I want to make sure when I'm buying rental properties, that they can remain profitable in any market. I ignore the possibility of the value of the property increasing, I only am going to make decisions based on paying low enough for a property that'll give me my desired cash flow.
However this can all go down the toilet if for some reason I buy at a good cash flowing price in a hot market, then the bubble bursts and forces rent prices down and I'm not cash flowing anymore.
I want to minimize my risk as much as possible, does anyone who has been affected in 2008 remember how much your rental income decreased in relation to your property value?
Thanks in advance. I'm a beginner still trying to figure everything out so all insight and advice is appreciated.
If the market bursts generally the first thing to be affected is that housing sales will be down. If nobody is buying houses, or worse, if people are losing their houses, then that means more people looking to rent. To me rent is not changed. I actually think that continued growth in the RE market could drive some rent rates down as many companies are building apartments like crazy and thus an over abundance of places available to rent. Simple supply and demand.
Rent price didn't go down much (if any) during the last housing burst. I like your approach of buying properties for the cash flow return. Are you looking in the city or suburbs? I could never mind anything in Chicago downtown that had decent cashflow but in the suburbs it completely different story.
Price is based on supply and demand. Housing price went down because demand for houses went down (high price, no finances). Demand for rentals never went down, people still needed to live and if anything I would guess demand for rentals went up a little as people got foreclosed.
Also would like to note that rent price and rent income is very different. Your lease could say $1000/month but tenants have been known to miss payments or be short a couple hundred here and there. Vacancy would be another big factor in rent income.
You have a great strategy of finding cash flowing properties. I wouldn't worry too much about the stuff you can't control. A bubble or downturn in the economy is bound to happen if you stick around long enough. All you can do is focus on what you can control; being a landlord. Hire an excellent property manager or do the job yourself and find great tenants. With the right tenants, you will be cash flowing even when everyone else isn't.
I know someone who has over 70 rentals, and he almost lost everything in the recession. Rents went down, and vacancies went up. I believe his vacancy rate was around 25%. In a bad recession/depression people get more creative with living arrangements, such as moving with mom and dad, friends, renting out rooms etc, thus more rentals are freed up
I found rents either stayed the same or went up. Those that couldn't afford to own, had to live somewhere...which usually means rent. I think it all depends on the type of rentals you have in your portfolio.
I think those with low end rents might have lost a little since those tenants situations started off on a low note...and probably got worse.
I think those with high end rents may also have lost a little since an economic downturn would affect them as well, and would probably cause them to move down in scale.
I'm one of those with properties/rents in the middle. Not affected. In fact, I found in some cases rents moved up. I picked up those that used to own, and those higher end renters that moved down.
It is a bit more complicated, your market, the inventory available, the rent level and price level of the home, the perception of housing prices and duration of price changes.
If you have tenants who are able to buy, they may as prices drop. The inventory dictates pricing to demand, buy or rent. No one wants to lease a 70K home priced as a 120K home, and perceived values will effect rent or buy decisions. A crash doesn't come about overnight as you think of the stock market crash, there is a slower trend over time. You won't lose tenants in a month, but in 6 or 9 moths they may begin to consider their options. Renewals may be effected and the next lease may be less due to market demands.
In RE basics, this is the economic effects of utility, in economics this is a concept of the marginal propensity of consumption, marginal changes that effect buying or consumption activities. Price changes in RE are slow moving and the tenant must be in a position to take advantage of price changes.
Tenants who are not in a financial position with cash on hand, income and credit may not be able to move out, the price level must take a significant change to motivate them to seek other alternatives. Those who have other alternatives available to them are more likely to act in their own best interests.
A market crash in RE has a trickle through on the general economy as we know, there will also be limitations as to inventory as new construction slows. A housing inventory that is in balance or with little growth will have fewer opportunities for quicker price changes, an inventory that is excessive to other opportunities can have much quicker effects on prices as there is a higher supply. If inventory is low, demand will be higher and fewer price changes expected as a higher price will be more stable.
You can't avoid market demands or market risk in RE and the effects will occur over time with most housing inventories. Functional obsolescence sets in, external obsolescence effects most housing over time, (look them up if you're not familiar with these aspects). These are generally slow moving effects on pricing rents.
