Why Buying A Rental Property In 2022 Could Be A Smart Investment

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Why Buying A Rental Property In 2022 Could Be A Smart Investment

seekingalpha2022-03-12

LifestyleVisuals/iStock via Getty Images If you have followed my articles for a while, you probably know that I am generally against the idea of buying rental properties. I believe that most investors...

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Mindthink
·2022-03-13
Wow
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jimcm
·2022-03-12
Agree
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I believe that most investors underestimate risks, overestimate returns, and forget to consider the negative impact that owning a rental property can have on your lifestyle, career, and even your health. Beyond that, several studies have shown that publicly listed REITs (VNQ) outperform private real estate over multi-decade time periods, and this makes sense when you consider that REITs enjoy significant economies of scale, are managed by the brightest in this industry, have better capital, relationships with tenants, and I pass on many other reasons: REITs outperform private real estate (OTC:EPRA) REITs outperform private real estate (Cambridge Research via NAREIT) (To learn more about why I generally favor REITs over rentals, you can click here to read my latest article on this topic.) But this does not mean that all rental property investments are bad per se. In fact, given the current world events, I think that buying a rental property may even make a great investment in 2022. Recently, I even bought one myself. It is not exactly a rental property since I will use it as my primary residence, but I made the purchase because of the same rationale. Below, I present 3 reasons why you may want to buy a rental property in 2022, and after that, I present a few REIT alternatives for those of you who don't want to deal with the ugly 3 Ts: tenants, toilets, and trash. Reason #1: Highly Leveraged Bet on Inflation Today, we have very low interest rates, but unusually high inflation. This combination strongly favors highly leveraged, inflation-protected real asset investments like rental properties. This is the best kind of environment to be a landlord/borrower because you are buying assets that appreciate in value with debt that's depreciating in value. Let's look at a simple example:  You buy a rental property for $200,000. You finance $160,000 (80%) of it with a 30-year fixed-rate mortgage. Your interest rate is 3.5% and your monthly rental income is $1,200.  In a low inflation world, this investment wouldn't be anything exceptional. I would argue that this is a poor investment once you properly account for all the expenses and the value of your time. But in a high inflation world, it is a very different story. Today, inflation is at 7.9% and housing is appreciating by even more than that in most popular and growing cities. Assuming your rental property gains 10% in value, then you essentially earned a 50% return on equity because of your fixed-rate mortgage. The asset increases in real value, but the debt is decreasing in real value, resulting in exponential equity value growth. Now, your loan-to-value also drops from 80% to 73%, which lowers risks and may allow you to refinance to pull equity out of the property and reinvest it elsewhere. In that sense, buying a rental property with a fixed-rate mortgage is essentially a leveraged bet on inflation, and given the current world order, it is an investment that may make a lot of sense. Even if you think that inflationary pressures will cool down, it may make sense as a hedge in your portfolio in case you are wrong and inflation remains elevated for years to come. As I explain in a recent article, a rental property is a far better inflation hedge than gold. Reason #2: War Or Not - People Need Housing Russia's invasion of Ukraine is causing extreme uncertainty. It is not only a humanitarian crisis, but also an economic crisis, and the consequences are still very much unknown to most of us. Businesses worldwide are already suffering the pain, and this could be just the beginning. To give a few examples: McDonald's (MCD) had to temporarily close ~1,000 restaurants in Russia and Ukraine but will continue to pay its employees. These stores represent nearly 10% of the company's revenue so it is significant. MCD is not an isolated case. KFC (YUM), Starbucks (SBUX), Coca-Cola (KO), PepsiCo (PEP), Facebook (FB), Netflix (NFLX), Visa (V), Mastercard (MA), etc... are all taking the same steps to protest against Russia's war crimes. Russia is a big market and so this is a lot of lost revenue and profit for these companies. Beyond that, the crisis is causing a spike in the cost of most natural resources, which will also impact businesses. Could this be enough for the stock market to crash? I don't know. I don't think that anybody knows. But what I know is that housing is a safe haven in this crisis because people still need a roof over