Rent Sense: Rental Ownership
By: Neil Fjellestad and Chris De Marco FBS Property Management
The new post-recession realities in our region will include housing shifts during the balance of this decade. Though we focus on the San Diego region we recognize that most of our advice applies to other global regions as well. Perhaps things will return to the way it has always been for Independent Rental Owners. Certainly we have experienced pent–up rental demand and short supply of rentals in the past. We have been through our share of economic cycles. It’s nothing new for us to receive unsolicited offers by brokers to list and/or actual offers to purchase by hungry investors.
21st Century Investment Philosophy – Hopefully all Independent Rental Owners, whether arriving at this ownership on purpose (Strategic Investor) or by circumstances not of your choosing (Situational Investor) have learned that you own a local business: rentable property is to be acquired, improved, held and maintained. This is fully utilizing what we must call “investment benefactors” including: renters “willing” to call our investment property their home for extensive periods paying “market rents” for the privilege; lenders that are “ready” to put up most of the “fair market property value” taking only a small interest charge for their money because they completely trust the real estate as their only collateral; then there are local, state and federal laws that are “able” to protect our ability to enjoy income tax benefits now like much riskier businesses while deferring other taxes as well as any “estate plan” could. While leverage is a wonderful way to begin our acquisitions you should be strategically reducing loan balances until you own your rental properties debt-free and professionally managed so that nearly 70% of rent collected becomes part of your retirement income wherever and however you choose to spend your retirement. We call this – “Owning Your Retirement.” Obviously, you want to optimize both property rent and value, taking full advantage of your “benefactors.” What is not obvious is why you would sell or otherwise dispose of your properties. We’re unsure why an independent rental business owner would want to reduce his/ her hard earned equity by triggering taxes and transaction costs that will become due.
Rental Ownership is at Tipping Point – However informed we are by local history, if we stop at what we know from the past we miss the real differences in this next cycle that spell additional value-added entrepreneurial advantages depending upon how we choose to conduct our rental business. Indeed, for an entire array of businesses that are related or supported by this essential rental housing part of the local economy we need to connect some important pieces of data; understand the details behind the current housing behaviors; and what can legitimately be predicted about rental ownership and operation. Then we can strategically plan our business opportunity.
Many zip codes within the region are reporting rental rates that have increased substantially during the last decade and are projected to grow at twice this pace during the next 5 years. For more details behind the surge of rental housing demand please refer to our recent Rent Sense Blog: What Does 2015 Mean to Me? Parts 1&2. Go to www.RentSenseBlog.com
Also take note that the majority of this essential rental housing stock is over 40 years old. Since it cannot be replaced it must be renewed and repositioned in the rental market place. Let me quote Roger Showley’s recent San Diego UT article on “Housing sustainability in action” – “Meadowbrook Apartments in San Diego’s Skyline neighborhood touts a community garden, granite countertops, computer lab, solar energy system and the latest in playground equipment. And yet this 448-unit low-income housing project on 22 acres is more than 40 years old.” Rental property upgrades will become standard because it makes financial sense given the positive rental trends. Though rental owners might feel pushed into these physical improvements such a break from the status quo has significant investment value including restoring emphasis on keeping rents square with the market. Also, a reinvestment in your properties encourages a long term ownership which is imperative.
Real Estate Industry is Shifting- While rental ownership seems enticing, the path forward is through a gauntlet of consumer protection and thorny customer relations. Our renters will not stand by during a property improvement that impairs or makes their life less convenient without your acknowledgement and compensation. Paying rent is going to be paid in a last minute, secure fashion that suits the rental customers, not your custom. Lack of communication on an unresolved issue will not be tolerated. If your ownership does not include being a full time operator with business hours it will not be your renter that is inconvenienced or feeling discriminated against.
The real estate industry has traditionally been dominated by the real estate transactional value of buying income property and holding it for price appreciation allowing the investor to trade up. Property operations are necessary between transactions creating a need to manage; mostly by controlling expense and vacancy. The millennial vision is one of an ongoing competitive business providing an essential bundle of product and services by professionals that are supported by management systems and technologies. The independent investor owning rental property MUST operate within this new paradigm since professional expertise is both available and affordable.
Local Economic Impact- We cannot ignore substantial 21st century economic drivers that will transform southern California into a world class “megaregion” and investment draw. We anticipate no easy solution to the needed housing that must accompany this kind of growth. Rather, we see the next 5 years as a renaissance of the Independent Rental Owner as an essential housing provider and a savvy business owner in the local community. This is an intelligent investor that is building wealth and providing for retirement in a practical way. The tired public notion of “landlords” taking advantage of captive “tenants” will be replaced with entrepreneurial leadership that attracts a community encouragement for private investments in improved housing and new life for established neighborhoods.
