A brief outline
As the US economy bounces back from the pandemic, so the housing market has been booming. Part of this boom has been the huge increase in demand for rental properties, and along with it came higher rent prices. But what does this mean for real estate investing?
In the wake of the pandemic devastation, we are seeing a new phenomenon emerge in the rebounding housing market and that is one of rising rent prices. In fact, it’s been a long time coming, over the past decade rent prices have risen by $600 in some areas and the after-effects of the pandemic have exaggerated this.
According to Zumper’s 2021 Annual Rent Report, rent prices increased by a huge 11.6% for one-bedroom properties in 2021 alone, and two-bedroom homes rose by an even larger 13.6%. While this spells tougher times for renters, what does it mean for real estate investing?
Why are rent prices on the rise?
A rise in rent prices can be caused by a number of factors, a variety of which are at play with the recent rent price increases. Here’s an overview of why rent prices in the US have been sky-rocketing over the last 2 years.
- According to the NRHC, the impact of the pandemic has reduced affordable housing options and the total supply of single-family homes. Which means that renting is becoming a more favorable option for many people.
- During the pandemic, many people had to give up their homes and move in with family, however now that restrictions are being lifted and the economy is bouncing back, people are looking for their own homes again which leads to a large increase in renting and the demand for rental properties.
- Those who own rental properties have hung onto these and put the rent prices up over time, as competition increases amongst potential tenants.
- Listed homes for sale are being snapped up very quickly and with housing prices on the rise, this leaves those who are looking for an affordable property in the lurch. These people are having to rent, instead of buy a house, until they can find a house to fit their budget. Which means that the rental market is also being flooded with a new type of renter, one who is wanting to buy but simply can’t find the right property right now.
- Some people are simply not willing to take on the financial burden of buying a house, in the current economic climate, which means they are choosing to rent instead. This further drives the demand for rental properties.
- Stimulus checks and the re-opening of economic activity has been of the biggest drivers of the rental market as people can now afford their own places, or to upgrade to better places.
- Millennials are a generation that no longer see owning a home as a major life goal and are instead preferring to rent as this serves their lifestyle better. They are less inclined to be tied into a loan and would rather free themselves up.
What does this mean for real estate investing?
- Fewer rental properties are on the market: Finding a rental property to invest in can be more difficult during these times because fewer rental properties are left on the market. They’re being snapped up quickly as the demand rises, as such finding a good deal is becoming increasingly difficult for investors as competition gets tough.
- Rental home vacancy rates are low: High rent prices indicates a high demand, which means that finding tenants is easier and vacancy rates are low on rental properties. In fact, vacancy rates are at a 25-year low. This ultimately means that rental properties are the place to be for investors.
- Selling rental properties: Some investors are choosing to sell their rental properties, with the market booming they can fetch higher prices and flipping rental properties to sell can be more lucrative in the current market.
- Location is key: Certain cities have booming rental real estate markets, and these can be good places for investors to focus on. For example, Texas has had a huge increase in rent prices and that bodes well for savvy investors looking to grab the opportunities presented there.
How to value a rental property
Income from rental properties is at an all-time high, so if you’re looking for a good rental property deal, here are a few ways that you can determine the value of a rental property:
- Sales Comparison Approach: This is the most used method to determine rental real estate value. It involves looking at similar homes in the same neighborhood that have sold or been rented out over a specific time period. These homes should be a similar size and have the same number of bedrooms and bathrooms, as well as similar features. This is assessed over time to determine your rental property’s value be based on these similar properties.
- Potential income: Looking at the income you could make from a rental property is one way to determine the value of the property for you long term. This approach looks at your yield over time and compares that to your initial investment. Which means working out the annual capitalization rate and the net operating income.
- Gross Rent Multiplier: This method uses the annual rental income from a property only. It’s different from the potential income approach in that it doesn’t factor in net operating income as the cap rate and relies purely on gross rental income.
How to determine fair rent prices
Before the pandemic, the 1% rule was the most popular method used by real estate investors to determine rent prices. The rule works like this: 1% of the property’s overall price would be the monthly rent price. If this didn’t add up for rental property, then investors would typically not buy that property. The 1% rule was a quick way to weed out properties that essentially weren’t going to be the best investment.
However, this rule might not be applicable in the current US real estate market, due to the major rise in property prices. Median home prices in the US have risen drastically over the last two years, and the demand has changed. For example, the sales price of a new home in the US in 2020 was $391,900 and in 2021 it was $453,700, according to Statista.
These days, there are few other ways that investors can work out rent prices that may be more fair:
- Comparable properties: Take a look at similar properties in the same neighborhood that are being rented out and what they are charging for rent. These properties should be similar in size and have the same number of bedrooms and bathrooms, along with similar features.
- Online rent calculator: There are useful tools online to help you calculate a property’s rent price, however bear in mind that these can be generic and it’s worth taking your neighborhood’s specific housing market into consideration as well.
- Check local real estate websites: Properties listed on these websites, and sometimes the data that the websites present, can give you a better idea of how much you should be charging for rent based on where your property is located and its attributes.
What’s next for rental real estate?
Home rent prices are expected to continue increasing over 2022, even though home price growth is expected to slow. Housing economist Jay Parsons seconds this, saying that rent prices are not likely to decline any time soon due to the overall shift towards renting being the more desirable option. This, according to Parsons is largely due to the fact that, “There’s a contingent of upper-income households that don’t want to be pinned down,”.
If this holds true, it will mean that the demand for rental properties remains high and therefore rent prices remain on the higher end for the foreseeable future. For real estate investors who are already in the rental real estate game, this can be great news, however for those that aren’t, it could be an opportunity to start trying to find a good deal and get in on the rental real estate market.
The bottom line
Getting into rental real estate has been a strategy for many moons amongst real estate investors, however the last few years have seen the rental real estate market beginning a whole new era. The future of real estate after Covid-19 cannot be 100% certain, however based on various trends all culminating now, the current market is highly in favor of landlords who can charge higher rental prices. So, getting into the rental real estate market can be a great idea, although it’s worth bearing in mind that competition is stiff.