their heads and what's happening in Eastern Europe has little impact on housing in the US. In that sense, buying a rental property in the US may serve as a hedge against the war in Ukraine. You get to secure nearly-free money through a long-dated fixed-rate mortgage and buy a defensive, inflation-protected asset that should continue to grow in value over time and throw off rental income despite the war. Reason #3: The Diversification Benefits Are Becoming Increasingly Valuable Now more than ever, investors need to make sure that they are properly diversified. Bonds (LQD) and Treasuries (IEF) yield close to nothing even as inflation is surging and stocks (SPY) have become extremely volatile. For better or worse, REITs have also become increasingly volatile, which may turn off many investors. Adding a rental property to your portfolio may help you diversify risks and sleep better at night knowing that you don't have all your money at the risk of a stock market crash. To be clear, it does not mean that a rental should be seen as a safe investment. But having some assets out of the stock market can reduce your portfolio risk during times of extreme uncertainty like today. Buying a Rental vs. Buying REITs: Which is Better? REITs are publicly listed real estate investment firms that allow you to invest in real estate by buying stocks. In that sense, they enjoy all the same benefits of leverage and inflation protection. You provide the equity by buying shares, and the REITs then add mortgages on your equity to buy properties and share the financial reward with you. To illustrate this point, consider our recent investment in BSR REIT (OTCPK:BSRTF), an apartment REIT that focuses on Texan markets. We invested in the company in May 2021, and in less than one year, it has already generated a near-80% return: Data by YCharts It was so lucrative because its balance sheet is about 50% leveraged and its properties enjoyed significant rent growth and appreciation. In that sense, REITs are not different from rental properties, but in addition, you also get professional management, diversification, liquidity, and likely superior long-term returns. For this reason, I favor REITs over rentals nine times out of ten. They simply offer better risk-and-hassle-adjusted returns in most cases. Even then, given what's happening in the world right now, there is a strong case to be made for also investing in private real estate for the extra diversification, control, and peace of mind that can come with it. It is not for everyone, but if you have the capacity to borrow at a low rate in a safe way, then it can provide you a good hedge against inflation and also the war in Ukraine. You could of course also get this hedge through the REIT market, but you can't be too diversified in this market. Russia's invasion of Ukraine does not just impact Europe, but the entire world and its REITs. Generally, it is a good thing to be publicly listed because it allows you to easily and cheaply buy/sell investments. But during times of extreme uncertainty like today, it is good to also have some assets that aren't susceptible to the mood of the stock market. That's where rental properties come in. Bottom Line Buy both: REITs and rentals. In most cases, I would favor REITs, but given today's extreme uncertainty, I would recommend investing in private rental properties for additional diversification. Today, I have 50% of my net worth in REITs/Rentals and about 90% of that is in REITs and 10% in rentals. That's the ideal mix for me.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[{"id":9036256946,"gmtCreate":1647131651337,"gmtModify":1676534196294,"author":{"id":"4102837759709900","authorId":"4102837759709900","name":"Mindthink","avatar":"https://community-static.tradeup.com/news/89b965229f7209196369426d161728ee","vip":1,"crmLevel":2,"crmLevelSwitch":1,"idStr":"4102837759709900","authorIdStr":"4102837759709900"},"htmlText":"Wow","listText":"Wow","text":"Wow","images":[],"top":1,"highlighted":1,"essential":1,"paper":1,"likeSize":2,"commentSize":0,"repostSize":0,"link":"https://ttm.financial/post/9036256946","repostId":2218427692,"repostType":2,"isVote":1,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"tweetType":1,"langContent":"EN"},{"id":9036238745,"gmtCreate":1647100304986,"gmtModify":1676534195009,"author":{"id":"4089870511727540","authorId":"4089870511727540","name":"jimcm","avatar":"https://static.tigerbbs.com/c32942224c09c28bda012467a9e0b80c","vip":1,"crmLevel":2,"crmLevelSwitch":0,"idStr":"4089870511727540","authorIdStr":"4089870511727540"},"htmlText":"Agree","listText":"Agree","text":"Agree","images":[],"top":1,"highlighted":1,"essential":1,"paper":1,"likeSize":1,"commentSize":0,"repostSize":0,"link":"https://ttm.financial/post/9036238745","repostId":2218427692,"repostType":2,"isVote":1,"likeStatus":false,"favoriteStatus":false,"reportStatus":false,"tweetType":1,"langContent":"EN"}],"hasMoreComments":true,"newsSizeData":{"likeSize":8,"commentSize":2,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false}}