Latest fad in housing: Buy, then rent
More investors are buying properties to rent out, but not everyone is cashing in.
"For rent" signs are increasingly showing up in tony bedroom communities, condos, and exclusive resort areas around the country.
They are one more sign of the magnitude of the real-estate boom in the US. Eager to cash in on one of the strongest housing markets in the postwar era, speculators and even average investors are buying homes and renting them out until they decide to sell them at presumably far higher prices.
To them, it's like having a bank vault with a mud room - and you can take in a little money (on rent) while your account grows.
In some parts of the country, so many rentals are flooding the market that they are depressing monthly rental rates. That's good news for consumers. But it may portend something ominous for the housing market: If too many people decide to rent over buying, it could undercut the booming housing market.
"Housing derives value from rents and the two cannot diverge for very long," says Mark Zandi, chief economist at Economy.com. "People may care about this if the weak rental market weighs on the single-family housing market."
The economics are relatively straightforward. If home prices rise too much or the cost of borrowing increases, those seeking shelter may not be able to afford the monthly mortgage payment. Instead, they may find it less expensive to rent. This will remove potential buyers from the market - particularly if landlords are offering incentives to rent.
Consequently, the home-buying market slows. This can be a good thing, if it helps prevent a housing bubble from bursting - in essence, acting as a self-correcting mechanism. But if too many people decide not to buy, it can crash the market.
At the moment, Mr. Zandi says, data from many different sources show that rents have been at best flat over the past five years and in some areas are actually lower. It's an indication that the home- buying market is still very strong - with more people trying to own than rent.
That's certainly the case in New Jersey, says David Legow, president of the N.J. Apartment Association in East Brunswick. He estimates that over the past two years rents are down 10 to 20 percent in some markets in the Garden State. Plus, owners have had to add free cable and Internet service, washers, dryers, and sometimes complete renovations.
"There is a big shadow effect [from all the condos and houses for rent] on our ability to attract tenants," says Mr. Legow. "It's a renters' market."
In the Phoenix area, some brokers report having to look six to nine months to rent a house, says Jay Butler, a professor at the Arizona Real Estate Center, part of Arizona State University. "It's tough to track," he says. "You have to look at advertising and rent levels."
Robert Fowler, who runs the website RentList.com and HomeRentalAds.com, says he has watched rental rates fall, but thinks they have stabilized at the moment. One reason for the leveling-off may be an increase in the number of people signing "lease-purchase" agreements. These are rental arrangements with a landlord who agrees to sell at a future date. "It indicates people would like to buy, but they can't afford it right now," he says.
Atlanta renters, like others around the nation, have watched rents fall. Homes that used to rent for $1,100 a month are now $1,000 a month, says Mike Nelson, managing partner at Excalibur Home Management LLC, which manages property in the Atlanta area. "A lot of our tenants have moved out and become homeowners."
The surfeit of rental homes is being exacerbated by investors dreaming of big gains in the real estate market. In Arizona, Mr. Butler says, local brokers are bringing in California investment clubs, which arrive at subdivisions in buses and snap up three or four houses at a time. Many are put on the market as rentals. "I've heard there are areas that are 70 to 80 percent rental," he says.
Other investors are being lured by so-called real estate investment seminars, which frequently advertise on Sunday-morning television shows. These seminars purport to show people how to get rich - by buying and renting real estate. They usually include sections on purchasing repossessed or foreclosed property. There are often promises that developers will pay many of the closing costs and provide appliances.
Yet the riches can be elusive. One woman, for instance, bought a new house in Cordova, Tenn., a suburb of Memphis, with the intention of renting it. On a real estate Internet chat room, she bemoaned that her closing costs ended up running $4,000 more than her mortgage broker had quoted two months earlier. She paid fee after fee, including $1,000 to a property manager to rent the house.
"Never did find a renter because they had 83 other properties closing in the same time frame as mine and in the same area!" she wrote. After eight months, she reduced the rent by $350 a month and eventually sold the house after a year for $10,000 less than the original purchase price. She did not return e-mails asking for more information.
Investors can get burned in other ways as well. Tim Allen, who teaches real estate classes at Florida Atlantic University in Boca Raton, says some investors are not figuring in condo association expenses and other fees. In Florida, he adds, the real estate market is so hot that some buyers planning to flip their properties don't even bother to look for renters. "Why put a tenant in if it's only a matter of weeks until the unit gets sold?" he asks.
One other sign of how frenzied - and "scary" - the market is: Some of his students are borrowing money on their own homes to raise the down payment on condos that have not yet been built. They hope to make 20 to 40 percent appreciation. "They put $8,000 down and make $80,000 when they sell on completion," he says. "They don't understand why their professor is not doing it."