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Why Holding Rental Properties for Five Years or More Produces High Returns, Low Risk

Market Wrap With Moe Ansari 

Steve Hovland, director of research for HomeUnion, sat down with Moe Ansari on Aug. 17 to discuss how we identify neighborhoods with single-family rental (SFR) homes that produce the highest returns and lowest risk over a five-year horizon during his Market Wrap radio show.

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Moe Ansari:
As I promised earlier today, we are going to talk about the 20 top zip codes with highest real estate returns and lowest risk. That’s what I like. High returns, low risk. HomeUnion has identified the top 20 zip codes that maximize real estate returns while minimizing risk over a five-year time horizon. What is the methodology behind this?

Steve Hovland: Basically, in order to get returns over a five-year time horizon, you really need to know how much a property is going to produce income-wise, and how much that property is going to appreciate. It may seem easy to get that info, but each one of these numbers can be challenging, especially with all the nuances of the markets, zip codes and neighborhoods across the country. What we look at, effectively, is how much a property will rent for currently, how much it will rent for in five years, and how that rent is going to grow over time. And the other factor with net operating income (NOI) is how many days that property will be vacant, and how much it will cost to maintain. That gets us to our NOI model number.

The second piece of that is appreciation. We are looking at historical trends on a neighborhood level, which is actually smaller than at a zip-code level, and we roll that up to a zip code. We underwrite every single property in the country: 100 million homes across 200,000 neighborhoods every single quarter. So, we are projecting this out every single quarter when we get new information and we are looking a 5-, 10- and 15-year horizon. That’s how we got the forecast.

To understand how rents grow and vacancy plays out, we look at the quality of the neighborhood. We are putting up to 12 factors into each neighborhood: unemployment, white-collar jobs, crime; and we are also looking at supply and demand factors: what apartments are coming online, what new homes are coming online (and those numbers). What is going to impact your ability to raise rents over time and what’s going to impact the number of days that house is vacant over that five-year horizon? Based upon those neighborhood rankings, we are able to forecast (on a market and a neighborhood level), rent growth specific to that property and figure out where returns are going to be a year from now, and five years from now.

Ansari: That’s interesting science. In the press release, you stated, ‘Any investor looking for long-term real estate investments should consider how the asset will perform during each stage of the economic cycle to mitigate risk.’ Why is this important?

Hovland: One of the questions I am asked most frequently is this: ‘Is the housing market too hot and are we in for a correction?’ As of July, we were eight years into an economic recovery and the longest expansionary period post WWII is exactly 10 years. So, we are coming up on another recession. You can’t dodge these things. I do think this will be the longest expansionary period but given all the factors, from a macro perspective, we are in for a very mature recovery. In fact, I would argue that we are in a period of economic prosperity. [We’ve had] 81 months of consecutive job growth, the equities markets are at all-time highs, and unemployment is below the full-employment threshold. The economy is really booming right now. It might not feel that was for everybody, but the economy is really strong. We are closer to the next recession than the last one. Because SFR properties are relatively illiquid assets compared to a lot of investment vehicles, you want to hold them for at least five years. It helps alleviate some of the transaction costs that come along with owning an SFR. In order to do that, you want to figure out today how your property is doing to perform during a recession.

In this study on zip codes with the highest returns and lowest risk, we looked at zip codes where the school districts were really strong. That minimizes risk. You can always pull renters up the quality scale by adjusting your rent. Even if rents go down a little bit during the recession (and SFR rents don’t go down nearly as much as apartment rents), you can always put a renter in that property (because of the school-district quality). That scenario will alleviate some of that risk, and you will be able to pay your mortgage or collect that monthly rent dividend.

That’s how investors should be looking at it because five years from now, there will almost certainly be another recession.

To find rental properties with high returns and low risk to diversify your portfolio, contact HomeUnion today.

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