In ordinary times real estate investors don’t worry much about where to invest. Every local market has opportunities, every one has rental properties you can buy, every one has homes you can develop to produce income. Growth markets provide the chance to get higher returns but even stagnant markets need housing that can provide better returns than stocks or bonds.
Right now we’re not in ordinary times. The covid pandemic still threatens economic recovery, work and living patterns may be permanently altered, and a surge in home prices has disrupted our notions of what a home could be worth or what an investment property should cost.
Despite these difficulties – or rather, because of them – here is our guide using data from Local Market Monitor, Inc. for where and how investors can achieve the best returns with the lowest risk in the coming year. We will identify markets where demand for rentals should be strong but also – because most investors want to stay local – will show how to maximize your return in any local market.
Let’s start with the basics, will there be more or less demand for rentals in the coming years, and what kinds of rentals? The pandemic has soured a lot of people on living in apartments in crowded cities, the recent jump in prices means a lot of them are trying to buy a home. On the other hand, there are still fewer jobs than before the pandemic, and fewer people who can afford a home. Last year household income fell in all income brackets but most for people with modest incomes.
The job situation tells a similar tale. Most of the jobs lost during the pandemic were in low-pay fields such as retail, restaurants, tourism, nursing homes and temporary work. Many of those jobs will never return, yet the people who held them still have to live somewhere, and many of the new jobs created (in Amazon warehouses for example) have similarly low pay.
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These developments point to an increase in renting over the next years, and especially in lower-cost rentals like apartments. In some places single-family homes are cheap enough to be part of that rent level but in many markets you’ll have to split homes into rental units.
Every local market has a rent profile – how many people pay how much rent – and a “best” rent range where you find the largest concentration of renters. At this time of greater demand, investors should aim for rents in the “best” rent range, which will usually mean apartments or row houses.
While this guidance applies in any market, it’s even more important in markets where home prices have recently risen sharply; you can’t just raise rents to match home prices.
The table “Big Price Increase” shows 24 markets where home prices rose dramatically in the past year, also the average home price, average monthly rent, and the ratio of home price to annual rent.
Quite aside from the strong possibility that some of these markets are in a price bubble that will burst in the next few years, the ‘home price/annual rent’ ratio points to the best way to invest in these markets.
Where the ratio is 22 or less, as in Las Vegas, Fort Worth, Camden and Atlanta, it’s possible – even with the recent jump in home prices – to buy a house and rent it out as is. (Often this happens in markets with low home prices, but not always; Knoxville and Fayetteville have the lowest home prices in the list, but even lower rents.)
Once you reach a ratio near 30, as in Boise, Austin, Spokane, Salt Lake City, and Portland, it’s almost impossible to find tenants who can afford to rent an entire house. You might be able to find a tenant now, in the middle of a boom when housing is scarce, but it will be much more difficult in two years, when the average renter moves on.
In high-ratio markets it’s best to stick with apartments or to buy a house that can be sub-divided into rental units.
For markets with a ratio in between, it can be possible to buy a straight rental but you must pay close attention to the local rent profile, which is usually different in different zip codes. With prices higher for investment properties you may be tempted to just aim for a richer renter, but if the rent you want is much higher than the “best” rent range you’ll have a lot of trouble finding one; remember that this will be a problem every two years, not just now, and especially if more renters are moving lower in the rent profile, not higher.
The big price increase isn’t the only problem for investors in 2022, there’s still the pandemic. It’s still here, it still depresses growth, and it has different effects in local markets. We don’t yet know if the job losses in some markets will be permanent or when they might return. In this situation of uncertainty, the lowest-risk investment is a single-family home that can be rented out with minimal upgrade; if your returns don’t work out as planned you can just re-sell, maybe even at a profit.
The table “Single-Family Rental” shows 24 markets where the ‘home price/annual rent’ ratio is low enough to allow straight single-family rentals. All of them had double-digit price increases in 2021 but the price/rent ratio is still favorable. We also show the current level of jobs compared to the level before the pandemic.
In a few markets, like Des Moines and Kansas City, the number of jobs is now higher, a strong sign of better growth as the recession recedes, in others like Greensboro and Virginia Beach it is still three percent lower. The difference is significant because markets where jobs lag behind may be on a slow growth track for years; we just don’t know if and when the laggards will ever catch up and that means future demand for housing in those markets is much less certain.
Any of these markets are good candidates for single-family investment, but in those with job losses still around three percent you need to be more careful about the price you pay and what rents you charge. Investments with rents in the middle of the “best” rent range can most easily be resold if it turns out in a few years that economic growth has not returned. The middle of the pack is a good strategy anytime but even more so in 2022, when future economic developments are still so uncertain.