QUESTION: Is this a good time to buy rental property in the Phoenix area?
ANSWER: With the volatility in the stock market since the beginning of 2018, investors are asking themselves if there are better and safer places to put their money to work with the prospect of producing growing and yet safer income that can be used for their retirement years. While corrections in the stock market look like buying opportunities to some investors, it raises fear in the minds of other investors who want some security that they won’t lose the profits they have made in this long running 10-year bull market.
Financial advisors always tell investors that diversity in investments is a good thing because it spreads the risk of losing money. Kiplinger Magazine forecasts “economic growth of 2.9% in 2018, up from 2.3% in 2017, and the unemployment rate to finish the year at 4.8%.” (Kiplinger Magazine, July 2018 issue, page 46.) As the labor market hits “full employment” (considered to be an unemployment rate between 4% and 5%), wage inflation starts to increase as employers need to pay more to attract workers. This leads to inflation from the increasing cost of what we all pay for goods and services. In turn, this prompts the Fed to increase short term interest rates to combat inflation. Both wages and short term interest rates have been slowly increasing with inflation at an annual rate of 2% as of March 2018 and wages rising at an annual rate of 2.7%.
Before addressing the question of whether it is a good time to buy rental property, one more economic indicator needs to be examined and that is the yield curve comparing the 10-year Treasury yield minus the yield on 3-month Treasury notes. The reason is that this curve has historically predicted recessions when the difference between long-term and short-terms yield drops below zero.
The graphic above plots the difference between the yield on 10-year Treasury securities and the yield on the 3-month Treasury. As you can see, the curve is hovering just above 1% which is below the average of 1.51% that has existed in an expanding economy since 1954. This market indicator is now flashing “caution” because the curve is now heading downward toward zero and you can see the recessions plotted in the gray bars above that occur each time this indicator reaches zero or below (except 1966). Some economists are now predicting a recession by 2020. Other economists see a rosy future with this curve never getting close to zero. For a more detailed discussion about this subject, see Recession Signals: The Yield Curve vs. Unemployment Rate Troughs.
Buying rental property with the expectation of a good return on your investment depends on both timing and location of that rental property. It is up to you to “read the tea leaves” and decide if it is the right time to invest in rental property. Experts project that economic growth will be 2.9% in 2018 which is up from 2.3% in 2017. If that growth continues in 2019 and 2020 while inflation remains subdued, now is an excellent time to invest in rental property because the property will only increase in value. If we do enter a recession in a couple of years, property values will stagnate or decline depending on the severity of the recession.
Regarding the question of rental property location, the outlook for the Phoenix area is excellent because of all the businesses which are either expanding or relocating to the area around Phoenix. Much of the new economic development will be on the south side of Phoenix. The Loop 202 (South Mountain Freeway under construction now) will not only relieve congestion on existing freeways around Phoenix but it will provide an easy transportation route for new businesses that want to expand in the Phoenix area. The Loop 303 Extension will start construction in 2020 in the west valley area and ultimately be a 35 mile expressway connecting Route 17 and Route 60. New malls, housing construction, and businesses will follow after this roadway is built. New business means more jobs which mean more people looking for housing and more rental opportunities as people take time to decide where to buy a house or if they want to buy a house. These locations for rental property will NOT be ideal for a number of years.
However, the south and west sides of Phoenix are not the only area where growth will occur around Phoenix. Experts predict the Phoenix-Casa Grande-Tucson corridor to be one of the fastest growing areas in the next two decades. There is also room for expansion north of the loop 101 and this will be especially popular with businesses that cater to people who frequently travel to the “high country” like Sedona and Flagstaff.
Phoenix has a population of 1.6 million and the U.S. Census Bureau estimates that by 2030 the population of Phoenix will grow to 2.2 million. The metropolitan area around and including Phoenix has a population of over 4 million people. The U.S. Census Bureau estimates that by 2030 the population of this metropolitan area will be over 6.3 million. The growth is here and will continue unless there is a giant economic depression and not some mild recession. No one is forecasting this gloomy scenario!
Where you buy rental property for investment purposes around Phoenix really depends on where you live now. Dave Ramsey, a financial author and money coach who has a daily radio program and who has made most of his fortune from rental property, advocates living within 25 miles of any rental property you own so you can oversee it or else get a property manager. This advice should help you concentrate on where would be the best location to own rental property.
