all your stocks, bonds, mutual funds, ETFs, and CDs, and buy rental properties. Even if you do invest in real estate, it should only be a portion of your total portfolio, along with all of your other investments.

But I will tell you that the number of people seeking rentals in many areas is rising. Starting with the same June 2006 time period as before, the rental statistics from my local Multiple Listing Service tell a story that is almost the exact opposite of home sales:

Month Year	Number of Closed Leases
June 2006	428
June 2007	477
June 2008	573
August 2008	614

The statistics show a steady increase in the number of closed leases over a 26-month time period, to the point where the August 2008 total is 43% higher than the June 2006 total. 

And while the number of persons seeking rentals was climbing, what was happening to the prices of homes? Right, they were declining. And that means the ratio between rents to sales price has been improving for investors. Even if the fair market value of homes in your area does not yet support rental prices, the foreclosures and other distress sales will almost certainly do so. 

Granted, there were some areas of the U.S. where price appreciation of rentals did not occur or was limited over the past few years. One of the reasons for that was an increase in rental units, due to a large number of people who couldn't sell their homes, trying to rent them instead.

But what happened in many cases is the owners couldn't get enough in rent to cover their sky-high sub prime mortgages, and soon dropped off the market. Many of those homes have now become foreclosures as well, decreasing the inventory levels of rentals. While some apartments have struggled to get tenants, the rental homes that were priced right and in good shape have continued to fill vacancies quickly.

An increased number of tenants means a greater demand, and will result in getting one's property rented more quickly. With a larger group of tenants to choose from, landlords can become more particular, thereby decreasing the risks of getting a bad tenant who won't pay or who will not treat the property kindly.

I can honestly tell you that all of my rentals command much higher rents today than they did two years ago.  If you buy in good locations and maintain your properties well, you are very likely to have similar results.  It may seem strange, given all that has happened in the last three years, but over the next decade, this is one bull market you may not want to miss.   

Comments

[NoFate:]

I agree that the DEMAND for rentals will go up as more people get foreclosed on ...or simply can't get financing to buy a home.

I would also point out that the SUPPLY of houses (and apartments) increased dramatically in the past 7 years also.

So demand for rentals should increase, but supply of rentals should increase as well. I would be very careful with the author's thesis.

I would also point out that the C-S Index is still dropping like a rock and will likely shoot past the mean before it starts to flatten out. Banks are demanding 30% down on rentals because they realize this (i.e. grew a brain). So even if you get positive cash flow, you will likely lose equity immediately (unless you get a really good deal).

I plan to buy houses to rent, but am waiting for blood in the streets. When the Case-Shiller index is almost flat in another year or two I will start looking. Until then I am very happy sitting on cash.

2008 Oct 05 04:19 PM

[Basic Finance:]

Agree with NoFate. Just because demand is increasing doesn't mean that rental prices will increase. Even if rent does increase, you aren't cash positive until the ownership costs (prices and or mortgage rates) drop further. Wait a year...AT LEAST

2008 Oct 05 09:35 PM

[RatWatcher:]

"And who will profit from this bull market?
People who own rental properties!"

In a time when people cannot afford much, and there is a significant oversupply of units, rents can't safely be raised. A modest rent is far superior to a vacancy. 'Treading water' is a more likely outcome than profit, although if rent can cover PITI on the rental you can consider the 'P' portion as long-term profit, if / when underlying home value recovers.

Also, profit would depend greatly on whether the owner used the rental property as an ATM with a cash-out refi during the mania. A fixed-rate loan from, say, 1998 on the 1998 value may well have a cash-flow positive even with stagnant rents. Conversely, a 2004 cash-out refi based on overvalued property will likely have a PITI greater than rent that can be collected today.

And for simplicity I've left out maintenance, which in either case will come out of the owner's other incomes.

Profit, thus, is unlikely. Break-even is winning for rentals in this era.

2008 Oct 05 10:48 PM

[Urbane Gori...:]

I'm a long term landlord and although the real estate market in my area (Sacramento, CA) has taken a terrible beating...60% down in the last year, I do have to say, that as long as you buy cheap, you'll still do well. The property we bought 12 years ago for $50K is now paid off and although it could have sold for $230,000 last year and only maybe $110,000 this year has still doubled. This isn't much different than a 50% stock retracement. Further, it rents for $1100 per month which at present nets me $800 a month.

However, I do have to question the choice of renting to people that have been foreclosed upon. If they put themselves in a position where they couldn't handle their mortgage and had to step away, then will they also do the same to you? Will the mortgagee come after them and attach their wages straining their ability to pay their rent? I'd be more inclined to look for long term tenants with a solid employment background in a field that is not shrinking (I'd suggest not renting to bank managers, or ex-CEOs for example).

jegan ;-)

2008 Oct 06 11:07 AM

[Jan VanDenB...:]

So what does everyone see happening in the commercial apartment complex market in your area?

2008 Oct 06 01:17 PM

[MichaelSchm...:]

I agree with the comments above that higher absolute demand (i.e., more people in the rental market) does not equal higher net demand, in comparison to overall supply (i.e., proportion of renters to rental properties). In Southern California (and I suspect, Florida, Nevada, Arizona, etc) the hidden inventory from recent years is coming back on-line and rents are softening to declining. This is being compounded by the large number of investors who are currently buying distressed properties at ostensibly "rational" prices (that bear some reasonable relationship to the perceived income generation prospects, based on current rental rates) and placing more inventory on the market. In my view, rather than being at the start of the rental bull market, we are at the peak of the rental bubble, where declining rents imply lower asset prices, more investor-owned foreclosures and even tighter credit conditions for investors. I wouldn't buy residential rental property now unless the price paid made economic sense with a rental rate discounted by 25% (e.g., in places like Santa Monica) to 50% (e.g., in places like Riverside) from your current estimate for annual rents.

2008 Oct 06 03:04 PM

[carey_jim:]

IF there is significant price deflation during a long recession then property values will go down, taxes (might) go up (states need more money but citizens make less money to tax) and people will have less money to pay rent as they lose jobs.

If you own rental property with already paid mortgages and have good tenants then you will (probably) be able to ride out a recession.

Location is important because wealthy people don't suffer during depressions or recessions.

Depending on how deep your pockets are, it might make sense to buy depressed real estate during a recession, but don't buy in urban working class areas, whatever you do (if you want to come out alive.)

If the past isn't prologue, it is at least echo and the past history of severe recessions and depressions echoes trouble for real estate except in wealthy locations but even THEY are sometimes subject to steep drops in price, as was the case in Russia in 1917 and Cuba in 1959.

Ceteris paribus, caveat emptor.

2008 Oct 06 04:34 PM

[cheech:]

Best investments I have made have made were duplexes, triplexes, and small single family homes. Reasonable rents kept a steady flow of tenants thus minimal vacancy over last 20 yrs. The mortgage was finished on a duplex last yr and a duplex & triplex will be free of debt at end of this year. Net income from these units afford me a worry free retirement!

2008 Oct 06 09:03 PM