How To Invest In Real Estate When The Bubble Deflates

With increasing signs that the rapid rise in house prices is over, rental property investors will have more options over the next few years as sellers outnumber buyers and prices fall – slowly in most markets but very quickly in others.

As has ALWAYS happened in the past, house prices and rents will eventually adjust back to local incomes. This rebalancing may take years, but investors don’t have to wait that long to spot good opportunities.

In all real estate markets, some areas perform better than others, in both down and boom periods. Investors can see the differences with solid local data.

Local data can tell you if there will be strong or weak demand for housing, what rental price range you will find the core of the rental market in and what type of investment performs best in the local housing mix. Then investors can decide whether an available property suits the local conditions.

For example, Charleston, South Carolina has been a strong real estate market for years, few places like Austin and Boise have grown faster. But some areas within the Charleston market will do better than others over the next few years.

First, let’s look at local income growth, by which I mean total income, not just average. This gives an indication of how strong the demand for housing will be: whether people and money will flow into an area or not.

Look at the table Ladson (zip code 29456). In the last three years, total revenue has increased by 45 percent. In Summerville (zip code 29485, just down the road) income rose just 14 percent; and in Hollywood (Zip Code 29449, just west of the city), total income fell by as much as 4 percent.

It sure looks like Ladson is the better bet for rents and real estate prices going forward. If prices go down, Ladson will present better opportunities than the other two. That doesn’t mean you shouldn’t invest in Summerville or Hollywood, just that you need to trade harder there because you can’t anticipate strong future demand.

The next step in valuing a property is to identify the heart of the local rental market – the range of monthly rents where you currently find most renters. This is very important because if the property rent is much higher than this range you will have trouble finding a tenant, maybe not now but in two years time when the average tenant moves out. That’s when you might be left with an empty property or need to cut the rent.

Let’s look at Ladson again in our table. In 2021, the majority of tenants paid between $1,007 and $1,524 a month in rent; Add about five percent to bring that to $2022. A property with rents in this range will easily attract renters, but if you plan to charge $2,000 there will be far fewer people who can afford it.

The final step is to figure out what type of investment is easiest. The ratio of the average home price to the average annual rent can give you some clues as it is a measure of how expensive homes are compared to renting. Typically it is around 18. A single family rental is easiest when the ratio is between 15 and 22. Over 22, most houses are too expensive to rent, so it’s easier to split up apartments or a house into rental units. Under 15 apartments are cheap relative to rents, so buying and upgrading to a higher rent is a good opportunity.

In Ladson, the median home price in 2021 was $216,000, while the median monthly rent was $1,271. The average annual rent was therefore $15,252 and the home price to annual rent ratio is 14. This low ratio means that just about any type of investment is fairly easy here, whether it’s single family rentals, apartments or renovations.

In Hollywood, on the other hand, where there are significantly fewer renters, the rate is a high 28. Here you have a hard time with a single-family rental, apartments are an easier investment.

None of these are hard and fast rules, they are guidelines. They let you see the forces driving the local market. They rely on hard data, not wishful thinking. A good investment opportunity might go totally against what they’re proposing, but if it does, you should probably find out why.

How to get the data

It’s a bit tricky the first time, but it’s worth being patient.

Local income data is available through the census.

censusExplore census data

On the left side of the page are filters. For Geography, select ZIP code table area and select the desired ZIP code. Select “Income and Poverty” as the topic, then “Income and Earnings” and then “Income”. Select for years 2020. Then click the Search button at the bottom right.

You will see a list of tables. Click on S1902 Average income in the last 12 months. The table shows how many households there are and what the “mean” (average) income per household is. Multiply them together to get total income.

Repeat for 2017 and then calculate the increase. This is step one of the strategic analysis, and the most important.

For the rental area, go to the Census website again and select the zip code. Now select Housing as the topics, then Financial Characteristics, and then Tenant Expenses. Select 2020 as the year and then search as before.

You want table B25063 Gross Rent. It shows how many current tenants are paying how much monthly rent. For the 29456 zip code, the core of the rental market is likely to be between $900 and $1500 (note that the reporting intervals are not all equal). Update this range for inflation to 2022.

To calculate the price to rent ratio, go to the Census website and select the zip code. Choose housing, financial characteristics as the topics and check both the housing value and the tenant costs. Select 2020 as the year and then Search.

You get Table DP04 Selected Apartment Characteristics. Scroll down to get median occupancy ($182,600) and then median gross rent ($1,199, monthly). In this case, the ratio of home value to gross annual rent is 13. Updating the values ​​to 2022 gives a ratio of 14, not much different.

Alternatively, Local Market Monitor provides the data in this article for Charleston, SC and publishes over 200 reports with those calculations already done for you.

Softening markets are a time of opportunity. You are looking for an investment that will retain its value and provide good returns year after year, well into the future. If you take the time to analyze an area’s attractiveness, the most suitable rent and rental type for the local housing structure, you have the best chance of making a solid long-term investment.