Lately I have been receiving e-mails from real estate agencies Mondinion.com and PropertyO.com, both headquartered in the United Kingdom, advertising preconstruction opportunities to buy individual rental units in hotels, senior care facilities and apartment buildings. These opportunities are often accompanied by guarantees of rental income for a period of two or more years and sometimes an optional buyback from the seller at higher price after a few years.
As it has been 4 years since my last UK valuation assignment, I cannot comment on the merit of these investment opportunities which are mostly in the UK. It has been my observation over the last 33 years, though, that when properties are being built for investors rather than occupants, that is the sign of a real estate market entering a bubble phase.
If owner-occupants cannot outbid investors, that is a sign of impending weakness. Investors often enter these transactions expecting that negative cash flows will be rewarded by ever-increasing property price appreciation, but such a market collapses on itself when there is an insufficient number of renters to occupy all units and cover the investor’s ownership costs. In Southern California I saw this happen in the early 1990s and again starting in 2006 in the more distant L.A. suburbs. Southern California home prices plunged afterwards.
One disingenuous technique I see used by advertisers on Mondinion is to advertise unbuilt projects with projected 9% yields, ignoring the Law of Supply and Demand. An increase in the supply of units could drive rents downwards. This is a natural consequence of building for investors rather than occupants. New York City is already experiencing the consequences. The median price of a new condominium has so far declined 27% this year, yet many more luxury condos continue to be built. Likewise, the ultra-luxury Metropolis in downtown Los Angeles is experiencing a slowdown of sales as an estimated 60% of buyers are investors, not occupants.
Existing Rental Properties for Sale
Recently, Mondinion and PropertyO have advertised U.S. rental home investment opportunities in areas I have appraised in. One thing in common is that all the properties have been in depopulating cities.
The first opportunity was that of rental homes in the Detroit, Michigan metropolitan area. Curiously, the advertisement stated that this investment was not suitable for U.S. investors, raising the question of “how can an investment unsuitable for U.S. investors be suitable for foreign investors?” Another questionable claim was that all of this seller's properties were in "safe neighborhoods". The broker is Marigold Investment Properties, a British company.
Having a friend make an inquiry, I was informed of a 900 sf, 3 bedroom, 1 bathroom rental home, built in 1955, available in Inkster, Michigan, a western suburb of Detroit, for the price of $48,000, guaranteed to produce $9000 per year in rent. The owners paid $26,500 for this home on 4/23/15 and have assumedly renovated it since then.
Checking a demographic research web site, I found that this forecasted rent was close to the estimated median rent of $738 per month ($8856 per year) for Inkster. I was also pleasantly surprised to find that the official living area (per tax assessor) was 1036 square feet. What was more sobering was an estimated local vacancy rate of 16.9% (better than Detroit’s 22% vacancy rate), and a population decline of 37% in the last 50 years. More troubling is that NeighborhoodScout.com rated Inkster as having a higher crime rate than 93% of Michigan communities, with a violent crime rate three times the Michigan average. Not a "safe neighborhood", as advertised.
I sometimes consult data-aggregating web sites such as Trulia.com and Zillow.com to garner real estate market information. All analysis is done by computer, which is not quite as accurate as a competent and honest real estate appraiser. Trulia has estimated the median home value in Inkster as $42,300, having declined 50% in the last decade. Zillow placed the median home value at just $40,900. Zillow estimates that this home has decreased in value by 14% in last month. CoreLogic indicated nearby home sales in the last month in the $38,000 to $43,000 range.
Trulia.com report on the subject property and its neighborhood
Why you should hesitate to buy rental homes in depopulating cities
I have seen other rental home opportunities marketed by PropertyO in other cities such as Chicago, Cleveland and Memphis. These are all depopulating cities. DNAinfo.com, for instance, compiled a list of the 10 U.S. cities losing the most residents between 2015 and 2016:
5. St. Louis
9. Jackson, MS
Here’s the reason to avoid such investments: Depopulating cities experience decreasing property values and rents. Investing in older buildings in depopulating areas is a prescription for failure. The Rust Belt, for instance, has many cities that have lost half their population in the last 50 years, including Detroit, Cleveland, Youngstown and Dayton. This usually means increasing vacancies, despite gallant leasing efforts. Rents are so low that only the lowest cost renovations make any sense, too. Even then, new space gets built, hastening the demise of the older buildings.
Back to Inkster, this investment is being marketed without any guaranteed rents, but the seller will manage the property for you for 10% of gross rental income. Such a high rate is typical of a problematic housing market where good tenants are hard to find. 4% is more typical.
I have also seen other rental properties marketed with short-term guarantees of rental income. “Guaranteed rental income for the first two years” is a seller promise that should be interpreted as a sign of weakness, not security, because an adequately performing rental property does not need to be sold with any such guarantees. It is almost tantamount to saying that Year 3 is going to be a crapshoot because tenants are hard to find. Do not be surprised to see that the property’s previous asking price has been inflated to more than cover the amount of these guaranteed rents. Can the guarantor remain solvent if real estate rents and prices decline, though?
This reminds me of a phrase I have sometimes read on Craigslist:
“Only a scammer will ‘guarantee’ your transaction.”