Two-and-a-half years into the U.S. housing recovery, the
real-estate industry is rolling out new ways for individuals to invest in the
property market. Brokers, property managers and others are helping buyers
purchase houses in distant cities and manage them as rentals for a fee.
Publicly traded trusts that collect rental income are selling shares to
investors. And crowdfunding startups are matching buyers with willing lenders.
The latest deals often don't depend on home values going up,
which sets them apart from the house-flipping strategies that cost many home
buyers dearly when the market collapsed. Yet investors could still face losses
if, for example, the economy weakens and renters can't keep up with their
payments.
Those who buy a rental property and then need their money
back down the road could also get burned. Unlike stocks, bonds and mutual funds
that can be sold quickly, it can take months to unload a house even in a strong
market. And if prices decline, investors may lose a chunk of principal for
good.
Despite the risks, investors worried about pricey stocks and
meager bond yields can be lured by the prospect of a steady income stream and
average annual returns that could range from 5% to 15%, if things go well.
Here's what you need to know about making money in the
rental market.
The Traditional Route
Many investors become landlords on their own.
There are many benefits to going the traditional route. You
get to choose the tenants, and you decide how much rent to charge them. You
don't have to pay fees to a property manager, which can eat into your returns. But
it also means taking on a lot of responsibility, both when buying the property
and while owning it.
Would-be landlords should figure out whether they are paying
a good price. That means knowing the market and hiring an inspector to
determine what repairs a house may need. Buyers should lower their offer to
account for expensive repairs such as to the roof or boiler.
Investors should also research the expected annual expenses,
including property taxes, insurance and maintenance. Allow for the fact that
property taxes and insurance rarely decline, and can sometimes spike suddenly.
Be prepared for worst-case scenarios, and study local laws.
Landlords, for example, may have limited options if a tenant stops paying rent,
and evictions can take months in some places.
One-Stop Shopping
To many investors, doing all that work sounds hard. An
expanding roster of real-estate firms promise to make the process easier—for a
price.
Firms generally look for homes that have low prices, usually
$60,000 to $150,000, but that have the potential to fetch relatively high
rents. In addition to helping investors find a house to buy, the firms make it
easier to invest far from home, including in markets where home prices may be
lower.
But investors also surrender a great deal of control in such
deals, particularly if they don't live nearby. They should consider visiting
the property before purchasing it, or at least request extensive pictures of
the home, including all the rooms, the roof and major appliances.
Research the local market, too. For example, investors can
check the Bureau of Labor Statistics website to see whether the local
unemployment rate is decreasing, which could suggest a smaller chance of
renters falling behind on their payments.
There are other potential drawbacks. Fees can also add up.
HomeUnion, for example, charges 1% of the purchase price annually as long as
the investor owns the property. It also charges 7% to 10% of monthly rent when
the home is occupied.
Investors should also plan to closely track a property
manager's expenses and review receipts for repairs. In addition, investors
should consider what could happen if the home is vacant or the renter doesn't
pay. Some of the firms guarantee rent payments for a year, but even they make
no long-term promises.
Taking Stock
Investing in a home means placing a risky and concentrated
bet. So does buying shares in a company that owns homes—but the price tag can
be much lower.
Firms that own portfolios of single-family rentals are for
the first time offering shares to the public through real-estate investment
trusts, or REITs. Six REITs that are entirely or primarily focused on
single-family homes have started trading publicly since the end of 2012.
Many of the properties were distressed homes purchased from
banks at a discount, then repaired and rented out. Much of the rent the REITs
collect gets passed on to investors. Shareholders must receive at least 90% of
a REIT's taxable income in the form of dividends each year.
Investors should consider the risks of an investment that is
so new. Before buying shares, investors should review a REIT's holdings by
checking the firm's website and filings with the Securities and Exchange Commission.
The company's management can also be crucial. Returns could
depend on the companies' access to capital and operating efficiency, among
other factors.
Crowded House
Crowdfunding—the practice of pooling small amounts of money
from many investors—has helped budding entrepreneurs capture the imagination of
strangers who combine to bankroll a dream.
Recently, home buyers who think they have found a promising
fixer-upper have gotten into the act. New online crowdfunding platforms that
focus on housing, such as Groundfloor, iFunding and Patch of Land, have
launched over the past year or so. These firms consider pitches from borrowers
who want to repair a home, then sell it or rent it.
The firms then post the approved projects online, listing
the property, the requested loan amount, the interest rate the borrower will
pay and the amount of time it will take the borrower to repay the loan.
But there are limits and risks to crowdfunding. In some
cases, investors may only be able to participate if they live in the same state
as the house. If borrowers default, the platforms say they can foreclose on the
properties and sell them to make investors whole. Some will consider renting
the property instead. But investors could be at risk if home prices fall or the
economy falters—two possibilities that investors who lived through the
financial crisis should know are all too real.
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