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Mom and Pop Investors Propping Up Home-Buying Market

Rent
Rent

Chicagoans Linda and Debra Basili thought about becoming landlords years ago. But even two professional women's combined salaries were no match for the Windy City's high housing prices.

Then the biggest real estate crash since the Great Depression hit, driving down Chicago home prices by a third in five years. The 54-year-old twins took the leap.

Last year, they bought not one but two condominiums near downtown. They found renters within weeks, and the rent more than covers their costs.

"Tell Donald Trump to look out," says Linda Basili, a State Farm insurance manager.

Mom and pop investors like the Basilis are snapping up homes and condominiums to rent out all over the country. They're capitalizing on a confluence of events: depressed home prices, rising rents and strong rental demand. A typical plan? Buy cheap. Collect rents to cover costs. Cash out — one day — when home prices recover.

"An unprecedented number of investors are looking into this," says John Burns, CEO of John Burns Real Estate Consulting.

Investor purchases are strengthening demand in a still-weak market for home sales. Through the first nine months of last year, investors bought more than 26 percent of single-family homes and condominiums sold in 167 U.S. markets, indicate data tracked by Burns.

That's up from 21 percent in 2007.

Even the U.S. government wants to capitalize on a strong rental market. It recently started a pilot program for investors to buy and rent out foreclosed homesowned by government-backed mortgage giants Freddie Mac, Fannie Mae and the Federal Housing Administration. Together they own more than a quarter-million single-family homes.

In a recent paper, the Federal Reserve noted that "small investors" are buying foreclosed homes and converting them to rentals. It also said that larger investors were struggling to do so, in part because of tight financing and their inability to buy enough properties in the same area to make it worthwhile.

"Right now it's just that perfect storm for mom and pop investors," says David Hicks, co-president of HomeVesters of America, known as the "We Buy Ugly Houses" company.

A multiyear investment

As with any real estate buy, good timing is key.

Jason Huerkamp, 35, a Coldwell Banker real estate agent in Minneapolis, got especially lucky.

He and his wife, Brooke, cashed out some stocks in 2006 to buy rentals in their former college town of Mankato, Minn. Nothing panned out, and home prices started what's turned into a five-year fall.

"That was dumb luck," Huerkamp says.

In 2009, the couple bought their first rental. "That was probably premature," he says, as home prices dropped further still.

Since then, the couple have bought four rental homes, plus a duplex. They paid $310,000 for the properties and spent $90,000 to fix them up.

Now, they take in about $7,100 a month in rent and clear about $2,700 after expenses, including financing costs.

While home-loan financing has tightened since the go-go days, the couple secured loans for all the rentals. They did have to put 20 percent down. Their interest rates are also higher than for owner-occupied homes. At today's rates, that might mean a 5 percent rate vs. a 4 percent rate.

Assuming home prices rise in three to five years, Huerkamp says the couple hope to sell the homes at a profit and buy small apartment buildings.

"By the time we're 60, we hope to have 60 doors (rental units) and make that our retirement lifestyle," he says.

That buy-and-hold mentality is now common among investors buying homes, says Zillow economist Stan Humphries. Unlike "flippers," who quickly bought and sold homes for a profit when prices were soaring, the buy-and-hold investors intend to keep properties for years, Humphries says.

Rental markets vary by city. An 8 percent annual return is now about the norm, with some markets higher and some lower, Burns says. That means that someone who buys a $100,000 property — and pays cash for it — makes $8,000 a year after expenses, including maintenance and taxes.

Given today's tight financing, Burns says, many rental properties are purchased with cash. Many banks will also lend to investors, assuming they have good credit, for three rentals in addition to a primary home, Hicks says.

The soft costs

The Basilis' experience as landlords has also been positive, so far.

They rented both units quickly, one to a friend of a friend. The young professional renters pay on time. Except for a busted microwave and broken refrigerator, the units have been largely hassle-free.

That isn't everyone's experience, and a "fair number of people aren't cut out to be landlords," says Eric Tyson, co-author of "Real Estate Investing for Dummies."

Landlords not only have to be tough enough to evict people — even families in the dead of winter as Huerkamp had to do — but to take midnight calls about broken plumbing, confront late-paying tenants and live with a heightened risk of legal hassles.

They also have to be able to "crunch the numbers," Tyson says.

Paying too much or underestimating the cost to make a place rentable can sink even cautious investors.

Then there's the risk of deadbeat tenants.

Shelley West, 49, a physical therapist in Tampa, just bought a $100,000 townhouse to turn into a rental. She and her husband, Tom, plan to rent it to a friend.

She still thinks the rental market is a good business despite her experience renting out another home in 2008. In that home, the first tenant "was nice but couldn't pay after five months," West says. The second tenant stopped paying, too, and even demanded money back when West moved to evict him.

The Wests gave the tenant some money so that he wouldn't delay leaving, she says.

The whole experience cost the Wests about $7,500.

Jason and Tammy Bezdicek experienced the emotional toll of becoming landlords.

Last year, they bought a $140,000 home in St. Paul that had been flipped after going through foreclosure.

The health care manager and pharmacist paid a "premium," to get a home that had been largely fixed up, Jason Bezdicek says.

His plan was to rent it out without it taking over his life. He looked at more than 30 homes. He put each into a spreadsheet to calculate rents, taxes, assessments, insurance, utilities, repair, cash needed and the "time value of money" to calculate the years it would take to break even on the investment. They also put 20 percent down and financed the purchase.

"This home was the best," says Bezdicek, 34.

But then water leaked into the basement, requiring drainage improvements to the front yard. The couple put central air conditioning into the house and found that it needed a new furnace, too. That cost several thousand dollars. Someone had stuffed food, garbage and toys in air ducts that needed to be cleaned.

Bezdicek hired a company to screen applicants for credit scores and employment histories. But he showed the property himself.

More than 20 applicants traipsed through.

"They all loved it, took an application and then we didn't see them again," Bezdicek says. "It kind of stressed me a little bit."

The time he poured into the house caused some conflict at home, especially since the couple had a new baby.

While Bezdicek says he had been keen to think of another rental purchase in the future, his wife "isn't sold on doing it again," he says.

Barring any disasters, he estimates it'll take them six years to recoup their initial investment, not including any home price appreciation that may occur.

"We bought at the right time," he says.

Risks exist in rental market

Buying a house cheaply and getting someone else to cover the costs sounds like a no-brainer financial move.

But there are some big risks, given the potential for hidden costs and struggling tenants, Burns says. Because there are so many foreclosures in some cities, there's more danger now that someone might buy a rental only to see the neighborhood deteriorate around it, Burns says.

There's also the risk that too many people will turn rentals into cash-flow machines and then attempt to cash out at the same time if home prices rise, says Hessam Nadji, managing director of real estate investment services firm Marcus & Millichap.

"They could flood the market," he says.

Real estate is also cyclical. Demand is strong now for single-family rentals because so many people are losing single-family homes to foreclosure, says Ronald Johnsey, president of apartment market researcher Axiometrics. But as foreclosure rates drop, home prices are likely to rise. That could inspire home buying and lessen single-family rental demand, Johnsey says.

For now, though, many economists expect home prices to continue to fall and then flatten for some time. That will continue to lure real estate investors, real estate experts say.

"For this year and next, the market will be hot," Humphries says.

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