There's no denying that rentals are in high demand. Investors see the potential opportunity for good returns as rental rates climb and vacancy stays low.
But will the trend continue? Keep reading to learn how rising rents affect real estate investors and what to consider before buying rental properties in today’s market.
High rents and high demand bring opportunity for high returns
The U.S. economy has been recovering and expanding for over a decade, bringing high rental demand and rates with it. As of the second quarter of 2019, the national rental vacancy rate was at 6.8% with the median rental hovering around $1,500 per month.
A large contributor to the high occupancy and rental rates is affordability. According to ATTOM Data Solutions, renting is more affordable than buying a home in 59% of the country. Housing affordability is very low and many homebuyers are completely priced out of the market. Especially in coastal urban cities.
While expensive housing prices continue to prop up the demand for rentals, but what about long-term affordability? ATTOM found that 52% of the counties analyzed for the report are seeing rental rates outpace income growth. This has caused a record demand for affordable housing and a competitive rental market.
When rental rates are up and vacancies are down, there's an opportunity for investors to get higher returns. Now may be a great time to purchase investment properties in areas where rental rates support the average property value.
Of course, growth and rates may stall in the coming years. So keep that in mind when making long-term plans.
Don’t expect continued growth and super-high rents to last forever
When evaluating rental properties future growth is important, but shouldn't be the sole deciding factor.
The real estate market continuously moves through cycles. While we may be in a period of expansion, or possibly hyper-expansion, there will be a pullback in the market. One of the indications of a recession is higher vacancy rates and lower demand for rentals, pushing rates down.
When rental prices rise quickly, building costs surpass rental rates, and supply outpaces demand, the market will probably pull back.
If your investment relies on a steady increase in rental rates or only works when vacancy rates are low, it may not be sustainable through tough economic times. When analyzing the rental investment, make sure the current rental and vacancy rates support the investment -- but be flexible with your numbers. This will help in the event of lower rental rates or longer-than-anticipated vacancies.
Avoid buying properties in a rental “bubble”
Just as markets have real estate bubbles for housing prices, they can also have bubbles for rental prices. The national average appreciation rate for rental prices is around 1.6%, while some cities are growing at rates of 3%–5%.
It’s unlikely that these high rental rates will be sustainable in the long run. Eventually, the rental prices will have to adjust to meet the household income of the area. Apartment List has rent and appreciation data on all 50 states and several large metro areas to help you identify which markets may be in a rental bubble.
Conduct due diligence on your market.. Evaluate the long-term health and stability of rental demand, population and economic stability, and rental affordability in your specific area.
It’s best to err on the side of caution and invest in rental properties that provide your targeted return on investment at an affordable rent. If the market supports higher rental rates, the return on investment will increase as the market supports it.
Rental properties continue to be a worthwhile investment if done properly. The largest opportunity in today’s market is to find rental properties that provide desired yields with affordable rents. While the current market holds opportunities for investors to receive higher returns, it’s imperative to hedge against potential risks and changes in the market.