Blog | Real Estate

It’s Time To Invest In Rental Property In America

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It is becoming increasingly certain (or, at least, probable) that the Fed intends to increase the size of QE 3 (i.e. the amount of money it creates each month) at the end of this year when Operation Twist expires. Operation Twist is another, less effective Fed program.

The minutes from the Fed’s October FOMC meeting stated, “Looking ahead, a number of participants indicated that additional asset purchases would likely be appropriate next year after the conclusion of the maturity extension program in order to achieve a substantial improvement in the labor market.” [The “maturity extension program” refers to Operation Twist.]

And, “If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.”

Finally, yesterday, a report by the Wall Street Journal quoted John Williams, the president of the San Francisco Fed as saying, “A decision not to continue buying long-term Treasurys when Twist expires would be a surprise to markets and that would be counterproductive.”

My guess is that the Fed will announce at its next FOMC meeting on December 11th and 12th that it will double the size of the amount of money it prints each month from $40 billion to $80 billion. And, I expect that the Fed will drop loud hints to that effect between now and then.

This is good news for the price of stocks and gold. The fiscal cliff hullabaloo is keeping the lid on stock prices for the moment. However, as I wrote last time, I expect that to turn out to be more of a fiscal ditch than a cliff, with only slight tax increases and very limited spending cuts when the deal is finally cut. Once that’s out of the way (if not before) stocks should move higher in anticipation of more paper money flooding into the financial markets. Gold may move higher even before then.

Stocks and gold won’t be the only beneficiaries, however. The expansion of the size of QE 3 is also likely to give a good boost to the property market as well. When the Fed prints money, it buys bonds – either mortgage-backed securities or government treasury bonds. That pushes up their price; and when bond prices rise, their yields (i.e. interest rates) fall.

US interest rates are at extraordinarily low levels. The yield on the 10-year government bond is 1.65%. The average interest rate on a 15-year fixed mortgage is below 3%, an all time low. The Fed has already practically promised to keep rates low until mid-2015. If it now backs up that promise with an announcement that it will double the monthly size of QE 3, investors are bound to become increasingly bullish about property. After six years and an average nationwide decline of 34%, it seems pretty probable that US home prices have bottomed.

This, therefore, should be a good time to invest in rental property. In fact, at this stage, I believe that an investment in rental property offers better prospects than either stocks or gold. The Dow Jones Industrial Average has risen 80% since its crisis trough in February 2009. Gold has more than doubled since then. Home prices are just now beginning to move off their lows. Over time, the odds are much greater that home prices will move higher from here rather than lower. The rapid growth in the population of the United States by itself makes this highly probable. Between 2000 and 2010, the population of the US rose by 27 million people or by 9.7%.

In my opinion, however, the real attraction of an investment in rental property is not the possibility that the property will appreciate in value. The real attraction is in the cash flow it will provide far into the future. The more cash flow you have, the more financially secure you will be. And, over time, if your rental property does appreciate in value, then all the better!

When investing in rental property, consider the following:

Fixed is better than floating. I believe it’s a much better idea to take out a fixed rate mortgage rather than a floating rate mortgage, even though a fixed rate mortgage will have a higher interest rate. There is a very real possibility that inflation (and, therefore, interest rates) will rise sharply in the US during the next decade or two. In that scenario, if you have borrowed at fixed rates, inflation would be to your advantage. Your rents would go up, but your mortgage payments would not.

Shorter is better than longer. Take out a 15-year mortgage instead of a 30-year mortgage. You will save an enormous about of interest expense that way.

Location, location, location. If you buy rental property, you had better be absolutely certain that it is in an excellent location so that you can find tenants even if the economy becomes much worse than it is now.

It’s better with land. If you invest in a house rather than an apartment, you will not only have the cash flow from the house, you will also own a piece of something they aren’t making any more of: Land. When the government prints money, hard assets like gold and land appreciate. Land is an excellent store of wealth.

Watch the leverage. Each investor must strike the right balance between borrowed money and equity. Keep in mind that the global economic crisis is far from resolved. There is a chance that the world economy will collapse into a new great depression. If it does, your rents will drop sharply. Of course, the price of everything else will drop sharply too, so you will be no worse off – so long as you can still service your mortgage. I believe that even in a worst-case scenario, that kind of depression will not occur within the next five years, and maybe not even within 10 years. Therefore, investors with a 15-year mortgage have a lot of time to pay it down before then. Nevertheless, keep this disaster scenario in mind when deciding on the size of your down payment. Be prudent.

Not every property market offers good value. Property prices in London, Hong Kong, Singapore, Sydney and Melbourne (to name only a few of the most notable cities) have remained very high or even risen in recent years. Investors who live in such places would be better advised to buy property in the US rather than at home.

Original publish date: December 01, 2012

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