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 Ali in KS: Hi Brian, I just can’t decide what to do about investing in today’s real estate market. I’ve been sitting on the sideline since this time last year when COVID-19 sent everything into total confusion. Throughout the year, I kept expecting the market to go bust because of delinquent rents, unemployment, and total uncertainty. Obviously, it turned out very different from my expectations with shortages persisting and values making huge gains. Now we’re seeing the promise that life will start getting back to something looking like normal. However, interest rates are expected to go up. What in the world should I be expecting from the rental investment market as this new world emerges?
Answer: Hello, Ali. You’re right on track by mentioning that higher interest rates are likely to be a driving force. But how much downside will that have considering the demand for more housing remains consistently high? First, single-family rentals provide investment returns in two ways: through appreciation and rental income. So let’s look at those independently.
Appreciation will continue being driven by high demand from first-time buyers. "A rising tide lifts all boats" and this will include the value of most single-family rentals that typically fall into the same category of homes that first-time buyers qualify for. The strong economic recovery that appears to be beginning will also raise the tide. Yes, increases in interest rates can be expected but the forecasts look to be for a modest increase (slightly above 3%). Because of the affordability challenge for first-time buyers, any increase will knock some people out of the market but this isn’t likely to be enough to cool the market in any meaningful way. In fact, the proposed tax credit of up to $15,000 for first-time homebuyers will likely more than offset the slightly higher interest rates.
The $15,000 tax credit has not yet been passed into law but it does have strong congressional backing. Depending on the version that passes, it could push some renters 14 years ahead toward homeownership. That would be the version that allows the credit to apply at closing rather than waiting for it as a tax refund. Multiple analysts believe that the applied at closing scenario could enable 9.3 million renter households to afford the monthly payment for a median-valued home sold in their metro area. Zillow's research says this is true based on a 3.5% down payment on a 30-year mortgage with a 3% interest rate. But not all of those people will qualify because of mortgage qualification hurdles involving income, job security, and debt problems. Still, even a moderate portion of 9.3 million more buyers would put a substantially higher demand on the very tight inventory of first houses. Values can be expected to go up.
So what does that mean for rental income? Rental income is primarily driven by two sources. The value of the rental house and the local vacancy rate. Values going up means rents can be expected to follow. However, COVID-19 has added the third dimension of eviction moratoriums. The moratorium issue keeps being kicked down the street but should come to some type of resolution later this year. Eviction moratoriums are probably the biggest unknown. But the fact remains that there are still not enough homes to come close to meeting demand. More single-family house sales will mean fewer rentals will be available. Naturally, that means higher occupancy for existing rentals and that leads to higher rents. There are still going to be more than enough renters to keep vacancy rates low and therefore cause a rise in rental income. We hear about the tighter mortgage qualifications and those people will remain renters. Since the Great Recession and housing crash, the median credit score for purchasing has gone up 45 points. The number of gig workers has also risen significantly and their type of employment is generally considered unreliable. A recent Urban Institute report found younger millennials will have a homeownership rate of 64% as opposed to the 72% of boomers who owned homes at their age. This may sound bad economically but these are the people that will remain in the rental market. As a strong indication, institutional rental investors remain bullish. Single-family rental REITs, like American Homes 4 Rent and Invitation Homes, have seen very strong returns. They are now building homes specifically to rent. The share of all homes specifically built for rent continues rising steadily.
Ali, real estate investing is low risk but it’s not without risk. Looking at the most important data that we have now, residential real estate investing looks to have a bright future after COVID-19.
What is your view of the post-COVID rental market? Please add 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].