Investing in rentals is increasingly affordable. Purchases made now will reap handsome rewards when the economy rebounds
Few people these days have confidence in the real estate market. Sellers are anxious, buyers are cautious, and prices across the nation are tumbling, month after month. But for a careful investor, fear and uncertainty can set the stage for opportunity.
Lower purchase prices and interest rates are making it easier—even for an individual investor—to find a single-family home, condo, or a small apartment building that brings in more than enough rent to cover mortgage, taxes, insurance, maintenance, and other expenses. And with so many properties lingering on the market, buyers can have their pick.
Of course, purchasing a rental property right now comes with a fair amount of risk, beyond the fact that property values are falling. Rents are also dropping, and vacancies are rising as layoffs across the country are becoming increasingly common. The pool of renters generally shrinks when unemployment worsens because renters tend to find roommates, or move in with friends and family.
Looking Toward 2011-15
"Even though we know rents will decline in most markets in 2009 and 2010, beyond that there will be a shortage of new supply [of apartments] coming," said Hessam Nadji, managing director of research at Marcus & Millichap, an Encino, Calif.-based commercial real estate investment brokerage firm. "And the rebound in demand, because of an improving economy, could spell healthy growth from 2011 through 2015."
BusinessWeek asked Marcus & Millichap to come up with a ranking of the markets where apartments provide the most rental income for the least amount of investment. These are metro areas that, for the most part, are affordable for folks who don't have millions to invest. Single-family homes and condos in some of these markets can sell for less than $100,000 and a 20-unit apartment building can be purchased for less than $700,000.
Topping the list was Dallas-Fort Worth, where apartment buildings sell for an average of $30,000 a unit and every $3.76 of investment (in terms of the sales price) produces $1 of rental income. By comparison, investors need to spend about $8.19 on average nationwide for $1 of rental income.
Other low-priced markets that ranked high were Cincinnati, Cleveland, Columbus, Detroit, Houston, and Kansas City. Many of these metros—like high-dividend stocks—come with the risk that both the income and the value of the property could fall off. Dallas' job market is weakening, and many new apartments are under construction, which will create more competition for landlords. Fort Lauderdale, Jacksonville, Orlando, and Tampa, which also made the list, have plenty of bargains, but you'd be competing for tenants with condo owners who are renting homes they cannot sell. And the manufacturing-heavy Midwest is in serious economic decline.
But some major markets made the list: Boston, Chicago, Philadelphia, and Washington. These are markets that have a record of strong rent growth and appreciation. The District of Columbia, in particular, with its federal government and defense contractor jobs, could provide good opportunities, Nadji and other analysts said.
In the Boston metro area, investors are picking up low-priced foreclosures outside the city in towns like Attleboro, Framingham, and Marlborough, said Nancy McCreary, manager of the rental group at Hammond Residential Real Estate in Chestnut Hill. But prices are still too high for properties in the more upscale Boston-area neighborhoods for the rental equation to work, she said.
But investors have been finding good income-producing properties geared to the area's many college students—a factor that also applies to other big university towns such as Columbus, Jacksonville, Houston, and Orlando. One investor, for example, is buying a 760-square-foot one-bedroom unit with four rooms for $222,000 in Boston's Brighton neighborhood, near Boston College and Boston University. The condo fee is $465 a month, and the taxes are $150 a month. The buyer is hoping to rent it out for $1,600, which should cover the costs, McCreary said.
Prices have fallen enough that it has become somewhat easier to find condos in nice urban areas that make sense as rentals, she said. "A year or two ago, it was really impossible because the rental market was going down, and the sales market was skyrocketing," McCreary said. "The two are coming together a little bit now."
It's much easier to make the rental equation work in Detroit, where the economy along with the auto industry is in terrible shape. Median prices dropped more than 50% from a year earlier, to $42,500, but sales rose by nearly a third as cash-ready bargain hunters jumped in. In the city itself, the median price has fallen to $5,800—much less than it costs to buy a new car produced in the Motor City.
Out-of-town investors are coming in to take advantage of the low prices. Jeremy Burgess, a former baker at a Safeway supermarket, and his partners have made a business of finding investments for buyers who don't know the ins and outs of the risky market.
Burgess, manager of Urban Detroit Wholesalers, said he has found about 100 houses for investors, who mostly are from outside the state. He says the company looks for three-bedroom apartments that cost about $30,000 including all rehab costs. A cash buyer can make at least $200 a month after all the costs, including property management fees, Burgess figures.
"The good thing is it's a low buy-in," said Burgess, who acknowledges that the Detroit market has risks. "Not everybody has the attitude to do this: You have to have a pioneering spirit."
But Ron Johnsey, president of Axiometrics, a Dallas apartment research firm, said the problem with markets like Detroit is that it's not easy to see how or when a recovery might occur. And it's difficult to find a good exit strategy, because it might not be easy in a few years to find a buyer, he added.
A Coming Shortage
Johnsey says that it will pay to wait a year or more before investing in any market. Rising unemployment will cause rents to drop and vacancies to rise at least through the end of 2010, he said.
But when the job market recovers, the upside for investors will be huge, Johnsey said. New construction of apartments and single-family houses have slowed so dramatically in many places that there will be a shortage of properties in a few years, he said. And demand will increase as many unemployed Americans in their 20s and 30s suddenly will be searching for their own digs, he said.
"There are some great buys out there in the apartment market," Johnsey said. "But not as many as there will be coming down the pike. We're just at the tip of the iceberg."
Nadji agrees that things will get worse before they get better. But he said it's impossible to time the bottom and it makes sense to get in before interest rates rise and big institutional investors jump in and drive up prices.
"Once there's a little more confidence in the economy, with this strategy of waiting, you might miss an opportunity," Nadji said.
Click here to see the 20 U.S. real estate markets that offer the best rental returns for investors looking to get into the rental property business.