By M.P. MCQUEEN for the Wall Street Journal
Home prices are falling, rents are tumbling, and apartment vacancies are rising. So why are thousands of small investors becoming landlords?
Because real-estate prices have fallen much faster than rents, the math of buying a rental has actually improved substantially in most parts of the country. Money invested in an apartment complex today typically generates annual returns of 7% to 8% right off the bat, up from less than 6% at the peak of the housing bubble in 2006.
If your property appreciates in value or rents rise, you could end up with double-digit annualized returns when you sell it. But higher returns usually come with higher risks. If you overpay for a rental property or you buy in the wrong market at the wrong time, you can lose a lot of money.
In general, landlords should pick communities where real-estate prices and rents appear to have nearly bottomed out, and jobs are stabilizing. Some of the best deals are in places like Fort Worth, Texas, or Columbus, Ohio, where prices never went wild. Markets like Las Vegas and Phoenix, both plagued by overbuilding, and Detroit, hurt by auto-industry woes, still look dicey.
But other markets like San Francisco or Chicago can still be attractive for landlords who find the right neighborhoods. Fred Bertucci, 50 years old, has been investing in small apartment properties in the Chicago suburbs since 1990. In August, he and his business partner, Kevin Moriarty, 54, bought a six-unit apartment house out of foreclosure for $280,000. It brings in about $25,000 per year in net operating income, he says, or about a 9% yield on the dollars invested. That’s up from roughly a 5% yield several years ago when prices were higher, he says.
Being a landlord now isn’t easy. You need good credit and plenty of cash—as much as 50% of the purchase price—because banks are still skittish about lending. You need extra cash for handling repairs and vacancies, and you must have the patience to deal with difficult renters.
If you buy an investment property, you should expect to hold it for three to five years or more. Much of the big money from quickly flipping properties already has been made, and conditions now favor long-term owners who want an investment that will throw off income and slowly gain value over time.
“It’s a great time for someone who is focused on increasing his net worth, rather than doubling his money in a short period of time,” says John Burns, a real estate consultant in Irvine, Calif.
Geoffrey Koblick, 55, who has been investing in residential and commercial real estate for many years, recently scooped up two apartment buildings in Northern California. He didn’t buy any properties from 2003 through 2007, when “prices were too high based on the income the properties were generating,” he says.
Mr. Koblick says he and his partners paid $3.3 million in May 2009 for a 23-unit building in Berkeley that generates $199,500 in net operating income, for a 6% return. They are upgrading the property, and Mr. Koblick expects its value to increase dramatically over the next seven to 10 years, when he hopes to sell it. Since they bought the building with a 33% down payment, he projects the partners will end up with an annualized return of 15%.
Of course, things often don’t go as planned in real estate. J.P. Botha, 33, bought a new one-bedroom condo in Manhattan for $775,000 in 2007. Property values were rising, and he figured he’d sell it for a profit. Instead, its value on completion fell more than 25%. So he rented it out. His first tenant bailed after five months when she lost her job. He had to make a price concession to find and keep a second tenant.
“I’m hemorrhaging over a grand a month,” said Mr. Botha, who took out a 30-year mortgage to finance his investment. Still, he says he is taking the long view on his investment: “Once I pay off the loan I will have an income-generating property for the rest of my life.”