Investors and analysts have tried to call the bottom in the housing market for years. Instead of trying to guess when home prices might stop falling, some investors have turned elsewhere to look for gains -- and they're finding them in the red-hot market for residential rental properties.
Going with the flow
Just five years ago, the key to success in real estate investing was simple: Buy just about any residential property, wait anywhere from a month to a year, and then sell it at a huge profit. After all, since the turn of the millennium, similar investors had made boatloads of money flipping houses, and investors were seduced by the idea that even during past real estate busts, overall housing prices hadn't actually fallen in price substantially.
Of course, we all know the aftermath of the housing bust, as that long-held real estate wisdom fell prey to harsh reality. Millions of homeowners have lost their homes, and millions more are underwater on their mortgages. Shareholders of companies related at all to housing, from homebuilders and banks to Fannie Mae and Freddie Mac, have suffered greatly. It's tempting to think that after such a huge drop in prices, the housing market must offer great values.
But rather than trying to decide whether single-family homes are a great value or merely a value trap, look instead at these figures:
- Apartment rents have risen 6% since 2006 and are expected to rise another 3% this year.
- Vacancy rates for apartments have fallen from 8% just a year ago to 6.2% today.
- Millions of displaced former homeowners have no choice but to rent.
At the same time, low interest rates have made it easier for prospective real estate investors to buy rental properties and have reduced carrying costs. Combined with higher rents, that adds to the profit potential of rental properties.
How to cash in
Plenty of real estate investors make a small business of their rental properties. But you shouldn't look at rentals as free money. Investors earn a lot of their profits through hard work, going through the often difficult process of finding creditworthy tenants, dealing with repair requests and other problems that demand immediate attention, and juggling the ongoing maintenance needs that any property owner has to handle. And while you can pay a property management company to take care of some of those jobs, doing so adds to your overhead, reducing your potential returns.
If you don't want to deal with individual properties, you can find easier ways to invest. The obvious first place to look is at real estate investment trusts that focus on apartments and other rental real estate. Let's look at a few of the biggest options in this space:
- Some REITs have national scope. Equity Residential
(NYSE: EQR), for instance, has properties in 24 states. Apartment Investment & Management (NYSE: AIV)and UDR (NYSE: UDR)have a similarly wide area of operation.
- Other REITs have a more geographically focused approach. BRE Properties
(NYSE: BRE)rents almost 24,000 units on the West Coast and in Arizona and Colorado. Home Properties (NYSE: HME)operates 125 communities on the East Coast.
- Some rental REITs have a more specialized focus. You can find plenty of REITs that include senior housing, such as health-care REIT Ventas
(NYSE: VTR). On the other hand, American Campus Communities (NYSE: ACC)targets the other end of the age spectrum, building and operating student housing facilities as well as providing management services for colleges and universities that own their own dormitories.
When you look at the returns of these stocks over the past two years, you won't see the losses that homebuilders have sported. Rather, their shares are reflecting the favorable fundamentals of the rental industry. Yet as REITs, these companies provide significant dividends to investors -- returns that any real estate investor can appreciate.
Wave of the future?
Some have argued that the American dream of homeownership is dead. Rather than mourning that fact, though, you might do better for yourself by investing in the countertrend of rental housing. With conditions favoring renting, it's possible that you'll find more gains either in rental REITs or from rental properties you find on your own.
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