Investors would do well to be very aware of the rental activity in their local market before investing too heavily in rental properties. From small "mom and pop" investors buying single family homes, to REIT's who are focused on building more apartment complexes, there has been something of a new "fever" developing in the rental market.
With all the news about foreclosures, the media has developed a theory that those displaced former home owners will be seeking rental property instead of buying. But many of these former home owners have suffered significant losses of income, or are still unemployed. One effect of the widespread long-term unemployment is that the total number of new households has been shrinking. This points to less demand for existing housing, not more.
As a rental property investor, I am seeing more and more tenants who are having difficulty paying the existing rental rates. Due to inflation and rising costs for fuel and food, tenants who have never had a problem paying their rent are beginning to struggle. Even those with better incomes are finding it more difficult to make ends meet. This means that landlords in many markets are unable to raise rents to cover rising costs for insurance, taxes and maintenance.
With millions of homes already foreclosed on, and millions more still in the foreclosure pipeline, prices are still falling in those markets hardest hit by the housing crisis. You would think that rental property is a "no-brainer" with lower housing prices and lower borrowing costs, but this is not translating into higher rental income in many areas.
In spite of all this, uninformed landlords are rushing to buy properties for rental, only to find them difficult to rent at a decent positive cash flow. New apartments are springing up in areas that already have lots of foreclosures, in anticipation of millions of former home owners needing a place to rent. But my feeling is that this could be "deja-vu all over again", as too many properties will likely be put back into service as rental property over the next few years. This would in turn lead to higher vacancy rates and reduced rents as a result. Then another round of investor foreclosures, as the positive cash flow goes negative.
While stronger markets in the major cities will likely do well because of the close proximity to better paying jobs and higher demand, suburban areas are not likely to sustain such demand. Housing tends to have a herd mentality, in that whatever appears to be the "hot" investing strategy of the day will eventually attract too many participants, create too much competition and skew the market. This happened during the housing boom, when everyone jumped on the price appreciation bandwagon. Today everyone is jumping on the rental property bandwagon, with the likely result that many markets will see flat to falling rental rates, as competition grows and demand simply cannot keep up.
Smart investors will watch their local communities carefully for things like too many "For Rent" signs, and ads that say things like "rent reduced" or "first month's rent free!" Also, if you're a "mom and pop" investor, don't buy rental properties near large apartment complexes. It can be difficult to compete against larger corporate investors. And whether you are an individual investor or a REIT investor, keep an eye out for signs of too much rental property being added to your local market. The mistakes that lead to over-investment or over-development in a particular property type are easily made and repeated by all genres of investors.
And if the government ever does start selling off bundles of Fannie and Freddie owned properties with the requirement that they be used for rental, all bets are off. This could really skew the rental market in the wrong direction across the entire nation.