Consider your financing obligations as well. Interest rates fall with consumer perceptions, falling prices, consider refinancing with indications in bond prices as housing prices will generally lag, consider before continued market prices effect the loan to value. Look in the review mirror to underwater properties. Rents lag to housing prices. :)
Here is a graph, courtesy of the Federal Reserve Economic Data website, that shows median sales prices of existing homes vs. CPI of rent for the last 10 years. You will notice that rents continued to rise during the 2007-2009 downturn.
Notice that rents declined slightly at the end of the recession in 2009 (shaded area). So it would appear that rental rates are correlated most closely with incomes. The effects on rental prices of the decrease in incomes were not felt until a few years after the recession started (lagging).
There was no corresponding decrease in rents during the massive decrease in housing prices in 2008-2009, so it appears rental prices do not appear to be closely correlated with the sales prices of existing homes.
Here is a graph of median incomes vs. rents demonstrating rents are more closely correlated with income than housing prices.
If you haven't checked out the FRED website and you enjoy looking at historical housing data, I would highly recommend it. You can build your own graphs using thousands of available economic indicators.
Good find Nate!
I'm speaking at micro market levels. I can't rent an 85K home for what is expected in a 140K home. I can rent a 140K with a waiting list at rent levels for an 85K home. Regardless of income, competition in the local market will be reflected in inventories.
While assumptions can be made as to housing on a national basis with economic indicators, such as the CPI, it isn't that applicable at micro levels as all metropolitan areas are not the same, average income levels are different. The greatest and quickest effect on prices on any market from a macro level will be reflected in bond prices, with an inverse relationship. Interest rates down, borrowing power increases, prices increase bring purchasing power in equilibrium. It also changes the buy vs rent equation at middle income levels.
The only real influences are at lower median and median income levels, very low, low and high income are less effected, either you have no other alternatives or you have reached an income level where market changes are irrelevant to your desired living standards.
Now, check those average income levels with the rate of unemployment, I'm sure the greater differences will be at lower income levels. Local demographics will have different results than national averages, it's always, location, location, location. :)
Thanks for all the perspectives everyone. That's awesome how rent prices are more stable than real estate prices.
My original thought was that competition from other landlords brings prices down because they'd be scooping up properties for cheaper and wouldn't need to charge as much. But I see it's a lot more dependent on factors and I'll just have to figure it out according to my specific markets.
@Sibbir Noman I'm not looking downtown but I am sticking to the city and near suburbs because of the abundance of brick 3-flats all close to each other. Hermosa, Cicero and Pilsen are piquing my interest right now. Pilsen is weird it's kind of gentrifying because there are a lot of artist lofts there. The half-gentrified, half not-gentrified neighborhoods are confusing for me because it's like apples and oranges combined mucking up the numbers. Do you remember which suburbs you found that have good CF?
@Roger Vi Your reasoning about how people still need somewhere to live even in a downturn is what got me into real estate. My genius epiphany was that the population is always increasing and everyone needs to live somewhere, and thus Landlord became "what I wanna be when I grow up". I'm accounting for 10% vacancy and conservative expense estimates when playing with spreadsheets. That's good advice about having as much control as possible over the things you can actually control. It's also like any other business where you cater to the customer. If your tenants are happy because you're an excellent landlord, you'll be more protected against market trends.
@Kendall T. I wonder if that's an example of the differences between economic groups. It sounds like your friend mostly had younger tenants without families to house that could move around more freely or something.
@Joe Villeneuve That's a great position to be in and now I'm thinking if I wanna incorporate that into my strategy. Good stuff to think about. Right now I'm looking at what I think are B-/C+ working class neighborhoods, where I'm assume people make enough to support their families but not enough to save up for their own houses.
@Bill Gulley Cool website! I'm going to go play with graphs on it now.
@Account Closed my friend had lower end duplexes,I believe he liked 2 bed 1 bath, and I would call it C property
There was an interesting event that took place after crash where the multi-family rental market flooded with investors all looking to take advantage of the displaced borrowers. The general idea was occupancy would decline and rates would rise.
