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Rent’s Upward Ride: Could Prices Follow?

 Rising rents are increasing the allure of investment property, especially for those with cash.
November 2011 | By Lawrence Yun

Housing affordability is about the best it’s ever been, but tight lending conditions have made it difficult for buyers to take advantage of the good conditions. For investors with cash, though, it’s a golden time to buy, and we’re seeing the investor community step up. Its share of home purchases reached 22 percent in August, a good part of that in all-cash transactions, because lending is especially tight for non-primary occupant homes.

For investors who can hire out or manage property themselves, the attractive rates of return from rising rental income is a strong lure. Rents rose at a better than 3 percent annualized rate in the third quarter of 2011, government data show, and private data sources imply even faster rent growth.

Nor is there any reason to believe this rent growth will cool, given the favorable demographics of a rising number of young adults over the next 20 years, a high number of owners of foreclosed homes who can’t buy in the near term, and the low construction rate of apartments.

If annual rent gains stay near 3.5 percent, rents will double in 20 years. If they reach 5 percent, rent doubling would occur in 14 years.

In addition to strong rent returns, investors can anticipate solid home price appreciation over the long haul. Using 2000 as a “normal” year in which the market saw neither a bubble nor a bust, the metrics on home prices in relation to consumer prices imply a 14 percent undervaluation, and in relation to rental rates, a 20 percent undervaluation.

With the bubble clearly gone, the future home price path should follow the future rent growth path. That means home prices could also double in 14 to 20 years, though it is unclear when home prices will begin to catch up with rents. But long-term investors buying today are sure to catch some, if not most, of the upward ride.

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