The New Growth Business: Becoming a Landlord
Business + Economy

The New Growth Business: Becoming a Landlord


After years of losses and disappointments, those hoping to make a buck in U.S. real estate are back. Investors from Warren Buffett to mega financiers like GTIS Partners to small-time wholesalers are looking to cash in on the U.S. housing market. Though home prices have continued to fall in most parts of the country, a rapidly improving rental market has prompted many investors to become landlords.

2011 was a banner year for rentals because of improving demand, slow growth in new apartment construction, and low interest rates, according to a January report from real estate research firm Green Street Advisors. U.S. Labor Department data show that rents rose 2.5 percent last year. For 2012, Green Street predicts growth in monthly rents of 3 to 7 percent, depending on the local market.

That plus lower prices have made distressed properties look much more appealing this year, say real estate insiders. The median price that investors paid in 2011 for a house was $95,000, almost 11 percent less than in 2009, according to numbers from the National Association of Realtors (NAR). With prices down and rents up, buy-and-hold investors—those who purchase, fix up, and then rent out houses—are more likely to see positive cash flow.

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The federal government has further stoked investors’ interest with its new plan to stabilize the market by selling off some of the 210,000 foreclosed properties on the books of Fannie Mae, Freddie Mac, and the Federal Housing Administration. In February, the government issued invitations to groups of large investors to apply for permission to buy these foreclosed homes in bulk, through a sealed auction, in distressed areas like Florida, Las Vegas, and Phoenix. The first 2,500 foreclosures went up for sale on February 27. Program rules say that whoever wins these bids must hold and manage the properties as rentals for a “specified number of years.”

While that plan aims to stabilize distressed markets, many advocates worry about possible side effects. Deborah Goldberg of the National Fair Housing Alliance, a nonprofit that addresses housing discrimination, says she’s concerned that the plan won’t have a mechanism for correctly pricing the houses being sold off—prices that are too low could actually further drag down surrounding values, especially in marginal and minority neighborhoods.

Others worry that investors buying up multiple properties for rental income could push out individual homeowners. “If you’re a first-time buyer who keeps running into investors who are outbidding you or offering cash where you can’t, it’s not a positive thing,” says DataQuick’s Andrew LePage. But during a downturn, investors also clear out often-decaying properties, fixing them up for rental or resale. That might be why they’re often compared to animal-kingdom scavengers. For Crocker Liu, professor of real estate at Cornell University’s School of Hotel Administration, they’re like “catfish—they keep the ocean floor clean.” LePage calls them “the necessary vultures who keep the real estate ecosystem in balance. Otherwise you’d have more distressed properties lingering on the market longer.”

In some cases, problems can arise when investors—particularly those that are located hundreds of miles away—become landlords. In the working-class community of Burlington outside Memphis, neighborhood association president Lynda Whalen says big, out-of-town companies that have bought there often don’t make it clear which property management company is responsible for a specific house, making it hard to contact the right person when a house becomes an eyesore and needs attention. She says her association just sued one investment company, the California-based Owens Consulting Group, over a house it bought two months ago and let deteriorate.

This comes at a time when banks, which own at least 270,000 foreclosed houses nationwide, have received recent attention for becoming slumlords after they’ve purchased or repossessed rental properties. According to a recent National Public Radio story, some banks have ignored needed repairs, allowed properties to decay, and failed to follow housing codes. Tenants in Oakland and the Washington D.C. suburb of Hyattsville reported broken windows, cut off water, exposed electrical wires, and pest infestations, with no phone number to call to get repairs made. Even calls to the banks from Oakland officials demanding action went unreturned.

But many small-time investors are also getting into the market, buying for the long term and close to home. According to a January white paper by the Federal Reserve, small investors have had a large role in converting distressed foreclosures to working rental properties. Most investors are new to the business and don’t flip properties—64 percent have done only one deal, according to a 2011 survey by online real estate website operator Move Inc. Two-thirds of those surveyed noted that they’re investing for the long term, and half plan to hold their properties for five years or more. Most also stay local—a 2011 NAR survey found that on average, investors buy 19 miles from home.

Small or large, most investors see current conditions as a rare opportunity. Over time, as additional apartments are constructed to meet the increasing demand, the rental market should eventually soften, according to the Green Street report, though the authors don’t predict when that might happen. Time will tell whether today’s landlords will remain enthusiastic about holding onto their properties should finding tenants become more challenging and yearly rent increases flatten.