Here’s why real estate investing is so popular with investors looking to build wealth over the long haul. The longer your property is rented, the more money you will make. Once you’ve recouped the cost of acquiring your rental home from your monthly rental income and you’re left with hundreds of thousands in equity, every month’s rent from that point on is virtually pure profit.
Millions of real estate investors are moving down that road today, confident that there will be a strong rental market for many years to come. Their faith is not blind. It’s founded on a good understanding of the forces remaking the way America is housed. Let’s look at the economic factors that are forcing us to rethink homeownership and rentership.
Why a Rentership Society?
In 2011, analysts at Morgan Stanley outlined these forces and described their consequences in a research paper titled “The Rentership Society.” It made five points:
- The combination of falling home prices, limited mortgage credit, continued liquidations, and better rental options is fundamentally changing the way Americans live;
- Excluding delinquent borrowers, the homeownership rate, which officially stood at 66.4% in 2011, would instead be 59.7%. As rental households increase and owner-occupied households remain constrained by tight mortgage credit and distressed liquidations, the official homeownership rate should fall.
- The demand for shelter is growing, but the lack of mortgage credit will drive this demand to the rental market at the expense of the owner occupied market. As household formations grow and distressed liquidations continue, the demand for both multi-family and single-family rental units will likely increase.
- Multi-family vacancies are already falling and rents are rising across the country, including in some of the hardest hit regions. Low levels of construction have limited supply, resulting in a booming market for multi-family rentals.
- Each distressed single-family liquidation creates a potential renter household, as well as a potential single-family rental unit. The better match of single-family properties for these involuntary owner- turned-renters should drive demand for single-family rentals.
Predictions are Coming True
Three years have passed and virtually all of Morgan Stanley’s predictions are coming true. The homeownership rate has fallen to 65.2 percent is continuing to decline from its 2005 high of 69.1 percent. Many experts expect it to continue to decline. Nearly six percent of all mortgages in the nation are delinquent. Lack of mortgage credit is still crippling home sales. Home prices rose in 2013 by double-digit figures but sales did not and by January, sales were the slowest level since July 2012.
By the end of last year the U.S. apartment vacancy rate eased to its lowest level in more than a decade. The national apartment vacancy rate fell 0.1 percentage point to 4.1 percent in the fourth quarter from the third quarter. It was the lowest vacancy rate since the third quarter of 2001, when it was 3.9 percent.
On average rents will increase 3.1 percent to 3.3 percent nationally and as much as 5.1 percent in strong markets like San Francisco. Nationwide, almost 230,000 new residential rental units will be added to the supply next year. That’s up from 170,000 this year and only 87,000 last year. Yet rents are increasing at a rate faster than inflation.
Conditions in the future may not always be quite as favorable for single family rentals as they are today for the simple reason that lots of people know it’s a good deal. Wall Street investors are spending billions to buy up tens of thousands of homes and converting them to rentals. Hundreds of thousands of new apartment units are opening in the best markets, creating new competition for singe family rentals. However, despite these competitors the demand will outstrip the supply of rental properties for the foreseeable future.
Millions of Americans Can No Longer Afford to Own Homes
Why? The simple answer is that millions of families that could have purchased a home eight years ago or earlier when it was much easier to get a mortgage will probably never will be able to again.
What it takes to buy a home in terms of income, credit and debt has changed dramatically. Hit with billions of dollars of losses due to the 4.8 million foreclosures that flooded the housing markets for six years, lenders changed the rules to require that borrowers have better credit, less debt, and higher income levels–requirements that a large segment of the society simply cannot meet. Last January, a new federal regulation called the QM Rule sets into law the many changes mortgage lenders made.
Credit requirements are higher. In the 2001-04 timeframe approximately 40 percent of residential loans acquired by Fannie Mae and Freddie Mac went to applicants with credit scores above 740. In Second Quarter of 2013, Fannie Mae’s average FICO score for new business was 756 and Freddie Mac was 758.
Slightly more than half of 4,000 Realtors surveyed by the National Association of Realtors reported FICO credit scores of 740 and above. NAR economists estimate that a significant number of additional sales—possibly as high as 500,000–could be made if credit conditions returned to the way they were in 2004. The median FICO score for ALL mortgages closed in February 2014 was 724.
Second, down payments are higher. About 38 percent of respondents who reported a mortgage financing reported a down payment of 20 percent or more. Realtors have reported that buyers who pay cash or put down large down payments generally win against those offering lower down payments.
Finally, there is question of debt. The QM Rule grants mortgage lenders discourages lenders from approving loans for prospective buyers whose total monthly debt exceeds 43 percent of their monthly gross income. However, the share of young people under 30 with more than $50,000 in outstanding student debt has doubled from 5 percent to 10 percent. If a homeowner earned $125,000 a year and had a $450-a-month car payment, he or she would fall within that limit. However, add a $100 student loan payment to the mix, and the debt-to-income ratio could climb above the new restriction.
Nothing New About the Rentership Society
The new emphasis on renting may seem like a “new normal” but there is nothing new about it at all. It’s the idea that all families should be homeowners that is new. As recently as 1940, only 40 percent of Americans owned their homes. Not until the 1960s, 20 years after the Second World War, did 60 percent of the nation’s households live in their own homes.
From 2007 until last year the number of homeowners decreased by 1.2 million, or from 69.1 to 65.3 percent. Should it fall as low as 60 percent, another 1.7-2 million families will be renting. That’s going to be good news for real estate investors.
What do you think about the Rentership Society? Are you ready to profit from the opportunity created by the way Americans will live?
Some statistics are from the Realtors Confidence Index Report.