Cash Flow: Top 20 Residential Rental Markets

20 Top Rental MarketsI’m constantly asked by clients to find them rental property in the Los Angeles market that “cash flows” — meaning that the monthly rent received on the rental property exceeds the monthly expenses (mortgage interest and principal, insurance, property taxes and maintenance).  These clients are often exhausted with the up-and-downs of the stock market, see the real estate market turning a corner, and want to put their money in a more secure asset (real estate) that will appreciate over time.  Makes perfect sense, right?  Well, it depends….

Generally, people feel most comfortable making a real estate investment in their backyard, no more than 20 minutes from their personal residence — a property they can physically drive across town to see and touch should anything happen.  This relative “closeness” to the property gives them the peace of mind and security that lets them sleep well at night.  But the truth of the matter is that buying a rental property in their backyard may not be the sound financial investment they were hoping for…and this is sure to cause some nightmares.

RealtyTrac just released a study highlighting the top 20 residential rental markets across the U.S. based on cash flow.  Notably missing was (you guessed it) any city in Southern California.  That’s because it’s becoming increasingly difficult to buy a rental property in the L.A. area, for example, with a effective cap rate (annual net cash flow) of even 5-6%.  Granted, this is significantly higher than most investors earn in the stock market or any bank savings account but it is a relatively poor return when looking where else around the county they could invest their money or considering other real estate investment options (ask me about this).

Here’s a few additional charts and the full article below:


Bang for the Buck: Where Investing in Rental Homes Is Most Profitable

Where can you make the most money as a rental-housing landlord? Not California, according to a study released today by foreclosure-tracking firm RealtyTrac.

Using a formula that calculates cash purchase capitalization rates—or the annual net cash flow an investor can get from a rental property if it is purchased with cash—RealtyTrac found that Memphis, Tenn.; Saginaw, Mich.; Toledo, Ohio; and Ocala, Fla. were the most profitable places to rent out single-family homes. Each of these markets has an annual cash purchase cap rate of more than 10%.

CashFlowThe calculation goes something like this: The median price for a three-bedroom home in Jacksonville, Fla., is $90,000, according to RealtyTrac’s numbers. The average rent on a three bedroom is $1,198. After setting aside money for taxes, fees and maintenance, the cash flow from renting such a property is $719 per month. Divide a year’s worth of cash flow by the purchase price of the house and you get an annual yield of 9.59%, the eighth-best in the country. That’s 2 to 4 percentage points higher than what most large institutional investors, including Blackstone Group LP and Colony Capital LLC, have projected in the way of returns for their single-family rental portfolios.

One shortcoming in RealtyTrac’s research on this subject, however, is that it doesn’t examine how much supply is available to investors in the markets it rates for landlord profitability. Over the last year, investors have gravitated towards markets with lots of supply and a legacy of foreclosure problems, because they know they can easily generate profits if they buy at a low enough prices. But what if the inventory drops or there are large price increases?

The answer, says RealtyTrac vice president Daren Blomquist, is that the rental cap rate calculation helps individual investors who are buying homes one or a few at a time, rather than large institutional investors looking to buy hundreds or thousands of discounted homes in a single market.

“We created this [report] with our customers in mind—the mom-and-pop, individual investors,” Mr. Blomquist says. “The folks I’ve talked to who are acquiring these in bulk or in larger quantities are saying that because foreclosures are starting to dry up, more and more they’re buying homes off the MLS,” he added, referring to multiple-listing services, the local databases of homes for sale used by Realtors.

Only a few of the markets favored by large, institutional rental investors made RealtyTrac’s top 20 list, including Las Vegas (No. 5), Atlanta (No. 7), Tampa (No. 11), Phoenix (No. 14) and Detroit (No. 15). Most notably absent are any markets in California. Beaten-down housing markets in both Southern and Northern California have caught the eye of investors over the last two years, and rising investor interest has driven up prices.

California markets don’t make the list, Mr. Blomquist says, because prices there have risen so significantly that it’s hard to make renting profitable.

“In California it’s really just a lot harder to cash-flow homes successfully,” Mr. Blomquist says. “Investors are doing it, and they’re making it happen, but it’s just harder to make it happen with the higher price points.”


Zombie Houses & the Myth of Shadow Inventory

Zombie HousesThere continues to be widespread news reports, economic bulletins, and opinions from well-known government and banking officials that the banks are still holding years of “shadow inventory” — houses that have foreclosed (and lenders now own) that have NOT been released into the general market.  Many real estate investors and large hedge funds have been anxiously waiting for this dam to burst and REOs to flood the tight market we currently find ourselves in.  Well, let me tell you folks, it’s not going to happen.

Why do I believe this?  Several reasons, but here are 4 BIG ones you can take to the bank:

1)  ”Zombie Houses” or “The Walking Dead” are what I like to call underwater houses in which the homeowner is current on payments, still has a job, and can afford the mortgage payments.  They look “normal” on the outside, but the house is dead in the water when you look at the liens on title versus the current market value.  Granted, the slowly rising real estate market this past year has awakened some of these Zombie House with some equity, but there are literally millions of houses across the country that are “trapped” in their current state — the homeowner can’t sell because the owe the bank more than the house is worth, they can’t refinance because they have no equity, and they don’t qualify for a short sale because they can effectively still afford their mortgage.

2) It takes most banks an average of 9 months to turnaround a foreclosed property and sell it as an REO.  Yet, most banking and economic experts indicate that there is currently 7 times the amount of homes in shadow inventory as there are REOs currently for sale on the MLS.  This means that the current pace in which banks are releasing REOs is successfully getting rid of their current inventory.

3) Banks have figured out that they can easily sell thousands of non-performing notes in bulk to hedge funds and large investors without all the headaches, time delays and expenses of selling via REOs.  The hundreds of thousands of foreclosed homes that have yet to hit the market as an REO have already (or will be) packaged in bulk and sold out the side door to willing and ready institutional buyers.  The volume of bank notes sold in bulk has gone up exponentially in the last year and will continue to be strong for several years to come.

4) The Homeowner Bill of Rights and other pro-homeowner, anti-foreclosure bills have both softened the banks stance or immediacy to initiate the foreclosure process and also encouraged underwater homeowners to stay in their houses longer hoping for a loan-mod or to wait out the foreclosure process as long as possible.  You are going to see more and more homeowners who still haven’t received a Notice of Default from the bank after going more than a year without making a mortgage payment.  But don’t think banks are getting the short end of the stick.  In fact, it’s the banks that lobbied to get these reforms passed into law because it gives them yet another tool to control the pace of shadow inventory hitting their books.

So now what?  Expect to see many more equity sellers coming off the fence and wanting to sell their homes before and during the Summer months this year.  These homeowners have been watching the market steadily climb over the last year and have been waiting for the prime real estate season to sell.  You’re also going to see a lot less big investor buyers (hedge funds, capital groups) competing for single-family homes as they are changing their strategy to buying the notes directly from the bank.

—Hope you enjoyed my rant. Want more info?  Give me a call and I’ll be happy to discuss how this further affects your particular situation whether you’re a seller, buyer or real estate investor.