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Neighborhood, local economy dictate profit potential

by Steve Bergsman

MonopolyBuying foreclosed, or otherwise inexpensive, residential  units with the game plan of renting the property for as many years as it takes  until real estate appreciation returns has proven to be a time-tested and  generally successful investment strategy.

Unfortunately, it’s not as easy as it appears.

Just  because a residence, whether a condominium or a single-family residence, can be  acquired cheaply doesn’t mean that a home-rental scheme can be  operationally profitable.

It would seem that with so many foreclosures and REOs (bank-owned  homes) on the market that now is certainly the time to make an investment in a  rental property, and many experienced investors are plowing through bank  auctions with vigor. Those folks I don’t worry about. It’s the novice investor  and those new to the business to which I have these four words of caution: You are  not alone!

There are so many investors buying up homes with busted  mortgages, thinking they are going to transform the property into a rental,  that a glut of houses for rent in your neighborhood is coming — or might  already have arrived.

New investors fall in love with a property. They see a house  or visit a condominium and immediately want it, sparing no effort in making the  acquisition. They become so entranced by the real estate that they don’t do the  research required to see if the property can, indeed, be a viable rental.

Let’s say, for example, that you find a house you want to  buy so you can turn it into a rental. It’s in a good neighborhood and you can  buy it fairly cheaply. However, you don’t do any research so you fail to turn  up the fact that a multifamily developer will be building a huge apartment  complex one mile from your property, creating intense competition for renters.  Or that most of the people in the neighborhood, where the object of your real  estate desires can be found, work in a manufacturing plant that will be closing  up in three months and putting everybody out of work.

Those are extreme situations. A more likely scenario is  this: too many rental properties in your city, creating too much competition,  driving down rental rates too severely to make investments operationally  profitable.

As I mention often, I live in Mesa,  Ariz., about 20 miles from downtown Phoenix. According to my  local newspaper, the Arizona Republic, in my city alone there are almost 17,000  single-family home rentals; in Phoenix,  there are 49,694 single-family home rentals; and in the metro area as a whole,  133,990 single-family home rentals.

I checked in with an associate and good news source, Alan  Langston, executive director of the Arizona Real Estate Investors Association,  about what this situation, which looked to me like a glut of homes, meant for  single-family home investors.

What I got was a verbal wagging of the finger; There is no  glut, he contended. There was enough demand — at the moment — so that home  rentals in the Phoenix  metro area still showed a low vacancy rate. However, even he admitted that the  market was rapidly changing and there was a downward pressure on rental rates.

Denver photoPhoenix  isn’t the only metro that might be facing a glut of home rentals. I got on a Denver home-rental blog  that reported although rents were still on an upswing, the supply of home  rentals was increasing as well, meaning that the upswing could easily reverse  and become a downswing.

The problem in Denver was the  same as in Arizona  and elsewhere. Real estate investors were diving into the foreclosure market,  picking up properties and then renting them out. In past years, these same  homes might have been flipped, but the lack of credit and millions of workers  picking up unemployment checks have combined to drastically narrow the pool of  potential buyers.

When considering becoming a single-family residential  landlord, use common sense. The basic law of supply and demand in regard to  single-family rental properties is this: Try to avoid a neighborhood with a lot  of foreclosed homes. It doesn’t matter if these homes have been purchased and  retain market appeal, because the owners are investors who will be renting out  the property just as you hope to do. And, as in all industries, a surfeit of  the same creates a glut, which will at minimum keep prices low, or at worse drive prices down hard.

If you want to invest in a single-family home that will be  used as a rental property, it might make more sense to pay more for a property  in a neighborhood that is not so beaten down with foreclosures. Without the  intense competition you could probably set a rent that will make the property  operationally profitable — at least for near future.

“I’m still telling folks this is one of the best real  estate investment markets ever,” says Langston. “If you can acquire  rental properties, buy and hold, it is a good strategy. You just have to be  careful. Depending on how you structure your transaction will make the  difference whether you will be in good shape or not.”

Obviously, an all-cash investor has the flexibility to lower  rents and still be in a profit position. That’s not true for an investor who  borrows capital to make the transaction. If there is a single-family home-rental  glut in your target area, which is becoming increasingly likely, it’s better to  do the research and discover it before you buy.

Then tread carefully.
Steve Bergsman is a freelance writer in Arizona and author of several books, including “After the Fall:  Opportunities and Strategies for Real Estate Investing in the Coming Decade.”

Copyright 2009 Inman News
See Steve Bergsman’s feature, Turbulence Seen for Reverse Mortgages.
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