What actually happened is occupancy did not increase in accordance with the displacement. In fact, the data eventually showed that the displaced borrowers moved back home to parents or in with relatives or alike. The general notion was that as a borrower struggling to make $X payment, instead of taking a slight haircut in their expenses renting at a lower rate than their mortgage payment, completely removed it from their expenses by moving home or in with other family. This behavior was a little shocking and caught some investors off guard. I believe the harder hit property class was multifamily apartments but there was spill over into 1-4 unit properties.
The fluctuation was on occupancy which did have effects on rates. As Bill points out, unless you drill down to a more micro level it is hard to discern that data from a national level as some markets had less and some had more of a concentration of available units both new and old. The revealing comparisons would be on an MSA or more finite level. The same type of skew comes from including the great nation of California into national numbers. California had a spotty declines but overall recovered and rose quickly in comparison to other markets. New York also comes to mind as pricing was suppressed for a bit and then as of late it has begun to rise which is getting exaggerated as investors re-enter the market in select areas.
This phenom in my opinion is important to keep in the back of your mind as the public may act in an unorthodox manner to some thinking. We could probably make an argument that a second crash, if one was to occur, may have some contrary reactions. The debt burden of the public plays an increasing role into this as well. That metric to some extent is a newer metric for consideration. Thus inferences from that metric are not widely understood yet.
Even now, we have a much lower absorption rate into housing for newly graduated students and younger generations. They come away from their secondary education with large balances of loan debt. Some of the occupational pursuits will simply not allow them to quickly handle that debt burden, many don't venture off into their respective fields of study as the jobs that are in that space are low wage. What ever their barrier, many students graduate already having the equivalent of a mortgage payment with student loans. A debt that can not be discharged. That is all new to us and the affects are not widely understood.
In addition, we also must consider the players and their involvement in the market place and what affects those had. We know tons of institutional investor capital poured into the rental markets. We know that, in fact, stability of prices, rates and occupancy came as a direct result of that event. We also know that capital activity has dropped significantly. Easiest example is Blackstone purchasing around $100 Million a week. Now, they are not.
Perhaps if rental streams can one day successfully find a footing in the securities market we may see a return of big capital but I am not inclined to think that is around the corner. In the event of a follow up crash, I am not inclined to think institutional capital will function the way it did before. Predominantly it likely can not, as the previous players would be full of inventory and if it has a detrimental affect could stay new investors from taking their place like happened before. So, this metric can have drastic affects on a similar future event. If that capital doesn't show up or only selectively shows up, the picture will be much different.
Finally, we currently have rental rates which exceed or are equivalent to mortgage rates. We do not fully understand this affect into the future. We can deduce metrics in today's markets are a bit different than previous market conditions. The core values of the public have been affected and to that extent, we can only know the extent in a hindsight manner predominately. So there are some metrics in the market that may throw a wrench in the works which could produce results contrary to past performance or belief. I would keep this in mind as you drill into local market data and make parameters to your investment criteria. Not only must we consider micro level metrics but the fluidity of the market conditions and the market participants as well with a dash of psychology insight.
My experience has been that rents are somewhat converse to housing prices. The resulting theory is that a hot housing market with more buyers reduces the rental pool, and that a cold one with less buyers increases the pool.
After the last recession, lots of should be homeowners found themselves renting, thereby lowering rents. During the same period in high foreclosure areas, the recession reduced inventory with bank owned properties, thereby raising rents.
My experience in 2008 was that there was no drop in rents. There are other factors, like if you are in a 1 industry town and that industry closes, rents will go down.
If you're in a good area with good schools, low crime and employment opportunities, that should remain as a good area even after the bubble bursts. Think about areas close to colleges and hospitals, they are still open for business after the crash.
I actually did a case study of our area since there was so many short sales/foreclosures. What I found in the Central Valley was rents didn't decrease. On the other hand people's mortgage was so much higher than rent that they had never had a plan to rent the house. They had planned to sell when the houses went up. Well when the houses dropped by 50% and they had to rent. The issues occurred.
This is an awesome topic. From my limited experience, I would agree with the other posters. Rents typically aren't correlated to sales price, but rather supply, demand, and income. @Nate Garrett , loved the reports!
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