Real estate has been a great investment option over the years, as it promises commensurate returns. That explains the over 19 million rental properties in the US, with about 70% owned by individual investors.
Consequently, the built-for-rent (BFR) business has been a buzzword in real estate circles, with everyone clamoring for a piece of that pie. However, there’s been a seismic shift in the economy, which could impact that market segment.
There’s been a general economic decline. There are fears of a possible recession, playing to the soundtrack of doubled mortgage rates and home sales crashing while wages have stagnated.
To some real estate observers, the built-for-rent business model is about to take a significant hit, but will this come to pass? This article investigates the truths and misconceptions about the impact of the changing economic climate on BFR.
Economic changes affect rental prices and housing demand and can lead to extensive periods of vacancies. Some of these factors include:
Change in interest rates dramatically affects the cost of mortgage. For instance, in a period of high interest rates, the mortgage payment cost will rise, leading to a drop in the demand for home purchases. The knock-on effect is that since fewer people can afford homes, the only alternative is leasing, which increases the demand for rental housing.
A country’s income growth determines the demand for housing. People will spend more on houses as the economy grows and incomes rise, increasing demand and pushing up prices.
Indeed, housing demand is income elastic (luxury goods), with rising incomes leading to a more significant percentage of income spent on houses.
Similarly, people can’t afford to buy in a downturn, and those who lose their jobs may fall behind on their mortgage payments and have their homes repossessed.
Another economic factor that affects the rental market is the ratio of the house to price-earnings. From 2015 to 2022, house prices are higher than income growth by 36%, which means the number of people who can afford homes has reduced since 2015.
With the various changes experienced in the economy leading to the steady rise in house rent, many states have come up with multiple strategies, such as enacting rent control. This program limits the amount you can demand from the house you lease.
While rent control benefits tenants, these programs directly affect the house markets, which would impact you as a real estate investor.
The research at Brookings University shows that although the effects of rent control will decrease rent prices for tenants in the short run, its long-term effects include:
Further research shows that 8% of owners of rent-controlled buildings are likely to convert their facilities to condos to avoid the effects of decreased market prices. That led to a 25% drop in the number of renters in rent-controlled rental units as the property owners replaced the existing units.
The pandemic period greatly affected real estate, but its market reignited in 2021, and the housing demand rose. According to the Census Bureau of Housing Vacancies and Homeownership, the number of rental households increased to 44 million during the post-pandemic period, leading to a decrease in rental vacancies by 5.8%.
The strong demand for rental units also fueled the rise in the price of properties. In 2022 alone, the price of rental properties rose by 13.4% from 2021. Therefore, although mortgage rates rose, rental property acquisition has remained the same since property owners have access to rental income and can increase the rental price to match the mortgage repayments.
Over the past couple of years, rent prices have been escalating continuously at a rate of 15-20%. That means that the rent is unlikely to go any higher in the next subsequent years, likely dropping by a fraction of the rent rates experienced now.
Since the income for most renters has risen over the last couple of years (and will probably continue to rise in the subsequent years), there’s a likelihood that most will experience rent growth at a steady pace in the middle of 2023 after going through a brief slowdown in the rent growth.
Still, the increase in the rental income also means there is room for you, as the property owner, to raise the rent. Some of the indicators that show this is possible is the recent research by Real page, which showed that renters spent about 23% of their income on rent which is well below the affordability rate.
Built-for-rent construction always follows demand. Although the US is experiencing an economic slowdown, this hasn’t affected the development of housing units. Although housing prices seem to have stagnated at such a high price, that isn’t because a lack of housing drives up demand and prices, as they would typically do. On the contrary, considering there’s a 2-5 million rental unit shortage, BFR constructors still have plenty of catching up.
However, this only applies to built-for-rent houses. Built-for-sale housing is likely to plunge for most of the year.
The growth of rental apartments mostly stayed the same, even during the pandemic. Several factors explain why the rental estate is experiencing growth during these tough economic times.
For one, young adults leaving their parents’ homes and looking to form new households usually make their first stop at rental properties as they settle down.
Secondly, there is limited availability of new houses as they are currently beyond the reach of the average home buyer. Further, although the price of almost goods has risen across the board, incomes have largely stagnated, only growing 17.5% between 1979 and 2020.
Although the negative economic changes signal doom for the real estate industry, the built-for-rent segment seems poised to grow in strength. Mortgage and housing prices are still out of reach for many, and incomes have stagnated, which bodes well for BFR.
To the keen eye, the benefits of investing in BFR far outweigh the potential risks, which makes it a viable investment option.
Gurpreet Singh Padda, MD, MBA, MHP