There are some great benefits to owning rental property. Renters will provide you with a direct stream of income straight to your business bank account (and it is a business if you rent property you own more than 2 weeks out of every year). How much you make depends on whether you market your property to short term or long term renters. Long term renters means your property will not be vacant and the income will be steady while short term renters mean you will market to seasonal renters like snow birds who come to Phoenix during the colder months and you may not have renters during the hot summers in Phoenix. You can charge short term renters higher rates in the winter months because demand for rental property is high but during the summer months, you need to charge low rates to attract renters because demand is low. Long term renters of a year or more will likely pay the same each month and will likely pay a rate that is less than half of what short term renters pay for winter months. You will need to evaluate what other owners in your area are getting for rentals with a similar size and location to your rental property. Price comparisons can easily be done on websites like VRBO.com (Vacation Rentals by Owner).
Your rental profits will not only be determined by your occupancy rate but also by your fixed costs for owning the property. If you have a mortgage on the rental property you buy, remember that you must pay a minimum of 20% down on your purchase price since it is not your primary residence. The more you can pay toward the purchase price, the lower your monthly mortgage payment will be and the higher your monthly income from the rental property. There are also fixed expenses like taxes, repairs and maintenance, utility bills, and HOA fees if the property is located in an area with an HOA. These expenses will affect your monthly profit but keep in mind that taxes can be reduced by what you spend on repairs, maintenance, improvements, and a property manager (if needed) along with any mortgage interest if you itemize on your tax return. Dave Ramsey advocates paying cash to buy any rental property because your income will be much greater without a mortgage payment but he tempers that advice in fast growing regions of the country where property values continue to grow as well. The Phoenix metropolitan area is one of those regions so you should be safe using a mortgage to get into the rental property business!
You will also profit from the increase in your rental property value over time. Even with the increase in property values in the past few years, Phoenix is still relatively affordable compared to a lot of other big cities across the country. In fact, the city was recently ranked #7 on a top-ten list of most affordable big cities for U.S. home buyers, by the mortgage information website HSH.com. The Phoenix area has a more moderate forecast for property value appreciation in the next few years which means it is on a more sustainable pace for price appreciation and not headed for a price bubble.
Your rental property value can also be increased by “sweat equity.” By doing upgrades to your rental property by yourself, you can increase the value of your rental property without significant financial cost. Depending on what improvements you make, you can increase the resale value of your property exigently. (And you will sell at some point to take this added profit.)
While I promote owning rental property as great investment option, there are some downsides that must be considered. Owning rental property is a major concentration of assets for most people and does not represent a diversification of assets plus it is not as liquid an asset as owning stocks because you cannot immediately sell your property on a moment’s notice. Also, if the neighborhood where you own property goes down hill or something happens to your property that insurance won’t cover, you will lose money. This is why you need the insight of a professional, licensed real estate agent who can analyze the market and help guide your decision making on where to buy rental property.
You also have tenant risk to consider. Some tenants do not pay on time. Others cause more wear and tear on your property. Sure, you have a security deposit to cover some of these costs but if you have to evict a tenant, this is a cost and a time consuming risk. Plus there is the risk that you may not have any tenant for periods of time while the costs of owning your property continue and you lose money.
Don’t forget about the costs of taxes and insurance in addition to any HOA fees. Property taxes are going up in the greater Phoenix area and the cost of property insurance is about 25% higher on rental property than it is on the home you live in. These costs are not insignificant and will reduce the profits you can make from rental property.
Eventually you will be responsible for repairs to your rental property plus there is substantial paperwork involved in owning rental property. While there are times you can sit back and let the money flow in, there is also a significant investment of time that must be devoted to handling these matters. Sure, a property manager or management company can do this work for you as well as vetting prospective renters but they will charge for their services and this will further reduce your profits. Having a property manager can be a good idea for someone who wants to try owning a property, but has no interest in day-to-day property management and can live with a reduced income stream to save themselves the headache.
For some people, owning a rental property might be a brilliant personal financial move. If you are in good financial shape already, have some spare time on your hands, and don’t mind handling home maintenance emergencies, a person who puts in some patient time finding the right property to rent can make a very nice profit on a rental property.
However, not everyone is in that group. Some people might not relish the interaction between tenant and landlord from the landlord’s side. Others may not be in a financial position to take on a rental property quite yet. Still others might not feel confident in their local real estate market.
According to the National Bureau of Economic Research, rental properties in metro Phoenix posted an average annual return of 8.7 percent over the past 28 years. Remember, this period includes the severe drop in the value of housing over 2008-2009 so there is money to be made in rental properties. If you feel that this is the right investment opportunity for you and you need guidance about where to buy a rental property now that can produce this level of income or better, please call me, Mary Jordan, at 602-576-2112.