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Single-Family

Should You Invest in Single-Family Rentals in 2020?

As Americans consider the need for more space, demand for single-family rentals will likely remain strong. Real estate investing requires capital, patience and discipline. It is a sound way to build wealth, but it is not for the faint of heart. Capital Capital is needed both to make the initial investment in a single-family property and to maintain it.  Are you planning to purchase a property outright or to finance it? Will you pay the taxes and insurance on your own, or will it be included in your monthly mortgage payment? The upfront investment required to purchase a single-family home can be significant, despite the infomercials and seminars that claim otherwise. Patience Patience is a must when investing in single-family rentals. Selecting a property, vetting it, screening tenants and engaging the vendors needed to manage the property requires time and careful analysis. Will you be the landlord, or will you engage a property manager to collect rents, field inquiries and so on? Who will maintain the property? Even if you are “handy,” you will need licensed contractors (e.g., plumber, electrician, and a handyman) to address issues that arise with the home. Having a team of trusted partners to manage your rental is essential to ensure positive cash flow. Discipline Discipline is necessary in all investing, but it is paramount when you invest in real estate. With the current strong and appreciating real estate market, will you be tempted to sell if your property appreciates significantly in a short period? Be clear about your investment timeline. Buy and hold in order to realize gains over a period of time. Despite what you hear, real estate is generally not a volatile market. Housing is a sound investment when expectations are realistic. If you cannot afford to have funds tied up in an illiquid asset for several years, real estate is not for you. Owners of single-family rentals need to be disciplined about maintenance too. The last thing any neighbor wants is to live next to a rental property that is not well-kept. If you purchase a property with a yard and landscaping, pay professionals to maintain it. Do not expect your tenants to do so. Know the age of the plumbing and HVAC systems and appliances. Be prepared to replace inefficient or mature systems. It’s always better to be aware of investments that are needed than to respond to an emergency about a mechanical failure. Reinvesting the funds you earn in this way requires discipline, but you are ensuring happier tenants and lower rental turnover rates, potential investment write offs for reinvestment and positive cash flow. If you decide to sell before the property is profitable, you will be able to declare reinvestments as a carry-over loss at sale. Driving Rental Demand Demand for single-family homes is very strong. According to the National Association of Realtors, sales of previously owned homes hit the highest rate since December 2006, surging nearly 25% in July. Nearly 31 million people—or 9.8% of the population—moved in 2019, according to the U.S. Census. In 2020, during the coronavirus pandemic, people have been leaving cities as they question whether it is necessary to reside in expensive metro areas such as New York and San Francisco. After being allowed to work remotely for the last several months, many employees are asking for permission to relocate out of state, seeking more space at a lower cost. Multigenerational households are becoming more common, as the U.S. population ages. As citizens reconsider their location, most do not initially purchase a home. Instead, they rent so they can acclimate to their new locale. Affordability and supply of single-family homes is a challenge for homebuyers. Many Americans chose to rent simply because homeownership is not within their reach, given current circumstances. With COVID-19’s economic impact, potential buyers who suffered unemployment will be on the sidelines for a while. In 2019, more than 45 million people resided in rented single-family homes, almost 40% of the population. As of March 2020, 215.23 million single-family units existed, compared to 38.58 million multifamily units, according to Statisica. Single-family housing units have steadily increased since the beginning of the 21st century and likely will continue to do so. Demand will continue to increase as households form, and as those who are aging downsize. Investing Potential Single-family rental properties are attractive for both income and appreciation potential. Individual investors should consider a rental property a long-term investment. Yes, there are fix-and-flippers who purchase and rehab a property, hopefully for a profit, within a short time. Single-family rentals, however, are retained as an asset, and the rents are used to maintain the property and pay the mortgage, if applicable. A real estate investor should choose a single-family rental property that has positive cash flow as well as potential for appreciation. Consider the following as well. Do you want to invest where you live, or in another market? Evaluate the current and future demand for a neighborhood and its appreciation potential. Suburbs with well-rated schools, low crime rates, access to amenities, transportation and short commute to commercial areas are important to consider. Once you have determined your location and property type, how do you plan to finance the property? Single-family rental investments allow investors to diversify their portfolios and mitigate risk, but the upfront cost can be substantial.  Rates are higher for investment properties than for a primary residence, but with interest rates at historic lows, it is an opportune time to consider adding a rental property to your investment portfolio. Financing for single-family rental is often done through private lenders. Borrowing can enhance your return on the rental property because you do not need to invest the entire purchase price of the property up front. If you can find a property that does not require significant work and can rent it above your mortgage to create positive cash flow, that’s a win-win. Returns on single-family rentals are similar to the stock market, but with significantly less volatility. The housing market

Funding

How Long Will Rates Be So Low?

