As Housing Recovery Lags, Rental Business Set to Boom

The severe and prolonged downturn in housing likely will have one notable beneficiary: Demand for multi-family dwellings is expected to rise as more owners switch to renting.

Home For Rent
Home For Rent
Home For Rent

With foreclosures numbering more than 200,000 a month and lending regulations tightening, more homeowners will be pushed into renting, which in turn will see a demand for apartments and multi-family homes increasing.

"The most severe housing collapse and recession in post-war history will naturally leave scars on the economy for years, with the housing market most vulnerable," Michelle Meyer, economist at Bank of America Merrill Lynch, wrote in a research note for clients.

"The resulting decline in demand and tightening of credit has triggered a decline in homeownership and downsizing toward smaller homes, which in our view will underpin multifamily construction," Meyer added.

Though foreclosures in February saw what is expected to be a temporary drop, RealtyTrac expects that move over the course of several months to reverse as allegations that homes were taken improperlywork through the system.

February saw more 225,000 foreclosure notices issued, which amounts to one for every 577 homes in the US. A government program to stem the foreclosure tide has been criticized as largely ineffective and could die a quiet death in Congress.

Indeed, Meyer said the problem is likely to worsen before it gets better, with 4.3 million homeowners "in foreclosure or seriously delinquent." There also are 3.5 million mortgages in modification, half of which likely will end up in foreclosure. And there are another 1.3 million mortgages 60 days delinquent.

"We believe it is reasonable to expect nearly 8 million foreclosures to enter the market over the next three years," Meyer wrote. "This means we can expect a steady shift into rentals from foreclosures through 2013."

CNBC Investor Guide to Spring Real Estate 2011 - See Complete Coverage
CNBC Investor Guide to Spring Real Estate 2011 - See Complete Coverage

Despite all the foreclosures, the homeownership rate remains at 66.5 percent. That is likely to fall to 63 percent over the next five years or so, said Richard D. Hastings, consumer strategist at Global Hunter Securities in Newport Beach, Calif.

"People are more conscious of the operating overhead of home ownership," Hastings said. "It's a very expensive thing to own and operate a house as people see their equity is not growing and overall mobility has decreased. There's been a psychological shift in which homeowners have become much more focused on the burden over time of the operating expenses, and some of them are pretty severe."

Meyer cites two other factors: Though unemployment is lower for young adults than the rest of the population, they don't make good potential homeowners due to tighter lending standards. Also, income disparities have grown during the recession, with more wage earners on the lower end of the scale and thus more likely to be renters than owners.

"Policy changes will encourage this shift," she wrote. "The rhetoric in Washington has started to shift away from the goal of Americans to be homeowners and toward a system that gives them choices between ownership and rentals."

From an investment standpoint, there will be several options.

Real Estate Investment Trusts, or REITs, have been performing well this year, with the FTSE NAREIT Index showing a total return of 8.29 percent this year. Real estate REITs in particular have been at the top with a 9.09 percent return.

"The multi-family side of commercial is going to continue to look pretty good as long as the execution is done properly with costs under control," Hastings said. "You get a little bit of pain on some materials costs, but when you're doing multi-family that can be manageable."

Meyer at BofA also believes apartment REITs, which have returned 6.5 percent in 2011, will do well, particularly for those that have gotten ahead of the construction curve and will have units available immediately to displaced homeowners.

In addition, she said stocks of construction equipment companies that are "tied to the multifamily market" should perform.

"The silver lining to an otherwise dire forecast for the housing market is that there will be some support to the construction sector from a gain in multifamily building," Meyer wrote. "At this point, we will take it."