Introduction
Investing in rental properties can be an excellent way to generate passive income and build wealth over time. However, as with any investment, timing is everything. In this article, we’ll evaluate whether now is a good time to buy a rental property by considering the local real estate market, rental demand, cash flow, financing options, the current inflation rate and one particular rental investment type that we have personally made.
I’ll also share a few links to resources to help you gather data, none of which are links that benefit Trustworthyhomeadvice.com in any way financially, we only list them as resources to help you speed your research. I’ll also add some of my personal investing experience as another piece of data to consider.
Understand The Local Real Estate Market
Understanding the state of the local real estate market is critical in making this type of investment decision. Factors such as supply and demand, interest rates, and economic growth are all important to evaluate the viability of your investment. You should compare prices and trends, are they rising or falling? Are there many properties on the market, and how long are they taking to sell?
While you can research this information online, and sites such as PWC Investor Survey is a great resource, the best way to really understand these trends is to work with a local real estate agent in conjunction with your own research. They will have easy, accurate access to the data and be able to give you valuable insight into the subtleties of the local market. They can also run detailed comparisons of available properties in your price range. If you have already done your own research, the data that a real estate agent presents to you will be more impactful, and you will be better prepared to ask important, relevant questions.
Evaluation of Rental Demand
To evaluate rental demand, you should research the area’s population growth and job opportunities. Are more people moving to the area? Are there many job openings? These factors can indicate a high demand for rental properties in the area. If rental demand is high in the area, you are obviously more likely to find quality tenants to occupy your property.
Rentometer.com is a great resource to gather this type of data. There are paid plans if investing in rental properties is an ongoing endeavor for you, however, if this is your first foray into this space, there is a free 7-day access option that should allow you to gather all of the information you need for a particular area. Again, this data, along with working with a good real estate agent will be very helpful.
Vacation Rental Properties
This is an area near and dear to us. One of the best investments we have ever made is a vacation rental property in a seasonal summer shore town. Considering the climate of where the vacation property is located brings another interesting set of factors into play.
If you purchase a vacation rental in a warm climate, such as Florida or the tropics, the property can be occupied continually, allowing for rental income year-round. However, competition is key in places like this. Determining how much you can get for a rental period and more importantly, how many weeks throughout the year can you rent it, are key factors.
A rental property in a seasonal sub-tropical climate may actually be a better option than a typical rental property with longer term leases. For example, purchasing a “beach house” in a vacation town on the Jersey shore. The Jersey shore is a very popular summer destination, and weeklong rentals tend to be difficult to come by (Demand is always high), so owning a summer rental property in a city such as Ocean City, NJ or Maryland, Wildwood, Stone Harbor, etc, can provide many advantages for the property owner.
Rental rates are typically high enough that renting for 10-12 weeks throughout the summer, can bring in as much or more revenue than renting year-round in a “normal” rental, and you can have it for personal use when its not occupied. The other advantage of a seasonal rental is less wear and tear on the property as it’s not continually in use, and you can inspect it frequently between rentals. Because it’s only being rented for short periods of time, you or a property manager can keep up with maintenance issues before they become serious.
Also, depending on how you use it personally, there can be significant tax advantages of a vacation rental. Investopedia gives a good overview of the tax rules for renting your vacation home, however, it’s important to Consult a qualified CPA to discuss these details if this is an option you are considering as rules can vary from state to state as well as city to city.
Set Up An Investment Model
To calculate your expected cash flow, you should consider the rental income you’ll receive and estimate your expenses for the mortgage (if you finance the property), taxes, utilities, property management fees, repairs and routine maintenance? Set up a good spreadsheet to model your income and expenses to get a clear look at the investment over time. You can look at the trends of how property values have fared over the last few years, then with the research you’ve done on the location as well as overall economic outlook, you should be able to get a good 5-10-15 year look at what your investment will look like to make a data-based decision.
This is a semi passive income investment; However, you need to think of this as a long-term passive income option. If your investment covers ongoing monthly and quarterly expenses, even if it’s just break even, long-term equity build is a great way to build wealth over time. In 3, 5 or 10 years, you may be able to sell the property at a significant profit. Just make sure you spend the time to consider ALL of the potential ongoing monthly and annual expenses. If you run a negative cash flow scenario, there is a potential that the property value increase over time does not keep up with the cash burn, making it a poor investment.
Examination of Financing Options
Proper financing is critical. Take the time analyze different financing options and interest rates available to determine if you can obtain a favorable loan for the property.
Rates for financing rental properties are typically slightly higher than normal fixed rates for primary homes, so get multiple quotes when doing your research. I also think it’s best to look at local financing options in the city or area you are considering. Community banks with local market knowledge can be easier to work with than larger banks with national coverage. There are many different loan programs, and a local lenders tend to be more willing and most likely have more flexibility to work with you to structure the best option.
Current State of Inflation and Mortgage Rates:
While it’s true that inflation is at or near 40 year highs, it’s not historically high, and as of the time of this writing (April 2023), we seem to have peaked. The chart below from the St Louis Fed shows the average rate for 30 year fixed rate mortgages peaking and starting to fall. The chart also shows that while rates are elevated over where they were just a few years ago, they are not “historically” high.
Housing Prices
The counter to higher interest rates is the fact that average home prices are falling, so the dynamic between these two factors makes for an interesting investing analysis. How long housing prices will continue to fall is anyone’s guess, however as this trend is downward, and mortgage rates are flat to falling, now may be a very good time to purchase an investment property. If interest rates continue to fall, re-financing is always an option when rates hit certain thresholds based on your existing rate. I also don’t believe that housing prices will fall for very long, so this type of investment, while may seem like a poor option based on all of the economic headlines and doom and gloom scenarios, may actually be a good option.
Conclusion:
While it may intuitively seem like a poor investment with the current economy due to mortgage rates and home value trends, do the research as we described on the area you are considering, and build your 5-10 year spreadsheet model, the timing may be better than you think. Real estate has historically been a great place to invest. I believe it still is one of the best long term semi passive wealth building opportunities.
I also personally think if real estate investing is something you are really contemplating, you should give serious consideration to a vacation rental property, or a 2nd home in a climate that changes throughout the year, you may be surprised at the conclusions you draw with a comprehensive data analysis.