The recovery is dependent on employment and business growth, so rates will likely remain low for the foreseeable future. On March 15, 2020, in the wake of the coronavirus pandemic, the Federal Reserve cut the Fed funds rate to 0.25%. This reflects the rate at which commercial banks lend reserves to each other overnight, on an uncollateralized basis. The Fed’s goal is to encourage growth and spending. As the pandemic continued, the Fed maintained the target rate on June 10, 2020. Faced with increased unemployment and business closures, it is unlikely the Fed will raise rates during its July 28-29 meeting. Discount Window The Fed also cut the rate of emergency lending at the discount window for banks to 0.25%, and extended the loan terms to 90 days. The discount window plays a crucial role in supporting liquidity and stability of the banking system. It supports the flow of credit to both households and businesses. The discount window is part of the Feds as the “lender of last resort” to financial institutions. Its presence is to support bank’s liquidity needs. Banks generally reserve the option for extreme situations—exercising the right to borrow from the Fed can be an indication of financial distress. Quantitative Easing The Fed continues to make monetary moves to mitigate the economic turmoil caused by the pandemic. Pulling from its tactical bag of tricks, quantitative easing is being employed to purchase longer term government bonds and mortgage-backed securities. Purchasing securities increases domestic money supply and lowers rates by bidding up fixed-income securities. This measure is meant to lower borrowing costs and expands the central bank’s balance sheet. Mortgage Rates Mortgage rates will continue to remain low because of the low 10-year Treasury rate. There is a strong correlation between mortgage interest rates and Treasury yield. Coupled with the Federal Reserve lowering the target for the Fed funds rate to close to zero on March 15, 2020, mortgage rates will continue to remain below historical levels for some time. Average 30-year fixed rates, according to the Freddie Mac Primary Mortgage Market Survey, have been below 3.25% since the third week of May. For the week of July 9, the survey reported a historic low of 3.03% with 0.8 fees and points. Rates in the market have not fallen as much as anticipated, largely due to heavy demand for refinancing. Lenders get higher than typical margins on loans when demand is strong. Mortgage banks and companies are at liberty to set the rates to consumers. Banks and mortgage companies are also tightening credit standards in an attempt to hedge against borrowers losing their jobs and requesting forbearance. According to the Mortgage Banker Association’s Market Composite Index, mortgage applications are up 33% year over year for the week ending July 3, 2020. The Refinance Index is 111% higher than the same period one year prior. The market is largely recovered from the brief COVID-19 induced pause of spring and summer, and the rest of 2020 is on course for strong purchase and refinance activity. Prime Lending Rate In July, the prime lending rate is a low 3.25%, down 2.25% from the same time a year ago. This is reducing the cost to borrow for consumers. Auto loans, credit cards, home equity lines of credit and other short-term loan products are based on this rate. Banks use the prime rate, plus a certain percentage to calculate the loan rate, based on the borrower’s financial stability, credit score and other factors. Automakers chose to embrace the pandemic as a way to boost sales. Zero percent car deals, payment deferrals and incentives emerged in the spring and early summer along with contactless purchases. Although these deals seem attractive, with the economy as unstable as it is, there is the potential for future job loss and auto loan defaults. Lenders allowing 90-day payment deferrals at purchase cause consumers to pay more over the life of the loan. Also, with longer term car loans, borrowers are more likely to be underwater a good portion of the loan term. Auto loan delinquencies hit a nearly 5% past due in fourth quarter 2019, the highest 90 delinquency rate in seven years. Subprime auto lending has been on the rise for a few years. Performance on auto loans improved in the first quarter of 2020 but $7.8 billion in loans received forbearance in April, according to S&P Global Ratings. Car values are tied to supply, and an increase in defaults may further suppress vehicle values, especially in the event of repossession and auctioning of bank-owned vehicles. Banks are tightening credit standards for auto lending. As of May, more than 60% of originations were extended to borrowers with a credit score of 700 or higher. With forbearance policies and unemployment benefits, analysts forecast auto delinquencies may not rise until the third quarter of 2020. S&P placed 33 subprime ABS deals on Credit Watch with negative outlooks in May, an indication of a potential downgrade if delinquency ratings increase. Credit card issuers are offering attractive zero percent introductory offers and balance rate transfers, looking to retain customers and attract new ones. The Fed reported theaverage interest rate on credit cards was 14.52% in May, as opposed to 15.09% in February. In 2019, consumers were confident and using credit. For the final quarter of 2019, credit card debt balances rose to $930 billion. By February, credit card balances exceeded $1 trillion for the first time in almost three years. The economy was strong, and Americans were spending and carrying balances. The pandemic has had a surprising effect on revolving debt. Consumer’s outstanding balances dropped by $24.3 billion in May, leaving $995.6 billion outstanding, according to the Federal Reserve. Sequestered at home, consumers spent less on credit than before the crisis. The Federal Reserve Bank of New York’s survey of consumer expectations released in June reported that consumers were more optimistic about making debt payments than they were in the April survey. So How Low, How Long? The Federal Reserve will

