One of the best performing asset classes this year is residential real estate. According to most real estate indexes such as the Federal Housing Finance Agency (FHFA) or Case-Shiller, home price appreciation rose from 18.5% to 19.5%. Although this figure is lower than the 24% increase since the start of the year in the S&P 500, it was still a great year for house prices.
Professionally managed money floods rental space
As individual owners buy properties for rent, we’ve also seen a lot of professional money entering the buy-rent space. Investment giant Black rock (NYSE: BLK) bought Home Partners of America for $ 6 billion. Other large investment firms have raised funds to purchase rentals.
For institutional fund managers, this strategy is quite attractive as they earn rental returns on properties, deduct depreciation (which can lower taxes) and benefit from home price appreciation. I recently wrote an article on the Single Family Rental Real Estate Investment Trust (REIT) 4 American houses for rent (NYSE: AMH), where I explained how much appreciation in home prices has added to the intrinsic value of the business.
The government gave institutions an advantage for a while
Interestingly, institutional investors got a head start over more traditional mom-and-pop owners in the first half of 2021. FHFA ordered government-sponsored entities Fannie mae and Freddie mac to limit their loans secured by investment properties.
Family investors rely heavily on loans from Fannie and Freddie to finance real estate purchases. These limits have made these mortgages on investment property rare and expensive. Large institutions like BlackRock or American Homes 4 Rent have many other ways to raise investment capital. Eventually, Fannie and Freddie reversed the caps and leveled the playing field between institutions and individuals.
The math of rental investment
As home price appreciation has increased with high percentage growth rates, rents have followed, with some estimates of one and two bedroom apartments increasing by 21% and 17% respectively from a year ago. on the other.
So, from an investment point of view, rental properties have a capitalization rate of around 7% per year, which is the average for the last 10 years. Thus, the property generates an income of approximately 7% per year, and this income increases at a rate of 19%, just like the underlying property. If it were a stock, a one-bedroom apartment could have a yield of 7% (in other words, a price-to-earnings ratio of 14 times) and increase its profits by 21% per year.
Renowned investor Peter Lynch looked at the earnings growth and P / E of a stock and combined them into the PEG (or Price / Earnings / Growth) ratio. This rental property would have a P / E of 14 and a growth rate of 21%, i.e. a PEG ratio of 14 divided by 21 or 0.67. Lynch has targeted stocks with PEG ratios below 1, so the 0.67 ratio would be a clear buy.
Home hacking, flipping and passive income
The rental property space is still dominated by family investors who intend to rely on this passive income to supplement Social Security in retirement. Another great strategy is home hacking, where an investor buys a multi-unit property, occupies one unit, and collects rent from the other units, which can drastically reduce the investor’s cost of living.
Finally, we see a lot of fix-and-flip investors, but rising prices for materials and labor make this strategy risky for investors who don’t have six to 12 months of cash flow. reserve to rely on until the property is sold. .
As long as the stock market remains expensive and bonds earn paltry returns, residential real estate will remain a popular vehicle for investors looking for growth and income.
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