Investors who want to buy a new residential property for rental income in what appears to be a hot market have a few caveats to consider.
Sure, rental rates are increasingly outpacing mortgage payments and a record number of households are opting to rent over own. Plus, rising home prices are showing no signs of abating. But buying a home to lease to renters is not necessarily a financial slam dunk right now.
"It seems like a good economic backdrop for investing in multi-family housing - you have good job growth, you have the potential for higher wages," said Andrew Altfest, executive vice president of Altfest Personal Wealth Management. "But now is not the ideal time to invest in multi-family housing to try to be the next Donald Trump."
That's because despite the abundance of positive signs, the rental market simply no longer offers investors the slew of distressed properties such as foreclosures and short-sales that only a few years ago abounded with bargains yielding meaty returns.
Still, depending on where you live in the country and how far you are willing to dig into your local market listings, investors can find opportunities in today's rental market for instant monthly income, says Trulia Chief Economist Ralph McLaughlin. For example, markets like Rochester, N.Y., or Dayton, Ohio, have significantly higher rent rates versus mortgage payment rates to give investors instant cash flow.
Ideally, in any market, an investor would want to pick up a property where the monthly rent more than covers the mortgage so that he can draw a monthly cash-flow surplus to cover expenses. Before buying, investors should get a qualified inspector to provide estimates about what improvements need to be made to the home.
"Even with relatively new properties, investors should budget for maintenance costs," McLaughlin said. "Identify properties where rents are going to be at the minimum 5% to 10% higher than what your monthly mortgage payments may be to give you that little bit of extra cushion."
Tenant turnover is another risk to this type of investment. If you're investing in a market where people move fairly frequently, you can lose significant income when the tenant moves out and you have to conduct a search to replace that tenant.
Even if a real estate property doesn't yield instant lucrative rental income, buying a rental property can still be an ideal long-term investment to diversify your portfolio. After all, home values and rents do tend to appreciate together with inflation. Overtime, renters would essentially pay for your asset.
Industry experts like David Brickman, executive vice president of Freddie Mac Multifamily, say they expect rental properties to continue to be in high demand in the next several years, driven in part by Millennials, who have preferred renting over owning for both financial and lifestyle reasons. Saddled with student loan debt, many Millennials cannot qualify for a mortgage. Others like the mobility that renting affords.
"The rental market is still very strong," Brickman said. "We see more household formation. Renters are generally satisfied with renting, not that they don't have an aspiration to buy a home at some point. ... Renting is a broader social trend that's likely to stay strong."
Plus, the volume of new households is far outpacing the number of new rental units being added to the market so the pressure on vacancies, says Jonathan Smoke of Realtor.com. "We simply have a record number of renting households," Smoke says.
Existing home prices have appreciated between 5% and 7% nationally, and Freddie Mac economists forecast existing homes will appreciate 3% in 2016, which is still above the average of about 1% above inflation.
So, if you're taking the long-view for retirement income, it's not a terrible time to invest in property for renting. Just don't bank on instant windfalls of short-term cash flow.