Turning a Profit in the Post-Pandemic Housing Paradox
2023 Will be All About Disappointment…and Opportunity
By Bruce McNeilage
When the New Year rolled around at midnight on January 1, 2023, we entered what could be one of the most opportunity-filled years for real estate investors in more than a decade. On the other hand, we also entered one of the most treacherous years in housing that we have seen in over a decade.
Now that the country appears to be emerging on the other side of the pandemic, the only certainty among most investors and analysts seems to be that the euphoria is about to end. Naturally, this is a source of great concern for some people and great excitement for others. The reality of the situation is that there is always opportunity in real estate, but only if you are looking for that opportunity in the right places.
Big Changes are Coming, and There is No Easy Solution
At the end of the first quarter of 2023, the shifting market was already starting to emerge. For starters, what was working like a charm in 2020 and 2021 when it came to flipping houses had started to stall out in 2022 and came nearly full stop for many investors in 2023 thanks to rising interest rates and the cost of labor. Of course, the cost of materials was an ongoing concern throughout.
Nevertheless, when you could borrow money at around 3% interest, flipping was a great business model. Now, however, that interest rates are hovering closer to 7%, it is not a good business model. In my business of building homes to rent and for retail sale, my funding costs have nearly doubled over the past 16 months. Something has to make up for those new costs, and investors will be limited in how they can reduce and accommodate new budget constraints.
For example, for investors who own rental properties, 2023 brings rising taxes, rising insurance rates, rising costs of materials, and rising costs of labor. While rents are rising as well, it is unrealistic to simply double rents to make up the difference, which is what most investors would need to do in order to continue “business as usual” in 2023.
Tenants cannot handle that kind of rate hike nor should they be expected to. Rents already rose last year by between 10-20% in most areas of the country. In my rental developments, we are hoping to lower rents slightly to keep our tenants housed. This might mean our revenues are lower — possibly around 5 % — but since they spiked in the two previous years, we expect to see positive, solid averages and reliable, long-term tenants in response to this strategy.
As the cost of acquiring a home rises for retail buyers as well, investors will be well-served to pivot from owning traditional rentals to exploring creative strategies like rent-to-own. While it may be increasingly difficult for residents to purchase homes via the traditional route of a 30-year, fixed-rate mortgage, it will not become less appealing to own a home rather than rent one. In fact, about nine out of 10 millennials and “zoomers” who currently rent say they want to own their own homes — a far cry from forecasts in the mid-2000s that predicted these post-housing-crash young professionals would be content to rent their entire lives.
These generations are typically quite comfortable thinking outside the traditional home-buying box, making them excellent candidates for rent-to-own models and, as an added bonus, they are usually reliable tenants as well.
Breaking Down the “Affordability vs. Reset” Conundrum
Two terms we are hearing more than ever in real estate are the words “affordability” and “reset.”
First, the discussion deals with the topic of affordability. You tend to hear that in many states, only about half of the population has any chance at all of being able to buy and afford a home. Then, you learn that less than half of young (younger than 30) and young-ish (between 30 and 40) adults currently own their own homes even though roughly two-thirds of all Americans are homeowners.
Then, the lecture continues in this vein, addressing the legitimate concern that rising interest rates, stagnating wages, and rampant inflation are going to price many of these young professionals right out of homeownership until they are well into middle age. The conclusion is always the same: The nation needs more affordable housing.
The need for affordable housing established, the speaker then shifts topics. Now, they tell you about how housing is headed for a “reset” in the post-pandemic years. This is likely accurate.
Since 2010, if an investor was reasonably active and ran their numbers with any degree of care at all, they could generate some fat margins on their deals. Around the time the market might normally have started correcting in 2019 or 2020, the pandemic “accelerated” the market into an unprecedented mini-boom fueled by government intervention and buyers’ fear of the unknown (and apartment living). Throughout 2020, 2021, and the first half of 2022, homes that went on the market in the southeast, for example, were sold within a day and tended to have multiple offers within the first few hours of listing. Then, somewhere around the end of the summer, things shifted.
The bottom did not fall out of the market, but suddenly the only people making full-price offers were the i-buyers, and they were not necessarily moving terribly fast. When an algorithm is the only potential buyer offering you full price, you immediately know two things: Something in the market is changing or the software has not yet spotted the change.
Of course, today there are far fewer algorithm-driven buying systems operating in the housing market.
Investors will soon discover the coming “reset” is not going to be like 2008. Today’s market, with tighter lending standards, higher housing prices, historically low inventory, and as-yet unpredictable rates of inflation, is likely to experience a long, slow decline in some of the most expensive markets, a slight slide followed by an extended plateau in most markets, and a steady climb at an admittedly reduced rate of growth in the most affordable markets.
Investors should be poised to act when opportunities arise, but any investor expecting “easy pickings” will be sorely disappointed and, more importantly, they could be left holding capital that should have been deployed.
The Best Markets for Long-Term Investments in 2023
Having now burst many readers’ bubbles about the housing market conditions coming in 2023, it is time for a little good news. There are some great markets out there for long-term investments, in particular. The key is to find a market where the investor can balance the cost of acquiring and fixing up the home with the need to generate profit and revenue in such a way that the end result does not price the future resident right out of the equation.
Naturally, rental properties lend themselves particularly well to this environment, especially if you truly are willing to prioritize making homeownership affordable for those with the determination to set up a rent-to-own agreement and follow the process through to the end.
While most tenants in rent-to-own situations ultimately opt to continue renting for multiple years and may end up moving away rather than buying, these are the best tenants in terms of taking care of the property, paying rent on time, and “sticking” with the property until a job or other life experience forces them to relocate. Additionally, the value a rent-to-own investor offers to residents in the form of potentially owning a home is difficult to overestimate. After all, about half the population under 40 is currently feeling pretty discouraged — and with good reason.
Offering this segment of the population the permanence of a family home and the incredible wealth-building advantages that come with property ownership is something that you can feel good about while also feeling good about the returns you are generating on those investments.