Let’s continue with a more precise understanding of this modern rental customer.
The new millennial renters (all ages and situations) should be addressed as “renters by choice” because that’s exactly what they are. Their personal priorities include: lifestyle, safety, and convenience. Much more detail can be added to these priorities. You might be surprised to find that within sections of the U.S. and abroad individuals often own a rental as a landlord and live in another rental as a tenant simultaneously. These renters by choice are “demanding” and “discriminating” customers by nature and/or circumstance. They are educated to understand that they live in a renter nation, at least for now. And they are the rental generation – “large and in charge”. They collaborate with each other constantly in person and online. They add technologies to this collaborative effort so they know everything the typical rental owner knows about competitive rental rates, popular floorplans, and livable neighborhoods including walkability, police and school stats.
Our first tenants paid rent equaling 15-18% of their household income, most households had one income earner. Some of you might have owned property as long, so you remember. Today, the rent represents between one-third and one-half of household income. A substantial number of rental households pay more than 50% of income. Other differences: most rental households have multiple income earners and good credit is extremely important to them. Additionally, since the millennial renter has often lived in rental housing as a student and/or roommate they understand “splitting” household costs in order to avoid compromising on location, floorplan, common areas, neighborhood walkability or whatever they deem most important. Here we will rely on our history over the last two decades. We have advised residential developers and operators in no fewer than 60 metro markets throughout 29 states. It was initially surprising to us that much of the “high-end multifamily” was readily rented by this demographic especially during the recession. Often, they stayed within their respective budgets by curtailing other expenses: offsite health clubs, eating, entertainment and choosing shared and/or public transportation. Of course, in many cases their housing budgets were split between roommates and subsidized by parents. The point is this. These are renters that demand a particular lifestyle that they have become accustomed to as formative adults.
Where does the necessary supply of quality rental housing come from now remembering that we have generally run deficits on creating any housing supply during the last 5-7 years? In most regions of California land acquisition is difficult and developing any acquisition for building generally meets resistance. The building process is becoming elongated due to a variety of delays; labor and materials. Logically, we might believe that supplying multifamily will move faster. So, even though the estimates are that the current supply coming to market must double this should be doable. In California, most of the land acquisition expertise, residential development and construction expertise are versed in and comfortable with “for sale” subdivision construction. In addition, they usually lean toward higher-end housing. Multifamily construction is enticing but the risks, systems and timely performance all must become acquired skills. The “high barrier” California markets include dealing with local planning professionals being pressured by NIMBY attitudes that envision more traffic along with competition for existing services typically coming from single dwelling households. Then there are specialized lenders and asset managers found on the “multifamily” side. All these interactions are pretty unforgiving for the inexperienced. Therefore, for the near future any pipeline providing this supply is tentative at best.
How about all the single homes and individual condos that got caught up as rentals during the recession? Will these be sold to owner occupants? Will they be sold to investors and/or held as rentals? The answer is ‘yes’ to all of the above. The net effect will probably trend toward more individual rental homes held by enlightened investors that realize even a couple of houses can build their net worth and provide additional tax-favored income during retirement far better than the stock market.
So, there is no better time to be in the rental property business if you are willing to professionally manage your business. This means active “customer relationship management” CRM, RPM “residential property management” best practices and assertive marketing and branding. This will require external interaction: asking, listening, timely responses, transparent communication that anticipates renter customer preferences. We need to prove to our customers that our internal credentials, training, technological integration, oversight and offsite support are in place giving them confidence that “their home which is central to their lifestyle” is at the core of our “business plan.” We realize we might have introduced more questions. That’s okay. In forthcoming issues of this publication we will fill in the details.
“Rent Sense” is an informative series for Rental Owners or those looking to become R.E. Investors. This monthly insight is brought to you courtesy of Neil Fjellestad and Chris De Marco, Principals of FBS Property Management in San Diego, CA. The goal of “Rent Sense” is to educate individuals with correct expectations for investment performance; inform about trends and concerns for Rental Owners; give thoughtful consideration of “best practices” now possible due to technology advances being made by our company and other industry leaders. We are investors, responsible Rental Owners and entrepreneurs that have started, grown and sold a dozen real estate-related businesses. Currently FBS operates rental properties in 69 zip codes within southern California. Now in our 5th decade we report to 800 clients. All of this daily exposure provides us with a variety of topics to discuss. Neil, Chris and the rest of the FBS team is available at 619-286-7600 or www.fbs-pm.com.