Over the long run, rent returns may be more important than price appreciation.
There’s an old saying about risk that anyone in CRE should know: Don’t bet the rent.
For most people, it would mean not to risk core resources that you’ll need at the end of the month, no matter how certain you are that you could make a killing.
But for CRE pros, at least according to this analysis from CoreLogic, the message is not to think of rents as an also ran because you’re sure the big return will be from price appreciation.
CoreLogic’s analysis was specifically about owning homes and seems largely directed toward regular homeowners. But it has a lot to say for those investing in houses and renting them out—and more broadly.
“Owning a home is analogous to owning stock in that there are two ways to make money from it,” wrote Thomas Malone, a professional economist in the office of the chief economist at CoreLogic. “You can let the asset appreciate and resell it to collect the capital gains, or you can hold the asset and collect dividends, like collecting rent from a home. Only looking at one or the other will not measure the full return. Even if you are living in your own property and not collecting rent, you still benefit because you are not paying rent. This opportunity cost is often referred to as imputed rent.”
He added CoreLogic Home Price Index (HPI), which measures price appreciation, and Single-Family Rent Index (SFRI), which is “all rent over a certain time divided by the initial purchase price.” But the question is where does the money come from?
“Historically, rental returns have proven more stable than appreciation. Since 2005, annual rent has ranged from only 5 to 8 percent of prices, compared to price appreciation between 18 and 20 percent over the same period. This means that which component matters more will vary year by year but given the rarity of price growth that exceeds 5-8 percent, rent will usually give a better return,” Malone wrote.
And, for specific local markets, the balance of where the return comes from varies. “Looking solely at prices, California has been the best place to accrue value on a home for the past couple of decades,” said Malone. “This flips when we bring rent into the picture. Metros like San Francisco, Oakland and San Jose have experienced huge price gains due to demand for the areas’ high-paying jobs butting up against its restrictive housing supply. However, the rent returns in the Bay Area are lacking compared to locations in the areas like the Midwest. Chicago, for instance, has appreciated at an average annual rate of 1.7% over the last 10 years, but has made up for that by making an average rent return of just under 10%.”
Where this becomes important is on a more general basis. Rents can provide great regular returns. Property appreciation can provide a bigger return, depending on the local market, but also on timing.
There are CRE investors who have focused on price appreciation, especially in the last few years. Then there are those who argue that shrunken cap rates can make sense because of future rental income increases—assuming they keep going up.
The important thing is to do this fundamental analysis of the type of return and time horizon you have and whether the payoff is in primarily rents or price appreciation. Maybe your strategy will limit the geographic areas you consider.
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