Renters have been forced into bidding wars, due to swelling demand for homes to rent and a lack of inventory. It's a housing scrum out there.
So is now the time to add a rental property to your investment portfolio? Experts say yes.
Why? Despite the rise in interest rates this year, there's strong demand for long-term rental properties and vacation rentals. Plus, slightly dipping real estate prices and slowing sales are making it easier for would-be landlords to buy rentals.
The pullback in stocks and bonds is also encouraging investors to seek returns elsewhere. Plus, with low unemployment and wage increases, qualified renters are abundant.
"It's still a great time to be investing in the right locations," said Marco Santarelli CEO and founder of Norada Real Estate Investments. Norada, based in Laguna Niguel, Calif., helps investors find, purchase and manage rental properties. "The fundamentals for rental property are strong — we have a lot of tailwind as investors."
Buying Rental Property: What And Where?
Where should you buy? Norada is finding and selling rental properties in Florida, Missouri, Pennsylvania, Ohio, Maryland, Texas, North Carolina and Indiana.
And what kind of property is a good choice for a new landlord? Santarelli says "80% of the investors we work with buy single-family homes and duplexes as rental properties."
"The last two and a half years have been our busiest years ever," said Santarelli. The demand for rentals is outstripping supply — and no one expects the market to reach equilibrium any time soon.
Santarelli also notes there's "shadow demand" in the rental market, which isn't counted in many studies. "We currently have the highest percentage of young adults (18 to 29 years old), living with their parents in the past 120 years," he said. "And they want to move out and find homes to rent."
Rents Continue To Rise
| Metro Area Rental Markets | Metro Area | Zillow Observed Rent Index (ZORI) | Zillow Observed Rent Index Month-Over-Month Change |
|---|---|---|---|
| 1 | New York | $3,246 | 1.2 % |
| 2 | Los Angeles | $2,964 | 0.5 % |
| 3 | Chicago | $1,932 | 0.7 % |
| 4 | Dallas-Fort Worth | $1,834 | 0.6 % |
| 5 | Philadelphia | $1,844 | 0.7 % |
| 6 | Houston | $1,602 | 0.2 % |
| 7 | Washington, D.C. | $2,278 | 0.7 % |
| 8 | Miami-Fort Lauderdale | $2,841 | 0.4 % |
| 9 | Atlanta | $1,980 | 0.8 % |
| 10 | Boston | $2,834 | 1.0 % |
Source: Zillow, July 2021
Norada encourages investors to buy in the best rental markets. "We are market agnostic," said Santarelli. In the past, Arizona and Idaho were states Norada was active in, but both states saw prices run up, so they're not as attractive now.
Another hot property type? Rental properties that are suitable for multigenerational families, including those with accessory dwelling units (ADUs), says Jessica Lautz, vice president of demographics and behavioral insights for the National Association of Realtors. Homes with ADUs are desirable for "multigenerational families" and they're "extremely desirable" to investors who wish to rent one or both units, said Lautz.
When choosing a rental property, make sure "all the pillars" of renting are strong, says Santarelli. Those include cash flow, appreciation, loan terms, tax benefits and leverage.
"There's no other asset class where you can leverage five to one on your money — you only need 20% down to buy a property," he said.
Avoid Newbie Mistakes; Never Sell
Investors who listen to the experts can avoid costly mistakes. First, "stick to A- and B+ neighborhoods and avoid C neighborhoods," said Santarelli. And don't invest "purely on appreciation instead of cash flow — at that point you're a gambler not an investor."
Second, check your emotions. Don't "fall in love with a property or location and try to make numbers work when they really don't work," said Jay Parsons, chief economist with RealPage, Richardson, Texas. RealPage is provider of software and data analytics to the real estate industry. "It has to be a good investment, not just a good property."
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Also, "beware of regulatory risks," said Parsons. Some states and communities are unfriendly to landlords, with strict rent and rental property controls and legal protections for renters that make it hard for a landlord to manage a property or evict a destructive tenant.
"California has created a very hostile environment for rental investors," said Parsons.
Know What You're Buying
Of course you also want to buy a rental that's in good shape, or fixable for a reasonable sum. "Get a good home inspector to check your purchase," said Lautz. And perhaps "work with a seasoned property manager" to make sure your rental agreement is solid, she adds.
If you buy a great rental property, you've created a long-term income stream for now and for your retirement, and "you can pass that property along to your kids/heirs tax free," said Santarelli. That's because when an owner dies the fair market value (FMV) of the rental property becomes the market value on the date of the decedent's death — so there's no tax owed for the appreciation from the time the decedent bought the property to when it passes to his or her heirs.
"Never sell," said Santarelli. Or if you do want to sell for some reason use a 1031 exchange to purchase another rental property. A 1031 exchange allows investors to defer the federal and state income tax that would normally be due for selling a property that has appreciated if the investor uses the sale proceeds to immediately purchase another "like-kind" property.
