What You Need to Know
Investors eyeing the rental market should ask: What are the core fundamentals, and what property type will get the most value for the investment?
In a higher-interest, renter’s market, new properties command top dollar as would-be homebuyers search for an alternative to expensive home loans.
As interest rates come down and homebuyers return, new rental buildings in key growth markets should continue to do well.
With rising interest and cap rates, many real estate investors are moving into rentals, with guidance from their advisors. That makes sense — as home prices become more unaffordable, buyers who are priced out of the market will turn to rentals, driving up prices. But a brand-new rental building in Miami is not the same as a core multifamily property in Cleveland.
Beyond rentals versus homes, the questions every real estate investor must ask are: What are the core fundamentals, and what property type will get the most value for the investment?
Consider this: The United States has a housing shortage. For the past 20 years, U.S. population growth has outpaced home construction — and nowhere is that problem more acute than in the Sunbelt. In Florida specifically, roughly 1,000 residents are moving each day.
Between 2020 and 2021, Florida had the country’s highest net inflow of residents, with 221,000 more people moving in than out. Despite the influx of new residents, housing supply has failed to keep up with demand, as many homebuilders, still reeling from the global financial crisis, have been reluctant to build. But 2022 is different from 2008.
Back then, the housing boom was largely fueled by speculative homebuying. That’s not the case this time. With the rise of remote work, affluent professionals are looking to permanently relocate to low-tax states that offer a higher quality of life. This has caused tight rental markets not just in population centers such as Miami, but in places like Orlando, where competition for rentals is now stiff.
These are long-term demographic trends that likely won’t be upended by fluctuating market forces.
Considerations for Investors
In addition to location, investors must also consider property type. Most investors have exposure to real estate through public REITs, which are largely composed of core properties. But as valuations on REITs decline, so do returns, which, at their peak valuation, often yield more modest, bond-like returns of 4% or 5%.
Investors might consider looking at asset classes less prone to fluctuations in interest rates, and that yield higher prices than core or value-add real estate. One example is ground-up development. In a higher-interest, renter’s market, new properties command top dollar as would-be homebuyers search for an alternative to expensive home loans.
As interest rates come down and homebuyers return, new rental buildings in key growth markets should also continue to do well because average renters will be priced out of these markets, especially those that benefit from a lack of supply coupled with strong migration.
One of the key benefits of new development is that it can succeed in most economic cycles. As demand shifts, developers and homebuilders pivot to meet changing needs. Outside of quick market shocks, interest rates over the past 40 years have largely declined — and developers have been able to adjust to gradual changes. For example, while quick large interest rate moves can change investor appetite, development tends to shift over longer cycles, allowing developers to pivot across property types and markets to meet changing population needs.
As with other asset classes, real estate can fall prey to overcorrections — the Fed tightening too quickly, speculative homebuilding or banks approving loans to uncreditworthy borrowers. Investors should consider these potential risks and others when it comes to development. For example, a developer is always at risk of overpaying for land or raw materials.
In cases where changing market conditions pose greater challenges, a developer’s negotiating power and economies of scale can be highly valuable. Building contractors and suppliers prefer to foster relationships with stable partners that have significant pipelines. This puts established developers in a better position when it comes to securing concessions from those who may be less amenable to offering these to less-experienced developers.
While many people equate a recessionary environment to a rental market, it’s important to remember that real estate cycles last longer than a general economic cycle. Though we can’t know exactly where the economy will be in five, seven or ten years, we can look at larger demographic trends to understand the locations and property types that offer the greatest potential opportunity.
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Bernard Wasserman is the president of Participant Capital, a real estate investment management firm that empowers wealth managers with the ability to invest their clients’ capital in Class A real estate development projects alongside institutional investors.
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Reprinted with permission from the October 11, 2022, online edition of ThinkAdvisor © 2022 ALM Global Properties, LLC. All rights reserved. Further duplication without permission is prohibited, contact 877-256-2472 or reprints@alm.com.