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Why You Should Buy a Rental Property

It is an out-of-favor asset class that has attracted the attention of David Ackman, a hedge fund manager with a fondness for contrarian investments.  “The best investments we’ve made are the ones no one else would touch,” Ackman explains.  That’s why he’s so hot on Single Family Home Rental Property.  They are cheap, he says.  They are a buy.

Ackman argues that Single Family Home Rental Properties possess the identical investment attributes that strongly performing stocks typically possess.  Says Ackman:

We believe we’ve identified an investment with:

  1. A low valuation – The lowest valuation in at least a generation.
  2. Forced sellers – A large number of distressed transactions.
  3. Extremely attractive financing available – High loan-to-value, low-rate, fixed-rate, long-dated, non-recourse debt, pre-payable without penalty.
  4. Favorable long-term supply dynamics – Short-term oversupplied market, but long-term supply is controlled.
  5. Favorable long-term demand dynamics – Demographically driven demand growth.
  6. Out-of-favor – Currently, this is a somewhat shun asset class.

Ackman’s bullish perspective flies in the face of the pervasive pessimism about home-buying. “Experts Say Housing is a Lousy Investment and it Always Will Be,” an August 2010 headline on Yahoo! Finance declared. “The US Housing Market is Headed for a Complete and Total Nightmare,” another financial news service predicted. And just last week, a headline warned: “Why Home Prices Could Fall Even More.

“There’s a substantial risk of home prices falling another 15%, 20% or 25% more,” chimes in Robert Shiller, a Yale economist and half creator of the Case-Shiller Index of home prices.

No question about it; housing is out of favor, which is why Ackman is licking his chops.  But the doom and gloom surrounding the US housing market does not persist for nothing. It persists for a reason… or rather, for many reasons.  Therefore, any would-be bullish analysis of the housing market must begin by considering the main reasons why the gloom might persist for a while yet.

REASON #1: The housing market simply sucks.  There’s no sugar-coating it.  “Home prices in a majority of major US cities…have fallen to their lowest levels since the housing bubble burst,” the Associated Press reported last week, “and analysts expect further declines this year… In December, prices fell for the sixth straight month and for the eighth time in the past 11 months. Foreclosures are also expected to increase as the year goes forward.”  [Editor’s note:  While the market may “suck” in very broad and general terms, all real estate is local and there are plenty of great buying opportunities today in markets all over the country.]

REASON #2: Inventory continues to swell.  “There’s just way too many homes out there relative to demand and we’re not going to see that change anytime soon,” says Joshua Shapiro, chief US economist for MFR Inc.  Lenders continue to repossess massive numbers of homes, even though they are trying not to.  Despite foreclosure moratoriums, workouts and government-subsidized refinancing, the monthly foreclosure totals remain extremely high.

All Mortgage Loans in Foreclosure

Glass-half-full types will note that foreclosures, while still extremely numerous, have declined from peak levels.  Unfortunately, this modest improvement may be short-lived.  After a temporary dip in “Foreclosures Started” early last year, this metric is bouncing back up toward record highs.

New Foreclosures Started Each Quarter

At the same time, “negative equity” continues to rise – a trend that contributes to rising defaults and foreclosures.  According to a recent report from, home prices in the fourth quarter of last year plunged 5.9% compared to the fourth quarter of 2009.  As home prices fall, negative home equity inevitably rises.  Not surprisingly, therefore, negative home equity surged in the fourth quarter of 2010.  27% of borrowers are now “underwater” on their mortgages, according to, up from 23% in the previous quarter.

Rising negative equity does not guarantee rising defaults and foreclosures.  But “underwater” homeowners tend to lack the mortgage-paying enthusiasm of their above-water counterparts.  Net-net, the enormous volume of foreclosures – completed, newly started and prospective – is weighing heavily on the housing market.

As a result, the ratio of foreclosures to home sales remains extremely high.  As these foreclosed properties continue to flood the market, they continue to depress prices.  More troubling is the fact that this ratio has been trending higher during the last six months.

REASON #3: Demand refuses to recover.  Household finances are in tatters.  The dual bear markets in housing and stocks since 2007 have erased a whopping $12 trillion of national wealth – a sum nearly equal to one year of US GDP.  On the other side of the balance sheet, meanwhile, we Americans have been struggling mightily to reestablish some kind of balance… by reducing our debts.

