Real Estate Advisor:
June

• Real Estate Investing: The Landlord Speculator

Real Estate Investing: The Landlord Speculator

The reliability of return on real estate investments over the past two decades has enticed many buyers eager to "flip" homes for a quick profit. But with home appreciation slowing and housing inventory on the rise in markets across the country, fewer speculators are buying homes with intentions of re-selling. Instead, an increasing number of investment-minded buyers are purchasing homes with the goal of renting their properties. Welcome to the brave new world of the landlord-speculator.

While generating income from rental properties is by no means a novel concept, recent changes in the real estate market are causing more and more homeowners and buyers to investigate the landlord approach. This article will delve into some of the rationale, benefits and challenges of becoming a landlord in today's real estate climate.

Flipping flops

Real estate investors of all backgrounds fueled a significant portion of the housing boom of the past two decades. The art of "flipping" properties after relatively short periods of ownership has become so popular that it has generated its own spin-off "how to" industry, with countless books and television programs dedicated to the subject. But much of the flipping craze was modeled on the concept that steady (and in some markets, excessive) home appreciation would continue. Real estate investors now may face unique challenges when trying to "flip" a home:

Appreciation has slowed (or stopped) in many markets
In all but a few pocket markets, the soaring home appreciation of the nineties has begun to slow down significantly. This does not mean the potential for profit when "flipping" a home has evaporated entirely. In many cases successful "flipping" relies heavily upon minor aesthetic improvements made to the property which in turn can greatly increase its perceived value to the next round of buyers. That said, without "natural" appreciation the potential profit margin shrinks and the investor operates with less of a security blanket.

Growing housing inventory
Many factors can cause an increase in the inventory of unsold homes for a specific area (high home prices, overbuilding, changes in the job market, etc). As the inventory of available homes begins to grow, buyers have more to choose from and the advantages for a seller begin to diminish.

Some potential buyers have been priced out of market
High home prices have forced potential buyers in some markets to either look to condos (or other alternatives to single-family homes) or put their home ownership dreams temporarily on hold altogether.

Benefits of renting out

While now may not be the best time to try to re-sell an investment property, there are specific advantages in becoming a landlord in 2007.

"Priced out" buyers become motivated renters
Disheartened by the high cost of home ownership, a large number of would-be buyers are resigned to renting for the time being. That means that in markets where housing affordability is low, there is likely a segment of motivated renters who in different times would be qualified first-time buyers. Often these are singles or young couples looking to rent for two years or more as they wait for the buying market to normalize - a degree of stability that makes them ideal tenants.

Rents are on the rise
Higher home prices and rising interest rates have had a residual affect on rental markets, causing rising rents in countless cases. In part the option of home ownership serves as a check on rental rates: landlords as a whole can't raise rents drastically and risk convincing renters that their money would be better spent on mortgage payments. When average home prices exceed the affordability index, landlords are more inclined to begin raising rent.

Condo conversions cut the rental inventory
Like so many others, owners of multi-family buildings have sought ways to cash in on the real estate boom of the nineties. As a result, many apartment buildings have been converted into condominium complexes over the last several years. While condo conversions can be lucrative for the building owners, they also benefit landlords in the market by reducing the available inventory of rental units. In some cities, a spate of condo conversions has helped shift the market advantage from tenants to landlords.

Rental income is not tied to the home's appreciation
Unlike a re-sell investment, a rental investment's success is not directly tied to the overall appreciation of the property. Two key factors will determine the overall success or failure of a rental venture: 1) the rent that you can charge and 2) your ability to keep the unit(s) filled with paying tenants.

A home may have slow appreciation or even depreciate in value over the short term and still be a productive rental investment (provided, of course that you weren't planning to sell the property in the near future). If you intend to keep the home as a rental property, fluctuations in its sale value related to market changes do not (in general) affect its appeal to prospective renters. Naturally, this does not hold true if your home has lost value due to damage or disrepair.

Challenges

• Vacant Units - a landlord's greatest fear is a unit that sits un-rented for months on end. Vacant properties will fast cut into your profit margin and can turn your profitable rental investment into a financial drain. While periods of vacancy are all but unavoidable (especially during periods of tenant turnover), their duration can be minimized by monitoring the rental market and the satisfaction of current tenants.
• Finding viable tenants - selecting the right tenant is one of the trickier nuances of being a landlord. At the absolute minimum you should run a credit check on all applicants, and an additional background check is advisable as well. Insist on references from previous landlords. Fair housing laws prohibit discriminatory practices when screening prospective tenants.
• Rules and Regulations - a rental property is more than just an investment; it is the place of residence for your tenant(s). As a landlord, it is your responsibility to know and abide by all city, state and federal landlord-tenant regulations.
• Repairs - a responsible landlord always budgets and plans for repairs of normal wear and tear, and is also prepared to handle any larger repair projects that arise. In most states tenants cannot be charged for damages caused by normal use, and any non-refundable cleaning fees usually must be explicitly defined in the lease agreement.
• Emergencies - from flooding basements to broken toilets, every property that you rent has the potential to generate situations that require your immediate attention.
• Management companies - property management companies will screen tenants, handle repairs and emergencies, and handle tenant-landlord disputes for a fee. This may be attractive to landlords who prefer a hands-off approach, but the cost will diminish your profit margin.
• Insurance - if a tenant is injured on your property, you could be liable. Consult with a local insurance agent to determine appropriate coverage levels.
• Dollars and Sense - the price you pay for an intended rental property must be carefully weighed against the rental you can realistically charge. If you overpay for a property, your monthly mortgage payments may far exceed what you can expect to command in rent. Even some properties purchased at a reasonable price may be untenable as rentals if they are luxury homes

Strategies for success

• Don't rush in - set a realistic timeline that allows you to fully investigate the prospects of becoming a landlord, assess the market of available properties, secure funding and line up potential business partners.
• Educate yourself - spend time reading guides to renting property and become familiar with the applicable landlord-tenant laws. Before making any financial commitment, you want to be sure that you're prepared for all of the responsibilities of being a landlord.
• Research the rental market - areas with high ownership costs and low rental vacancy rates are ideal. Pay close attention to the job outlook for the region, as this can greatly impact the availability of qualified renters.
• The security blanket of college towns - any landlord will tell you that renting to college students presents its own set of challenges, but having a property near a university also affords a degree of stability. Areas near universities have a built-in supply of eager renters that will only be diminished if the university or developers construct additional housing. In particular, look for colleges that have a high ratio of students to on-campus beds. If buying an out-of-area college rental, the use of a management company is wise.
• Start small - chances are your first venture into the stock market didn't wow Wall Street, and the first home you bought didn't come with narration by Robin Leach. By the same logic, it's prudent to ease into the business of being a landlord with the purchase of a smaller property, even if you can afford a larger multi-unit complex. New landlords often underestimate the challenges and effort required of them. Pace yourself with a single family home or duplex. If your investment is fruitful, you can always move up the food chain later.
• Don't go it alone - smart landlords enter the business with eyes open and plenty of backup. An experienced real estate professional is your best asset when taking the plunge into the world of rental investments. Attain the services of an attorney (preferably one who specializes in real estate law) and keep your accountant in the loop. If you plan on using a property management company, review and select your firm of choice in advance. While it's usually not necessary to have a handyman on retainer, you should have a list of preferred repair and service companies at the ready. With the right help, you'll be on solid ground before you ever set out that first "For Rent" sign.

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