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Are We Seeing a Perfect Storm Building for Small Real Estate Investors?

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In moving around the Web and reading my news feeds, there is mounting evidence that a perfect storm may be building for individuals and small partnership firms investing in rental property.

If you've considered doing something other than riding the stock market roller coaster or settling for tiny interest rates on savings and Certificates of Deposit, it's time to take a close look at rental real estate investment.

In the movie The Perfect Storm, a combination of weather factors converged to create a storm of immense power. Let's take a look at converging factors in the real estate sector for a hint of things to come.

Interest Rates Rising

Multiple articles recently are pointing to rising interest rates as a barrier to many who are considering a home purchase. It's interesting to note that one article calls the 4.0 percent interest rate an "emotional barrier" to many buyers. We find it easy to forget the many years of rates 50 percent or higher than that, and the terrible years when rates were in the double digits. I'm not complaining though, because those who do not buy will be renters.

When the Federal Reserve begins to taper off its infusion of money into the mortgage industry, there will be more rate increases. This will hit first time home buyers the hardest, just as they were beginning to re-enter the market. First time buyer market involvement is down around 29% from a historical average of 40 percent.

The Younger Buyers Are Priced Out of the Market

Student debt now tops $1 billion and is growing. Many college graduates enter the job market with $50,000 to $100,000 in student loans to repay. They can't be discharged in bankruptcy, so they are at the top of the priority list for repayment. The younger buyer is also facing uncertainty in the job market.

Some will avoid buying to allow more flexibility in moving to get the right job. As blue collar jobs continue to be exported, more young people are forced into college and the debt with the hope that a degree will provide opportunity.

With student debt delinquency rates rising and now the biggest non-mortgage debt sector in the U.S., there just isn't any money left for a mortgage or a down payment. As long as rental unit supply can keep up with demand, the younger buyers will stay out of the market. A lack of wage growth and higher home prices and interest rates will likely continue the trend of a drop in home ownership for the young.

Baby Boomers on Fixed Incomes

With around 10,000 baby boomers retiring every day, and few of them with any retirement savings of consequence, there will be a strong demand for rental housing affordable on social security's meager payouts. It's a niche market and not for all investors, but there will be a high demand for smaller homes and units near medical, entertainment and shopping facilities.

The Big Players Are Doubling-Down for the Storm

Over the past year or so, around 30 percent or more of all home purchases were made in cash by investors. They are buying in bulk for institutions and large banking firms, turning the inventory into rental housing. Hedge funds are jumping into the fray as well, with estimates that recently as many as 50 percent of homes sold in Nevada and Arizona going to investors.

We're fast becoming a "renter nation," and these merging trends could create a perfect storm for smaller investors as well. Construction of apartment projects has begun to grow, as builders and developers see a sustained demand for rental housing and rising rents.

The smart small investor shouldn't be discouraged by the big competition. With so many who lost homes to foreclosure now renting and the younger would-be first time home buyers expecting to rent for years, there is going to be demand for something "better" than an apartment. Single family homes and condos and lofts for rent near city centers will be prime rental investments.

The more a rental property owner can do to make their unit a home instead of a "rental," the longer they'll keep good tenants and the rents will tend to be above-market. The storm is coming; are you ready to take advantage?

- Dean Graziosi