Perspective

Real Estate’s Short, Hot Summer

With any luck, demand will heat up the housing market this summer. Spring is a home-buying season. However, the 2020 season had a false start. 2020 started with new and existing home sales at a 12-year high. In late February to early March, mortgage applications were up, and the market looked optimistic. Then COVID-19 hit, and the U.S. sheltered in place. Open houses were canceled, and future homebuyers were suddenly unemployed. Homeowners who intended to list homes waited. Now homebuyers are proceeding with caution, easing into home searching, uncertain of the future. With any luck, the market will pick up this summer. Short Housing Supply, Pent-up Demand There is pent-up demand, and it is a seller’s market. With the shift to digitally enabled purchases and financing transactions, somemhomeowners rely on virtual searches, tours and secure financing online. According to the Mortgage Bankers Association, purchase applications increased 18% year over year. It is going to be a short, hot summer for real estate. Housing supply is constrained, and the pace of new construction is sluggish. The National Association of Builders/Wells Fargo Market Index (HMI), which measures confidence in the single-family market, was 37/100 in April, a five-year low. Housing statistics dropped to 30.2%, the lowest since 2015, according to the Commerce Department. On a positive note, the S&P CoreLogic Case-Shiller National Home Price Index showed prices increasing by 4.4% in March, the highest annual growth since December 2018. Sales dropped 8.5%, according to the National Association of Realtors, for the same period. After working and schooling from home, buyers are starting to look for their first or next home. States are beginning to open up, and so is the housing market in parts of the country. ‘Bright Spot’ COVID-19 has wreaked havoc on the economy and instilled a level of fear in consumers and businesses. The CARES Act provides temporary relief, but expanded unemployment benefits expire July 31. An extension by Congress of this benefit, which adds $600 to standard weekly employment, may incent workers to stay out of the labor force. Unemployment declined to 13.3% or 21 million people at the end of May, down from 14.7% in April. Many economists believe it will continue to climb to historic levels. It will be difficult to track those who have finished collecting unemployment and do not find a new job, which is not counted in official unemployment statistics. The actual unemployment rate is likely closer to 20%. The U.S. economy faces an uncertain and rough remainder of the year. Historically low-interest rates are a bright spot in the current environment. The 30-year fixed rate dropped to 3.15% at the end of May, a 50-year low, according to the Freddie Mac Primary Mortgage Market Survey (PMMS). Rates ticked up by 0.03 to 3.18% in the PMMS rate survey reported June 4. Low rates and affordability will hopefully induce the lagging purchase market. The lack of inventory will be a challenge for homebuyers, but signs show that the housing market is gaining momentum. Currently, 50% of mortgage debt is at a rate higher than 4%, and 24% is above 4.5%, which will continue to fuel refinance activity. Borrowers with positive equity are obtaining home equity lines of credit instead of a cash-out refinancing. Government-backed mortgage products will continue to dominate the lending activity. The housing market is a leading indicator of the country’s economic health, and real estate’s short, hot summer will contribute to the nation’s slow economic recovery, and likely extend until fall. With lower borrowing costs for builders and homebuyers, purchases of durable consumer goods should rise and drive gross domestic product (GDP). Consumers may choose to buy and remodel, and builders will likely increase activity to meet demandin both single and multifamily markets. The Federal Open Markets Committee meets June 9 and 10, and Jerome Powell is likely to leave the federal funds rate unchanged. The U.S. economy is still in crisis, and the Fed is unlikely to raise rates any time soon. Powell has a strong stance on negative interest rates, and the Fed will continue to employ other measures to push rates lower, such as quantitative easing (QE). The central bank is purchasing mortgage-backed securities, which is contributing to declining mortgage rates. Rates will remain at historic lows and may float lower due to monetary policy, investor confidence and exogenous forces. Mortgage Situation Non-qualified mortgage originators are adversely impacted by COVID-19, as holders of warehouse lines issued margin calls. Some lenders are waiting on the sidelines, holding off on lending, fearful of originating assets they cannot sell. The pandemic has negatively affected consumers of non-qualified mortgages, who are often business owners, self-employed or independent contractors. Private-label mortgage-backed securities issuers will need to collaborate and align to provide relief to borrowers impacted by the pandemic. Despite all these challenges, several private-label residential mortgage-backed securities (RMBS) were issued between April and the publication of this article, indicating there is still an appetite for higher yield RMBS. According to the Mortgage Bankers Association, from a single-family mortgage performance perspective, 4.2 million homeowners in May requested forbearance due to COVID-19, or 8.46% of all mortgages. On a positive note, data from Black Knight shows forbearances had the first decline since the beginning of the crisis. Whether this decline continues remains to be seen, as current political and social unrest will likely exacerbate economic conditions. From a rental perspective, 12 million renters have stopped making payments, which influences the multifamily mortgage market. Renters have also expressed apprehension about renewing leases, due to uncertainty. According to Datex Property Solutions, 58.6% of commercial renters paid their rent in May, making a significant impact on the commercial mortgage market. Bankruptcies and closures of some major retailers will also continue to pull down the CMBS market. Early in the crisis, HUD, Fannie Mae and Freddie Mac provided guidance for consumers facing impacts and are continuing to refine homeownership preservation programs. Forbearance and repayment options after forbearance are being rolled out in rapid succession. Other debt markets,

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