Most people who read this article are probably already sold on the notion of buying and holding real estate. There are numerous blogs written (many by me) about the benefits of owning real estate. From the cash flow that can be generated and the appreciation that can be realized to the use of leverage to increase returns and the tax benefits, there are many factors typically found in your average pro forma that can easily justify the long term investment in real estate.
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However, I see many real estate pro formas that leave out another huge benefit to owning rental real estate. It’s the fact that rents increase over time. Not only do they increase, but rents are currently increasing faster than most investors realize.
Zillow’s Chief Economist was quoted as saying:
“Over the past fourteen years, rents have grown at twice the pace of income due to weak income growth, burgeoning rental demand, and insufficient growth in the supply of rental housing. This has created real opportunities for rental housing owners and investors, but has also been a bitter pill to swallow for tenants, particularly those on an entry-level salary and those would-be buyers struggling to save for a down payment on a home of their own … Next year, we expect rents to rise even faster than home values, meaning that another increase in total rent paid similar to that seen this year isn’t out of the question. In fact, it’s probable.“
According to the latest Bureau of Labor Statistics report, the rent index increased 3.4% in 2014. Zillow’s report mentions median rents increasing 2.9% last year. So let’s assume rents are increasing nationally at a rate of approximately 3% per year. In theory, that means your rental house getting $1,000 a month could increase to $1,030 in one year! If rents continued to increase at a pace anywhere near this high, the returns on your rental property would jump significantly over a just a few short years.
The Importance of Knowing Trends in Your Market
I will concede the fact that 3% is a national number, and every market is different. However, some markets are actually experiencing rent increases that are even higher than this. It’s important to research the market you are buying in and understand the rental trends. While you will probably not see precise jumps in rent every year (i.e. an exact 3% increase every year), as you hold property over time, you should see opportunities to increase rents (sometimes on existing tenants and other times during turnover). I know in my market, it’s not uncommon for us to bump rent prices up in $25 and $50 increments as the market allows.
As an investor looking at potential long-term investment properties, are you building some sort of rental increase into your pro forma? I would venture to say that most investors do not. Perhaps there is a tendency to calculate returns as conservatively as possible, and there isn’t anything necessarily wrong with that. But in my opinion, if the data points to a certain predictable increase (whether in rent appreciation or price appreciation), why not factor that into your buying criteria and future return calculation?
How about you? Have you seen opportunities to consistently raise rents on your investment properties?
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