As investors search for alternatives that can help diversify their stock and bond-laden portfolios, some are turning the real estate market. If you’re not into flipping houses, there’s a lot to consider if you want to invest in real estate.
While unemployment rates have steadily fallen since their 10 percent peak of the Great Recession in 2009, median household income continues to stagnate, remaining 1.6 percent lower than it was in 2007, adjusted for inflation.
“This, together with the likelihood of rising interest rates, means that homeownership will remain depressed and affordable apartments will be in demand by the country’s workforce,” says Kevin Finkel, executive vice president of Resource Real Estate in Philadelphia. “With unemployment back to pre-recession levels, more and more young people will be leaving home and forming households, and they prefer to rent.”
With rental demand growing stronger, Finkel says some investors are looking towards mid-ranged multifamily housing.
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According to the FreddieMac Multifamily 2017 Outlook, the market will continue seeing growth at a moderate pace, with Sacramento, California; Tacoma, Washington; Colorado Springs, Colorado; Seattle and Portland leading urban markets, based on gross income growth.
Charles Gross an equity analyst at Morningstar in Chicago, says multifamily housing will make up a large portion of new housing construction — about 25 percent of all total homebuilding during the next decade.
“A lot of this is a function of constrained credit,” Gross says, which has led to more challenging conditions to secure a mortgage and led to a higher reliance on renting in recent years. As conditions loosen among big banks over the next five to 10 years, single-family housing will play a larger role, he says.
But Finkel says that won’t happen any time soon. With rising construction costs, many developers are concentrating on building or remodeling luxury multifamily units, often in urban downtowns that will deliver high rents.
That has created a mismatched diminishing supply and growing demand that could be an investing opportunity, Finkel says. There aren’t a lot of options for renters who need more affordable choices in the middle-income market. Even as developers have started building more for the entry-level market, Finkel says it would take years to create enough new affordable apartments and single-family homes to meet demand.
“The supply hasn’t been built for the past 15 years,” Finkel says. “Everything that is being built is high end so there’s a real housing crisis in the middle.”
Invest in existing units instead of new construction. Base costs for supplies such as drywall cost the same if they are put into a high-end or middle-end building.
“Which is why many developers are focusing on building new luxury rentals,” Finkel says. “Investors should play the opposite spectrum and be wary of new development. When you build from the ground up, there’s so much money flying around. You could build something no one wants, have costs overrun or people stealing from you. Development is a very messy business. It takes a lot of risk.”
Finkel also suggests investors avoid single-family units that aren’t going to produce a steady income. “Most people don’t rent out their homes,” he says. “So, it’s a consumer purchase of a commodity product, like buying a car, except with a house we are able to keep up the appreciation price because we are constantly putting money back into a home.”
Decide how much you want to invest. It’s also important to consider how much of your net worth you are comfortable investing with the understanding that all real estate investment involves investment market risks and capital market risks, ranging from interest rates and financing terms, says Yuen Yung, CEO of Casoro Capital in Austin, Texas.
“Even large institutional investors such as pension and endowment funds generally limit their exposure in real estate to somewhere between 8 percent and 15 percent of their investment portfolio,” Yung says. “Keep in mind that real estate is considered an illiquid asset, so carefully consider if you may need immediate access to your invested capital.”
[Read: How to Begin Investing in Real Estate.]
Before any small investor acquires real estate, they should consider if they have the time, capital and expertise to compete effectively, Yung says. If you are considering directly owning housing, make sure to decide who will manage the leasing, rent collection, repairs and maintenance and the inevitable problems that will arise or if it you plan on budgeting for a third-party management company.
Understand REITs and other options. Many people own real estate as way to diversify their assets. Unlike owning a share of physical piece of property, real estate investment trusts are typically modeled after mutual funds with income-producing real estate assets. Experts say many investors don’t consider them. Even though exchange-traded REITs offer more liquidity, they also include more volatility due to market fluctuations, much like owning stock in the Standard and Poor’s 500 index.
Instead, Finkel suggests every day investors consider looking at nontraded REITs that can be purchased through their financial advisors that offer “a lot more price stability.”
According to FINRA, both exchange-traded and non-traded REITs are subject to the same IRS rules, must distribute at least 90 percent of taxable income to shareholders and register and file disclosures with the Security and Exchange Commission.
Finkel says accredited investors may also want to consider limited partnerships where a group of general partners find investments and look for limited partners to invest.
Look at building supplies. While many investors only look at investing in property, Gross also points to non-direct assets. Roughly half of all lumber goes into new construction or repair and restoration, Gross says. He points to Canadian companies such as Canfor Corp., a small-capitalization company on the Toronto Stock Exchange that has made a name for itself as a low-cost producer, and Weyerhaeuser (ticker: WY), a timber REIT with minor lumber exposure.
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Even though housing starts declined 2.6 percent in February to a seasonally adjusted annual rate of 1.25 million units, Gross says he expects pricing and a depressed lumber market will rebound. “We think lumber is undervalued and the market is underestimating how much building is going to take place which needs lumber,” he says.
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How to Invest in the Housing Market originally appeared on usnews.com
