The Case For Rental Revival

Have you been wondering whether to invest in a modest rental property?
Good news: Rentals are not only showing signs of life for the first time in years, but demographic and economic indicators point to an improved rental market for the next decade.

Robert Sheehan, consulting economist for the National Apartment Association, predicts that apartment-vacancy rates nationwide in buildings of five or more units will decline from 10.2 percent to 10 percent by year's end, the best level since the fall of 2001. That means fewer competitors if you own a duplex, triplex or fourplex.
Apartments will likely see rent increases of 4 percent this year, the highest since 2002, according to Witten Advisors LLC, a Dallas consulting firm.
"From a market perspective, rentals are starting to look a lot stronger than they have in the past few years," says Rachel Drew of the Harvard Joint Center for Housing Studies, or JCHS. "Vacancy rates are slowly declining, which is, of course, good for landlords, but the rents are going up only modestly, which is also good for landlords but at the same time not detrimental to tenants. Demand is increasing at the same time that supply is stabilizing, so it's good for everybody."

From an investment perspective, residential rental markets have been flat or in decline the past decade, largely due to the double whammy of recession and the single-family housing boom. "I heard someone say, 'Anyone who can fog a mirror can buy a house,'" says Drew. "The pool of owners to be drawn from rental housing has been largely tapped."
Despite the exodus to homeownership, fully one-third of American households (34 million) reside in rental housing, according to the JCHS. That figure has remained remarkably consistent during the past decade as the influx of immigrants replaced those who bought their own homes and the conversion of rentals to condos helped offset new construction, primarily in the nation's suburbs.

The baby boomers have been the wild card in the deck. As they matured and raised families in homes of their own, they created a post-baby-boom lull that cast a big chill on the rental market. However, flush with the largest intergenerational transfer of wealth in history, they also have been gobbling up rental properties by the neighborhood-ful, either directly or through real estate investment trusts, or REITs, in anticipation that their children, the so-called "echo boomers," will shortly be along to take up residence in them.

The reverse gold rushIt has resulted in a reverse gold rush of sorts, in which Californians, in particular, have descended upon the South and Midwest, looking for bargain properties. David "The Duplex man" Hall, who has sold and resold duplexes in Austin, Texas, for 30 years, has seen the reverse gold rush firsthand.
"Californians are cashing out and taking that money to the middle states where the prices are much less and then think their experience is going to be duplicated," he says. "They think prices here are going to shoot up like they did out there, and that probably isn't going to be the case."
Sheehan says that, while it might be a good time to buy a rental, bargains can be scarce. According to the National Association of Realtors, Americans bought a record 2.32 million investment units primarily for rentals last year, up nearly 16 percent from 2 million in 2004.
"Now the question becomes price," he says. "There has been so much bottom-fishing going on for so long that the opportunities to make the numbers work are hard to find now. You can do OK if you find a place that hasn't been mined out."
He notes, however, that all rental markets are local and rise and fall on the health of the local economy. Job growth is perhaps the most important figure for landlords to watch because it most directly affects demand and, by extension, what they can ask in rent.

Here's how Sheehan views the regional rental markets today:
* The Midwest: "It's a basket case," he says. "You can't lay off that many people in manufacturing without ultimately impacting the Midwest. ... Minneapolis is starting to show a comeback, unlike Detroit, which is going to go through it for a while." * The Southeast: "Most of Florida is fine. Atlanta has come back. But when you get into North Carolina and South Carolina, the disappearance of the textile and furniture industries, in terms of domestic production, is hurting their rentals and limiting their comeback. Virginia is doing well because of defense spending." * The Northeast: "You have to have a lot of job growth to improve the rental market there. The existing market will benefit as soon as the labor market improves in that region." * The West: "The hottest market in the country right now is California, especially Southern California, which has become much stronger. Northern California is still coming back; in the Bay Area, the tech fall left a long shadow. The same is true in Seattle."
Meet the new rentersDespite the reverse gold rush, the outlook is rosy for rentals during the next decade: The economy is improving, supply of rentals is dropping, interest rates are rising and home prices are now out of reach in many areas.

But the best news for prospective landlords? The echo boomers are coming. And the kids of the baby boomers are likely to be more mobile in their 20s and 30s than any previous generation, meaning they're more likely to rent than own.
"Definitely from the demographic side of things, there's going to be a lot more demand for rental housing over the next 10 years relative to the last 10 years," says Drew.
That might mostly benefit owners of older rental units near major college campuses.
"A lot of young people are attracted to the city lifestyle, and not having the finances to own a house in the suburbs, they kind of default to rental housing, most of which is in high-density areas," Drew says.
If you already own rental property, Hall recommends a 1031 exchange as a great way to reap the benefits of current high prices and leverage your rental while deferring the capital gains tax.
"It's a very attractive alternative for someone who is selling real estate in California. If they want to get that money out, they can come to a state like Texas and buy two or three properties for the same price they sold the one property for in California. We get a lot of buyers in that situation," he says.
Owning a rental, even in a robust market, isn't for everyone. Hall says metropolitan Austin has 10,000 duplexes, and he has sold many for investors who "didn't want to get their hands dirty."
"I clean up a lot of messes," he says. "They were thinking of it like a mutual fund; something you buy and it takes care of itself. It's not like that. It's hard work."

Because rentals of less than five units are considered residential and not commercial real estate, they're easier to purchase; mortgage terms are favorable, and down payments are generally low. If you live in the rental, you also can avoid from 25 percent to 50 percent of the capital gains tax when you sell.
The best landlords, Hall says, are tenants themselves. Currently he estimates that 50 percent of Austin's duplexes are owner-occupied, and that figure has been as high as 70 percent in the past. It's a lifestyle well-suited for young adults saving for a home, older adults who are downsizing or multigenerational families.
"This isn't a get-rich-quick type of thing," says Hall. "It's for someone who is patient. Unfortunately in our society there are a lot of people who are not very patient, and I don't think this is the right thing for them. If, in your heart, you would be happy putting your mom in it and would be happy owning it for the next four or five years, it's a good move."

source from : bankrate.com