A nationwide trend shows the population of renters is expanding much more rapidly than home buyers. The National Association of Realtors estimates that roughly four million new renter households have been created since 2010, versus a one million decline in homeowners.
This trend is especially evident in areas around large cities that have traditionally been domains for homeowners. A report by New York University noted that renters represented approximately 29 percent of suburbanites living outside the nation’s eleven largest cities in 2015, up from 23 percent just ten years earlier. The metropolitan areas analyzed in the report were Atlanta, Boston, Chicago, Dallas, Houston, Los Angeles, Miami, New York, Philadelphia, San Francisco and Washington.
The 2010s is likely to stand out as the strongest decade for renter growth in U.S. history, according to the Joint Center for Housing Studies (JCHS) at Harvard University. Some of this growth may be attributable to “empty nester” syndrome among baby boomers (born 1946-64), many of whom are taking the opportunity to reduce expenses and simplify their lives. Renting instead of owning is becoming a common downsizing strategy for retirees as reflected in statistics from the Urban Institute that suggest the population of renters aged 65 years or older will nearly double to 12.2 million by 2020.
Another factor contributing to rising rental demand is millennials (born 1985–2004) forming their own households. As a group, millennials have been slow to embrace home ownership. One reason for this may be that millennials are much more mobile than past generations. A 2015 survey by Rent.com indicated that 43 percent of millennials have re-located at least once due to work and 44 percent said that they are likely to move again in the next 12 months. Another factor contributing to lower home ownership rates among millennials is limited financial resources. Burdened by student loans, large numbers of millennials cannot easily afford monthly mortgage payments. Lending standards have also tightened since the recession, which has kept many otherwise qualified millennials from obtaining mortgages. In addition, fears of rising interest rates are keeping some potential millennial home buyers on the sidelines.
It is not just empty nesters and millennials who are fueling demand for rentals, however, According to the JCHS study, middle-aged Americans (aged 45 to 64) account for twice as many of the new renters as younger Americans. Researchers attributed the increase in the number of middle-aged renters to after-effects from the recession such as flat wage growth and depleted retirement savings. Even wealthier households have been affected. The JCHS study noted that U.S. households ranking in the top 50 percentile of income represented 43 percent of renter growth.
The rise of the renter nation is fueling growth in rental rates, which is in turn increasing the attractiveness of rental properties and encouraging more real estate investors to switch from fix-and-flip tactics to buy-and-hold investment strategies. In many Midwestern, Western and Southern states, buy-and-hold acquisitions of rental properties are already preferred over fix-and-flip investments. In other areas of the country such as the Northeast where house prices recovered more quickly after the recession, fix-and-flip investments remain popular.
Both fix-and-flip investors and buy-and-hold investors are benefiting from vacancy rates that remain near historic lows in many real estate markets. RealtyTrac’s Q1 2016 residential property vacancy analysis showed that only 1.3 million of the approximately 85 million residential properties nationwide, or roughly 1.6 percent of the total housing inventory, stood vacant in February, which was down 9.3 percent from one year earlier. Unusually tight vacancy rates help real estate investors by putting upward pressure on both rents and home prices.
A 2016 Rent.com survey indicated that more than two-thirds of property managers believe rents will rise an average of eight percent this year. The majority of property managers also reported raising rents in the past 12 months and plans to increase rates further within the next 12 months. Other real estate experts have forecasted rent increases averaging approximately four percent this year, a rise still well above historic annual rental rate hikes.
Bankrate.com noted several metro markets where rents are unusually high compared to sale prices on residential real estate. These markets included Detroit, Chicago, Houston, Minneapolis St. Paul and Boston, In the Chicago market, for example, the median sale price for a home was approximately $135,000 and the median rental rate was approximately $1,700 per month. Chicago buy-and-hold investors were thus generating gross yields on rental properties exceeding 15%, excluding taxes, renovation and other expenses. In general, buy-and-hold investors consider gross yields above 10% an attractive return on their rental property investment.
For real estate investors, there are several advantages of a buy-and-hold strategy versus fix-and-flip. First, rent payments create a reliable stream of monthly income that can be used to fund other ventures. Second, buy-and-hold investments are generally taxed at a lower rate. The profits from a fix-and-flip transaction are typically taxed as ordinary income, but profits from the sale of a buy-and-hold rental property may be taxed at the long-term capital gains rate. In addition, investors who used a 1031 Tax Exchange to acquire their buy-and-hold property may avoid capital gain taxes altogether. Third, buy-and-hold investors have better control over the timing of the property sale. Fix-and-flip investments rely on quick turnarounds to generate profits and gains sometimes evaporate if a sale must occur during a market downturn. Buy-and-hold investors can time property sales to coincide with peak markets while continuing to generate rental income during market downturns.
Whether the real estate investment is structured as a fix-and-flip or buy-and-hold, the lenders that finance these transactions, which include banks and non-bank lenders such as mortgage pool funds, remain positioned for profitable growth as a result of rising rents and appreciating home values. A robust real estate market is making the properties in their portfolios more valuable, reducing portfolio risk and increasing demand for financing from real estate investors eager to close more deals.