2 Ways To Get Rich From The Strong Rental Market

Even with a flood of new supply, apartment vacancy is low and rents are on the rise. Here's how to profit from it.

Jun 27, 2014 at 6:00AM

The occupancy rate for U.S. apartments is at its highest level since before the Great Recession, with about 95% of all units currently rented.

Surprisingly, this is happening simultaneous with a large increase in the supply of apartment homes. Over the past year, 180,000 new apartment homes have become available, and rent prices continue to rise. In fact, rental price growth of 3.5% in May was the strongest it has been in more than a year.

Apartment Building Flickr Payton Chung

flickr/ Payton Chung

When you consider the trends, and the facts that younger Americans are facing a weak employment market and high levels of debt which could prohibit them from buying homes, now may be a great time to take advantage of the booming rental market.

The best way for most investors to get a piece of the action is with REITs that specialize in apartment buildings, such as Essex Property Trust (NYSE:ESS) and AvalonBay Communities (NYSE:AVB).

Strength in numbers
Perhaps the best reason for investing in a REIT as opposed to simply buying a small apartment building is the diversification that comes with spreading your investment over a basket of properties.

Essex Property Trust owns 234 apartment communities, and AvalonBay Communities owns 276 which contain a total of more than 82,000 individual apartments. So, when tenants leave, it barely affects the company's earnings and ability to pay dividends. On the other hand, if you were to buy a small building with five apartments, one tenant leaving would cost you 20% of your income.

You also get the benefit of geographic diversity as well. During the real estate crash of the last 2000s, many individual markets lost more than half of their property values, while many other markets were left relatively unscathed, suffering only small drops.

By spreading their respective portfolios over different states, Essex and AvalonBay are less susceptible to localized real estate market swings than individual property owners are.

Income and growth create long-term wealth
Successful dividend investors know the combination of growth and income is a great way to build wealth over time, and apartment REITs like Essex and AvalonBay are great ways to achieve both.

Essex and AvalonBay both pay similar dividend yields of 2.8% and 3.3%, respectively, and both have an excellent record of raising the payout. In fact, Essex recently announced its 20th consecutive dividend increase, with an average boost of 5.5% per year. This should more than keep up with inflation, a big concern for those who want to eventually rely on their investments for primary income.

These REITs also produce growth as the underlying property values increase. Rental properties appreciate in value a little differently than single-family homes, and tend to rise with the rent the properties can produce. For example, if market rates for apartments rise by 5%, the value of the apartment building should go up by a similar amount.

A stable part of your financial plan
To highlight the stability of these REITs, consider the returns they have produced, even if you bought in at the worst possible time-the pre-crisis peak of the housing bubble.

Even if you had bought in at the peak, you would be sitting on a total return (share price gains plus dividends) of 27% and 65% for Essex and AvalonBay, respectively.

AVB Total Return Price Chart

Over the past 10 years, these REITs have both produced total returns of about 280%, or more than 14% on an annualized basis. And, this includes the worst U.S. real estate collapse in recent history.

The point is, buying income-generating diverse REITs like Essex and AvalonBay is an excellent way to take advantage of the thriving U.S. rental market.

Is this an even better investment than REITs?
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Matthew Frankel has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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