Ask Brian is a weekly column by Real Estate Expert Brian Kline. If you have questions on real estate investing, DIY, home buying/selling, or other housing inquiries please email your questions to [email protected].
Question from Dean near Chicago: Hello Brian, I’ve been a small time landlord since 2010. All of the talk about a coming recession but that rents can still be expected to increase has me confused. Should I be looking to buy more rentals? Should I be happy with the three single-family houses that I have? Or should I be getting out of the landlord game? What’s coming at real estate investors in 2020?
Answer: Hi Dean. Being concerned as an investor in 2020 is a healthy attitude. This could very well be a transition year for real estate investors. The economy still appears strong but savvy investors know that it is overdue for a correction (recession). Real estate has cycles and we may have crested the top of this cycle. You should always have a plan B and today that is especially important. Nationally, average home prices appreciated in value about 5% in 2019, which is a decline over the past couple of years. For 2020, about the best you can expect is about a 3% average increase in values.
The real threat of a downturn in the market means different things to different investors. But buying opportunities are limited. Multifamily rental housing probably offers the best return on investment. In a shaky market with declining appreciation, fix and flips are the riskiest unless an exceptional opportunity presents itself. One possibly overlooked opportunity for investors is selling a highly profitable property close to the top of the market cycle. For those that can swing it, now is the entry point to sell high and buy low if the market takes a downturn in the coming months and years. Not that the market can be expected to go bust in the spectacular way it did back in 2007 and 2008. But when the market goes soft, desperate sellers have to sell at heavily discounted prices.
For investors that are looking to buy in the coming months, the rental market looks to remain strong. But of course, location is critical. There are two megatrends to keep a close eye on. One is where most jobs are being created because those will remain strong rental markets. The other major concern is the national trend towards rent control. A lesser (but real) trend is that builders will continue expanding in the starter home category. This could reduce the upward pressure on rents if enough renters can begin buying. But a lot of new inventory will be needed before this becomes a major concern for landlords. Another fact enabling more people to buy starter homes is that interest and mortgage rates are going to remain near historic lows and probably go even lower in 2020 (according to recent Federal Reserve interest rate announcements).
One of the biggest megatrends over the last six or seven years has been the types of jobs created and where these are being created at. The biggest demand for skilled workers has been in healthcare, IT, and office support. About 40% of these jobs have been created in large cities where office space and other resources are concentrated. The risk with some of these is that residential rents have increased by double-digit percentages for several years in a row (as have home values). Cities like San Francisco and Seattle have maxed out on affordability and some are already seeing rents retreat. New construction isn’t renting for what developers thought it would. Cities like these are also the ones most at risk for future rent control regulations. Employers that previously flocked to these hub cities are now considering other locations because they can’t attract employees in markets where they can’t afford to live. Dean, I don’t have a clear answer for this but investors should be aware of this trend. Boom markets are at the highest risk for a big bust.
Multifamily looks to be the most promising in 2020. The affordability problem for first time homebuyers is also a problem for investors. Investors might be able to afford single-family homes but the amount they need to charge for rent will be out the reach for renters. Multifamily offers economies of scale. Lower purchase and maintenance costs result when multiple families share common walls, roofs, plumbing, etc. Generally, they cost about 30% less per square foot than single-family homes. Of course, a lot of variables go into these costs. Things like the age of the building, recent updates, amenities, accessibility, neighborhoods, and other possibilities.
Multifamily covers many different types of housing from a duplex to a multi-hundred unit apartment building complex. Anything more than a four-plex is considered a commercial property that has different financing rules as well as other considerations like onsite managers and on call maintenance contractors. One trend that is gaining traction is somewhat of a hybrid between a fix and flip and traditional landlording. Some investors are showing an interest in purchasing large houses and converting them into multifamily homes. Of course, zoning regulations can be a concern with these. Multifamily conversions can be a good opportunity in 2020 as long as you look at real estate investing as a wealth building method rather than a get rich quick scheme.
Sell at the top of the market. This is the point in the real estate cycle to weigh the benefits of holding properties versus selling properties. I’ve written many times about the importance of reviewing your portfolio regularly to determine if it is performing at peak performance. The most basic advice is to sell underperforming properties to reinvest the money into better performers or properties with more potential. But when the market is near the peak (as it is now) is a good time to consider selling top performing properties for the highest profit. The strategy is to then wait for the bottom of the market to reinvest when prices are low. However, the affordability crisis is very real. Anticipating major price drops isn’t realistic in most markets. This strategy is only likely to work if you are willing to find a desperate seller in a soft market.
Low cost housing. The ongoing affordability crisis and the threats of rent control can create more interest in low cost housing. The federal government’s Low-Income Housing Tax Credit (LIHTC) has been around since the 1986 Tax Reform Act. Although it has not been widely used since the decade-long upsurge in the residential market, its time might be coming around as a tool against the affordability crisis and rent controls. Many cities certainly have an interest is more affordable housing. These work by the federal government issuing tax credits to state governments. State housing agencies then award the credits to private developers of affordable rental housing projects through a competitive process. That means these programs operate at the local level. But these aren’t all new construction. Similar to converting a large house into multifamily units, conversions are also possible with vacant buildings like factories, schools, and office space.
Dean, I don’t have a crystal ball but these are some of the possibilities I see going into the next decade with the probability that some type of economic downturn is on the horizon.
What do other readers think are good investment opportunities going forward? Please leave your comments.
Our weekly Ask Brian column welcomes questions from readers of all experience levels with residential real estate. Please email your questions or inquiries to [email protected].