Turn a profit on rising rents
The gap between home and apartment-rental costs is going to narrow, which means rents will keep rising. Apartment REITs let you profit without the hassle of being a landlord.
It looks like the axiom that says, "For every action, there's a reaction," applies to the housing market. Although new home sales appear to be falling off a cliff, the apartment-rental market is booming.
Many investors are profiting from the action via real-estate investment trusts (REITs) that specialize in that market. Is it too late to participate? Probably not. I'll show you how to pinpoint the best candidates in a minute, but first some background.
According to a recent report published by RealFacts, a research outfit that focuses on the apartment industry, occupancy rates and rents are rising all across the United State. Nationwide, rents are up 4% over the past year and occupancy levels are running at 94%. In San Jose, Calif., where the action is the hottest, apartment rents rose 9% on average.
All this is new. When the economy faltered in 2001, apartment rents dropped and continued falling until last year, when they bottomed out and began to turn around. What's behind the upsurge in apartment rentals? It's simple: In 2005, prices of single-family homes skyrocketed, dramatically shifting the rent vs. own equation.
The big question
Deutsche Bank Securities published a July 31, 2006, research report titled, "Rent or Buy?" that puts it all in perspective. The analysts at Deutsche did what most of us do when we think about making the move from renting an apartment to buying a home. They compared the cost of owning vs. renting.
To do that, Deutsche devised a gauge for measuring the monthly cost of owning a home, called the ATMP, which stands for "after-tax monthly payment." The ATMP adds up adjustable-rate mortgage interest, property taxes and insurance, but deducts principal amortization and income tax savings.
Deutsche compared average apartment rents to the monthly cost of owning a home in 47 different U.S. metropolitan areas. Deutsche expressed the results as the percentage cost of renting vs. owning. For instance, a rent/own ratio of 50% means that if it cost $1,000 per month to own a median-priced home, you could have rented an average apartment for $500/month.
Those ratios show why the rents have taken off. For example, according to Deutsche, in Los Angeles it cost $1,158/month to own a median-priced home in 1999. By comparison, it would have cost $885/month, or 76% of the monthly home ownership cost, to rent an average apartment.
Here's where it gets interesting. By the first quarter of 2006, the monthly cost to own a home in Los Angeles had jumped to $3,015, but you could have rented an average apartment for $1,215 a month, about 40% of the cost of owning.
The same story repeats, in varying degrees, around the country. For instance, in Miami in 1999, your monthly outlay would have been about the same for renting an apartment as for owning a home. But, by 2006, you could rent an apartment for less than half the cost of owning.
Obviously, something has to give. To get the rent vs. own equation back in balance, either rents must go up, or home prices must come down. According to Deutsche, if rents were to remain constant, home prices would have to drop 28% on average, and more than 40% in the hot markets. Conversely, if home prices didn't budge, apartment rents would have to rise 45% to return to the 1999 cost of renting vs. owning ratio. Most likely, of course, a little of each will happen. Rents will increase and home prices will come down some. Deutsche estimates that rents will increase 4% to 8% annually.....