Long-term rentals offer investors an attractive opportunity.
House flippers have had a long and profitable run during the current real estate cycle. But as home prices moderate, real estate investors and private lenders are increasingly turning their attention to long-term rentals, where opportunities appear to be as strong as ever.
Rent prices for single-family rental properties increased 2.9% in March 2019 (year over year), driven by strong employment, according to CoreLogic. Home flipping returns, meanwhile, dropped to a seven-year low in 2018. ATTOM Data Solutions reports the number of homes being flipped declined by 4% and the average gross profit dropped 3% from $66,900 to $65,000 in 2018.
Although slowing house appreciation and affordability are challenging both end-buyers and investors, tight inventory and strong demand for single-family houses suggest the opportunity for flippers is by no means going away. However, there are other attractive investment opportunities for enterprising real estate investors.
Nationally, home prices rose 3.7% annually in March, down from a 3.9% rise in February, according to the S&P CoreLogic Case-Shiller home price index, with double-digit housing gains of recent years now gone from the market. Las Vegas had the largest gain among index cities at 8.2%. Some cities saw a sharp deceleration of pricing growth. Among them was Seattle, which gained only 1.6% compared to a 13% price gain one year ago.
In an indication of a shifting housing market, there has been a spattering of media reports about home flippers getting more cautious about investing, especially in the luxury or high-end market.
One of the most dramatic anecdotes involved a Bloomberg report in which a flipper in the San Francisco area said he made $300,000 on his first flip two years ago but recently lost $400,000 on a property in Sunnyvale, California. It was located near Apple’s headquarters, where home sales have slumped and prices have flattened. And, a real estate investor from Austin, Texas, told the Wall Street Journal she’d been flipping houses since 2009 but paused her activity in 2017 as she saw profit margins getting squeezed.
Despite an enormous amount of attention being paid to iBuyers entering the house flipping market, Zillow Offers reportedly made a meager average gross profit of 4.9% in the first quarter on the 414 homes it flipped—just $14,700 per flip, according to a recent report from Wolf Street. The report also says once Zillow’s expenses are factored in, it actually lost an average of $109,190 per flip for an average loss of 37% per flip. So far, there’s no indication that Zillow plans to back away from its fledging flipping business.
The foreclosure crisis that helped to fuel the widespread conversion of previously owner-occupied housing to rental properties is now showing clear evidence that most of the distress from the last housing crisis has been cleaned up.
ATTOM Data reports that foreclosure filings in 2018 were down 8% from 2017 and down 78% from a peak of nearly 2.9 million in 2010 to the lowest level since 2005. The 624,753 properties with foreclosure filings in 2018 represented 0.47% of all U.S. housing units, down from 0.51% in 2017 and down from a peak of 2.23% in 2010, to the lowest level since 2005.
The popularity of single-family rentals is not showing any signs of slowing down, and the number of private money lenders offering financing for single-family rentals must certainly be nearing an all-time high.
Why Rentals Are Popular Now
The country’s more challenging fix-and-flip marketplace is likely fueling demand for single-family rentals. Rentals remain in high demand in many metros with some upside rent growth still on the horizon.
Among the 20 largest metros, Phoenix had the highest year-over-year increase in single-family rent in March at 7.4% compared to the year-ago period, followed by Las Vegas at 6.9% and Tucson, Arizona, at 6.3%, according to CoreLogic data.
Rental gains are due, in part, to a strong economy that is attracting an influx of workers who need housing options. Phoenix had year-over-year job gains of 2.8% during that period, compared with national employment growth of 1.7%.
Millennials who have delayed home buying due to student loan debt, the high cost of housing (especially in major urban areas), as well as delayed marriages, slow wage growth and other reasons have provided a ready market of renters across the country. Baby boomers who may be ready to downsize or to urbanize via a rental home, townhouse or apartment are also a potential client base creating demand for rental inventory.
The average annual gross rental yield (annualized gross rent income divided by the median purchase price of single-family homes) among 432 counties analyzed by ATTOM Data Solutions is holding strong at 8.8% for the first quarter of 2019, up from an average of 8.7% a year ago.
So far this year, profit margins are up in six out of every 10 counties analyzed by the real estate data company. Counties with the highest potential annual gross rental yields so far this year are in Baltimore City, Maryland, (24.5%); Bibb County, Georgia, in the Macon metro area (21.9%); Cumberland, New Jersey, in the Vineland-Bridgeton metro area (21.2%); Winnebago, Illinois, in the Rockford metro area (17.1%); and Wayne County, Michigan, in the Detroit metro area (17.1%).
Other large metros showing promise include Cuyahoga County in Cleveland, Ohio, (12%); Allegheny County, Pennsylvania, (10.9%); Cook County in Chicago (9.7%); and Philadelphia County in Pennsylvania (9.4%). Profits can vary widely. San Mateo County in the San Francisco metro area had some of the lowest annual gross rental yields at 3.4%.
Private lenders have led the way in the hard-money lending marketplace that drives the fix-and-flip market. Although lenders will certainly continue to offer financing options for investors looking to continue flipping, they are also seeking opportunities to offer innovative loan products that appeal to buy-and-hold real estate investors as well.
Private lenders may have a ready base of customers in their lending platforms via their fix-and-flip clients who may increasingly see the wisdom in diversifying their flipping business with a buy-to-hold portfolio. This suggests that lenders will likely come up with new loan products and new marketing programs to provide longer terms and lower interest rates in order to appeal to buy-to-hold investors. We already see five- and 10-year adjustable-rate mortgages—and 30-year fixed-rate products—being offered by private money lenders at terms that are not substantially different from some conventional long-term financing.
Lenders who have fix-and-flip clients challenged in selling their flips will want to offer a streamlined mechanism for converting a short-term fix-and-flip loan into a long-term rental loan. We expect innovation that will include financing that allows fix-and-flip investors to acquire a property, complete renovations, secure a tenant and then convert to a longer-term loan with a single-close program.
It’s also a good idea to keep an eye on the growing trend in the long-term rental segment: build-to-rent.
Homebuilders, private equity groups, REITs and others have gotten involved in this segment, either individually or via joint ventures. They are developing single-family rental home communities built from the ground up, generally with around 100 to 200 homes. These new communities are appealing to sponsors, in part, because they provide a way to get around the challenges of managing a portfolio of rental properties spread out geographically.
In one of the latest deals to be announced, New York private equity firm Lafayette Real Estate and real estate investment firm Guardian Residential formed an investment company, Lafayette Communities, to build homes that will be marketed as long-term rentals. Toll Bros., Clayton Homes, GTIS, AHV and some of the single-family REITs are also among those involved in this segment.
A shift is underway in the nation’s housing market, and as the real estate cycle gets a bit long in the tooth, it is important for private lenders to be prepared with lending products and services that will meet the needs of a changing marketplace.