Slowing housing markets and rising interest rates are not often indicators of a “buy now” period for most people looking to purchase a home. However, for just that reason, now could be an excellent opportunity to buy a residential property to operate as a rental for investment.
There has been much talk in the news about the end to the sellers’ market that was seen over the last few years, and the extreme housing boom in cities across the country such as Seattle, Dallas, Atlanta, and Raleigh. Prices have risen dramatically in these markets over the last few years, and what’s more, is that home values have significantly outpaced wage growth. In addition, while they are still at low points compared to historical numbers, mortgage rates continue to rise. In late October, the average mortgage rate on a 30-year fixed mortgage was more than 5 percent, which marked a full percentage point increase over the same time a year before.
According to online real estate website Zillow, the increase in mortgage rates combined with the continued rise in home prices have increased monthly costs for homebuyers by an average of 15 percent while also reducing their purchase power. To this point, a Redfin report found that a buyer with a monthly housing budget of $2,500 lost almost $30,000 in purchasing power in 2018.
All of these factors have scared buyers away and taken them out of the purchase market altogether. Many people are deciding to rent a home instead, and those who were already in rentals are remaining in them now longer than expected, which removes another segment of potential home buyers.
The elements that are detracting people from purchasing a home to live in are actually the exact reasons why now is a good time for investors to purchase a single-family home to operate as a rental. In addition to the influx of renters looking for a single-family home to occupy, there are a lot of other positive reasons why purchasing a single-family home, condominium unit and small apartment building of four units or less is a very attractive long-term investment.
The Demand for Rentals Is There
There is a lot of talk about the economy slowing in 2019. With that comes a projected slowing of the housing market as well. But the great thing about the rental market is it is insulated from the trends in the economy. Even if the economy slows, the rental market will still be strong for a few reasons.
First, no matter the status of the economy, people still need a place to live. Just because the overall economy isn’t as robust as it was earlier in 2018 doesn’t mean people will all of a sudden not need a roof over their head. What a slowing economy does, instead, is keeps people in rentals longer and slows the real estate purchase market.
That brings up the second point: A slowing economy convinces a lot of people to become renters by choice. When the economy trends downward, the general public invests less money. In terms of real estate, that means the rate at which the public buys homes slows, too. When things are uncertain in the economy, people often play it safe and don’t invest in purchasing a home they fear could plummet in value.
The final point to note here is many more people are forced to rent in a market such as the one that is presenting itself now. While home values and interest rates have risen, the down payment and credit standards implemented after the last housing crash haven’t laxed at all. Home ownership is therefore unattainable to more people now than it was, say, 15 years ago when the qualification levels were lower in terms of credit scores, debt-to-income ratio and down payment. Fewer qualified home buyers means more renters.
There Are Still Good Housing Deals to Be Found
In any real estate market, whether a buyer’s market or a seller’s market, there are good deals to be found for those who look closely. While home values have been on the rise the last few years, they aren’t completely out of whack like they were before the housing crisis about 10 years ago. In fact, there are plenty of bargains to be found in markets across the country, especially if you are willing and able to make some cosmetic fixes to the home to make it attractive to potential renters.
When the housing market slows, what often happens is homes sit on the market for long. Eventually, some of these homeowners who need or want to get rid of their home will lower their asking price. When that happens, it provides a great opportunity for investors who are ready to pounce and scoop up what could become an under-market valued property.\
Single-Family Rentals Have Tax Advantages
Perhaps the best part about purchasing a single-family home and converting it into a rental is there are tax advantages to doing so. You should always check with your accountant on all the tax advantages available to you and the proper way to document everything. In general, though, you should be able to deduct the losses you may experience against your regular income, which would reduce your overall tax liability.
Another great aspect to residential real estate investing is single-family homes, condominium units and small apartment buildings that have four or fewer units all qualify for a conventional 30-year fixed mortgage as long as you have a 20-25 percent down payment. This is a huge advantage for this sector of the market, as many other commercial real estate properties can only be financed for about 10 years and require a larger down payment.
What this means is that if you purchase a home at a good value and spend some money to spruce it up, the monthly rent you charge your tenant(s) could easily cover the cost of your mortgage and then some.
Remember That Cash Flow Is Still King
The most important thing to remember when you are contemplating an investment in residential real estate is cash flow is king. The goal is to get to the situation described above – where you secure a stable tenant who is paying a monthly rent that covers your mortgage payment on the home, plus some extra money. This extra money is what you should bank for times when your home will undoubtedly need repairs – emergency or otherwise – or in the case where one tenant moves out and you need to search for another one.
Also, you should look at your investment as a long-term investment. The overall housing market and the fluctuation of your home’s value really doesn’t matter in the short-term. If the value of your home drops 10 percent, for example, it really doesn’t matter to you as long as you have that tenant in place. Your mortgage will still be paid every month, regardless of what happens to the housing market around you. Over time, property values will increase as inflation does, thereby increasing the value of your home.
The best part about residential real estate investing in this aspect is you will only make a small initial investment of your down payment and any repairs or upgrades, and then the bank loan you get will allow you to leverage your investment over time. If you are able to pay off the majority of your mortgage from the income you receive from tenants, then if and when you sell your property down the line, almost all of the total home sale price will be profitable for you.
Tips to Keep in Mind When Looking for a Property
When it comes to residential real estate investment, it is always best to err on the side of caution. When you are looking at potential properties to purchase, you should base your projections on realistic numbers. Along these lines, you should calculate your monthly income and costs based on below-market rents and higher operating expenses, respectively. This will give you a worst-case scenario and will allow you to truly see whether the property is worth the investment.
It’s essential to have a good real estate agent to help you find the great properties that could become wonderful investments for you. You’ll want to hire a real estate agent who specializes in finding residential properties for investments, not just an agent who buys and sells residential real estate for occupation. It’s also important you research the rental rates that are being asked in your area because these differ throughout the country. HomeUnion® is a great resource to research those rental rates.
If your projections don’t result in a positive cash flow situation, then you shouldn’t buy the property. There are plenty of good opportunities in the market, so don’t jump at the first property you see. Cash flow is king, so if a property won’t give you that, move onto the next one.
Another thing to keep in mind is your initial investment won’t just include your down payment. It’ll also include any money you need to spend up front to fix the property to get it in the best shape to return the highest monthly rents. As such, you’ll want to do a thorough investigation of the property before you buy it, and come up with as detailed of a home value estimate as you can for what it will really take to get it in proper shape. Your total investment into the home will include this cost, plus your closing costs and your 20-25 percent down payment.
Have a Good Team in Place
Real estate investment is a team sport, as you’ll soon find out if you’re new to the game. It’s not just about how well you can do on your own. To truly succeed at the “sport” of real estate investing, you’ll need to have a good real estate agent, lender, and property manager all working for you.
If you need some help in this regard, HomeUnion®’s Property Provider Network is a great resource as you get your feet wet in the residential real estate investment world.