If the wealth doesn’t return, getting rid of debt is the only way to regain or improve solvency.  Unfortunately, wealth disappears much more easily than debt.  Compared to the $12 trillion of household wealth that evaporated during the last two years, only $1 trillion of debt has disappeared from consumer balance sheets – a decrease of only 7.4% from the peak consumer debt reading.

So even though homes are cheaper, prospective home-buyers are less capable of buying a home than they were a few years back.

REASON #4: Mortgages are much more difficult to obtain today than they were during the boom years.  Lenders aren’t lending as generously.  Consequently, borrowers aren’t borrowing as ravenously.  The volume of purchase-mortgage originations continues to slide… and shows no sign of rebounding.  There are stories of legions of individuals who wish to buy a home – and who legitimately possess the wherewithal to do so – but are unable to obtain a traditional 30-year mortgage from anyone.

Mortgage Applications

Painfully aware of these trends, home-builders’ confidence in the housing market languishes near all-time lows.  The National Association of Home-builders’ Index measures three categories of housing market activity: Foot traffic from prospective buyers, current sales, and builder expectations for home sales during the next six months.  Taken together, these metrics reflect little sign of a rebound.

Home Buyer Traffic

Given these dire data points for the housing market, is there reason to buy rental property?  Maybe.

Although the chart above shows that home-builder confidence remains at low ebb, the chart also shows a sharp recent uptick in the percentage of consumers who say they plan to buy a home during the next six months.  Mortgage lenders may not accommodate those plans, but at least the number of prospective buyers is on the rise.

Admittedly, signs of a recovery in the housing market remain sparse at best… and home prices do not lack for reasons to fall even further.  But the housing market is not without hope, as we will see in an upcoming article.

Editor’s Note:  In line with hedge fund manager David Ackman’s contrarian investing strategy, there have always been real estate investment opportunities in United States, even during the worst recessions.  It’s important to remember that real estate is local investment.  Although affected by national factors such as interest rates and the flow of investment dollars, there is a stronger impact on housing by local factors such as employment, and migration, etc.

  1. Comment by Guest
    March 9th at 6:13 pm 

    I just want to say how much I enjoy this information. Thank you for the info Marco.

  2. Comment by Clay
    March 10th at 10:24 am 

    Very interesting article. Hedge fund managers definitely diversify, so to hear one so bullish on real estate rentals is great!

  3. Comment by Jay Redding
    March 10th at 10:46 am 

    Great article Marco. There are so many great opportunities in the market today. Those who play for the long term will be very happy over the next few years. The short term players will find it much more difficult in the current environment. Wealth is not made over night, but developed over time with strategic purchases.

  4. Comment by David W.J.Irwin
    March 10th at 1:36 pm 

    My money is on Ackman.We run a private venture home fund(as well as commercial and land)and believe that their are niches “within” the housing sector where “baby bulls” are ‘gonna grow up” into big tough ones.On the rent side of the ledger, there are robust cash on cash opportunities galore, especially if your buying at the REO(real estate owned)store.This is a huge “get paid while you wait” play. Capital appreciation will be a slow burn,but with ROI on baskets of rentals delivering high double digit numbers,isn’t waiting cool!As for more downdraft on the housing sector,couldn’t agree more. Buy into it! I know, never average down say you equity pros.I say, find me the bottom and when you do,it’s too late because we call those upturns “a dead cat bounce”,all the while as the party train starts to leave the station and your not on it.Consider a play not mentioned but may be the next piece of wisdom from the “oracles of David Ackman”, that being a RENT TO OWN spin on this asset class.Not only does this approach create some real neat financial upside,it may contain a philanthropic element by helping people that are deserved, restore their dignity by becoming homeowners once again, and hopefully help America avert a catastrophe of becoming a renter nation.Selah.

  5. Comment by Las Sendas Homes
    March 18th at 11:55 am 

    Wonderfull article… I think the only real danger to rentals is the fact that the Fed continues to act irresponsibly with the money supply. This is ultimately going to force interest rate higher and drive home prices lower. Meanwhile, the market is still backing up… So if cash on cash is what you want be sure its a high rate or interest rates or inflation will make you investment yield less.

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