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 pitches generally aim to eliminate the day-to-day headaches of being a landlord, and the potential payoff can make the concept worth considering. Investors can buy in for the price of a single-family home or a single share of stock.
But the plunge in U.S. home prices in the financial crisis should be a fresh reminder that bets on housing can sour in a hurry.
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.
Don’t go overboard. Investors should maintain a diversified portfolio that also includes stocks, bonds and cash. Single-family homes shouldn’t exceed 5% of their investments, not including their primary residence, says Jeff Sica, president of Sica Wealth Management in Morristown, N.J.
For the moment, the supply of rental homes and the demand from renters are high. Some 14.9 million single-family homes were occupied by renters in 2013, up 31% since 2006, before the U.S. housing market collapsed, according to data released this past week by the U.S. Census Bureau.
The vacancy rate on single-family rentals fell to 7.3% in the second quarter, down from 10% in the fourth quarter of 2008, according to the bureau.
Here’s what you need to know about making money in the rental market.
The Traditional Route
Many investors become landlords on their own.
Millions of the single-family homes occupied by renters are owned by investors who have just one such rental property, estimates Jade Rahmani, who tracks the single-family rental market as an analyst at Keefe, Bruyette & Woods, an investment bank based in New York.
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, says Jack McCabe, an independent housing analyst in Deerfield Beach, Fla.
Investors should plan to own a home for at least 10 years and realize that they may shell out significant sums before seeing a return on the investment, says Mr. Sica. Be careful about taking out big mortgages. “Low borrowing rates encourage speculation,” he says. “Investors are constantly tempted to take cheap money and not be as diligent with the deals they do.”
Investors should also research the expected annual expenses, including property taxes, insurance and maintenance, says Mr. McCabe. Allow for the fact that property taxes and insurance rarely decline, and can sometimes spike suddenly.
The net gain, once taxes on rental income are factored in, should be at least 8%, he says.
Landlords also routinely get emergency calls from tenants about urgent repairs, so it is often best to live or work in the area to get to the property quickly, if necessary. Experts say tenants tend to take better care of a home when they know the owner is nearby.
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.
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.
Memphis Invest, a real-estate brokerage based in Memphis, buys properties—which have often gone through foreclosure—fixes them up, rents them out and then sells them to investors. It will also manage the property for a fee. It has been operating in the Memphis area since 2004, and it expanded to Dallas in 2010 and Houston in January.
HomeUnion, based in Irvine, Calif., helps clients find prospective rental properties and purchase them. The firm will then help buyers find property managers. HomeUnion launched in 2011 and operates in 15 metropolitan areas, primarily in the Southeast and Midwest, and is expanding to others by year-end.
San Francisco-based Dwell Real Estate Advisors also helps buyers find rental properties to purchase. Typically, the homes already have tenants. Dwell will help clients find a property manager. The firm operates in and around Atlanta, Chicago, Dallas, Houston and San Antonio, as well as in Northern California and South Florida.
The 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.
Mike Cook, who is 61 years old and lives in Hollister, Calif., says he has spent about $350,000 purchasing five rental homes in the Indianapolis and Cleveland areas through HomeUnion over the past 18 months or so.
“I was looking for what I consider a more stable return on investment,” says Mr. Cook, a manager at a construction-materials firm. “It’s not about appreciation of properties. It’s really about cash flow.” He says he has earned a 5.5% to 7% return on each property so far, after management fees and property taxes.
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.
In addition, the National Association of Realtors’ website provides quarterly updates on median home-sale prices in many metro areas. Rising prices suggest that investors have a better shot at recouping their cash—and possibly turning a profit—if they suddenly have to sell.
There are other potential drawbacks. Memphis Invest charges a 15% to 20% premium on the homes it sells, says Chris Clothier, a partner at the firm. That could make it harder for an investor to unload the property at a profit in the near term.
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. Memphis Invest charges 9% to 10% of monthly rent, depending on the number of homes it manages for an investor.
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.
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, says Jason Lail, manager of real-estate research at SNL Financial, a financial-information firm based in Charlottesville, Va.
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.
Performance varies widely. For example, one such REIT, American Homes 4 Rent, has logged an 8% gain this year, including dividends, through Thursday, while another, Altisource Residential, has logged a 12% loss, according to FactSet.
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.
REITs that bought single-family homes around 2009 and 2010, when home prices were near bottom, may provide greater returns, says Mr. McCabe. So may REITs that are currently buying in cities where purchase prices and other costs are relatively low, such as Dallas, Indianapolis and Nashville, he says.
The company’s management can also be crucial. Returns could depend on the companies’ access to capital and operating efficiency, among other factors, says Mr. Lail.
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.
Typically, investors decide how much cash they are willing to put up. Groundfloor will accept as little as $100 per lender.
Michael Patzer, a 27-year-old software engineer who lives in Atlanta, says he began making loans through Groundfloor in March and so far has helped fund seven deals by putting up $300 to $1,600 for each. The loans must each be repaid after six months, and the interest rates range from 8% to 12%. He has already been paid back on two of the deals.
He chose short-term deals and focused on homes he believes are a good value in an effort to limit potential losses.
“I certainly think of the risk in any of these projects,” Mr. Patzer says. “This hasn’t been done before.”
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. Groundfloor currently operates only in Georgia.
Others have a greater reach but are currently only available to accredited investors—individuals with annual income of more than $200,000 or a net worth of more than $1 million, excluding their primary residence. IFunding handles deals in Indiana, Louisiana, Massachusetts, New Jersey, New York, North Carolina, Ohio, Texas and Wisconsin. Patch of Land operates in California, Florida, Georgia, Illinois, New Jersey, New York and North Carolina, and it is expanding to seven more states soon.
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.