Co-produced with Treading Softly
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COVID-19 has shaken much of the world and its assumptions about how life operates. One aspect remains as important as ever – where you live. Often young men and women have a dream of home ownership. For years rising home costs and moderate mortgage rates kept a large number of Americans from having the ability to buy a home.
Recently however rates have dropped and the viewpoint on homes and their importance has come to the forefront as people work from home, seek to distance themselves from others, and seek something tangible that inflation will not de-value.
Let’s examine various aspects in the market today that are setting the deck for Residential REITs to soar, and soon.
Record Low Mortgage Rates
Buying a home involves many aspects. Some of them are the capital you have for a down-payment, interest rates, home values, and income of the buyer.
Over a 30- or 15-year span, a change of 1 percent of interest on a mortgage can make a large difference. Right now mortgage rates are extremely low.
Over the last 50 years, mortgage rates in the United States have never been this low. Money for a mortgage is easy to find as banks and lenders seek out those willing to do activities during this time.
Meanwhile, rental rates on average across the US have continued to climb. Renters are seeing a twilight zone between the cost of renting and the price of building equity in a home. Home ownership is not just a dream anymore, but becoming cost competitive in many areas due to low rates and rising rental costs.
If you were to ask many if they’d rather rent for $1,000 a month, or have a mortgage for $800, which do you think they’d pick?
The World Is Seeking Yield
Stepping to a larger picture for a second, investors and retirees are seeking out livable yields. The yields offered in the classic “safe havens” are extremely small as large amounts of cash are sitting on the sidelines.
With yields less than 1% for 10-year Treasury Notes and CD-rates less than 0.5%, Investors will be lagging inflation even at its marginal levels we have been experiencing for years.
So investors and retirees are forced to venture outside of the classic harbors of safety and move into new waters. Real Estate long been an area to place funds for long-term safety and growth. Most, however, do not have access to funds to buy additional homes and rent them or manage them.
The property REIT ETF Vanguard Real Estate ETF (VNQ) yields currently 3.7% – well above both CDs and Treasury Notes. VNQ represents a large swath of REITdom vs. just property REITs focusing on residential properties. The “stickiness” of residential properties makes REITs that focus on this sub-sector less dramatic than Commercial or Office space-focused REITs. This is a large benefit to those looking for a more passive investing style.
Home Sweet Home
Homes have long been a safe place for many. With low mortgage rates, many are readily buying new homes or up-sizing their homes. This causes a net impact of rising home prices and driving up mortgage rates. Think of it as supply and demand, as more people want to buy the more lenders can charge. In the end this causes a rotational effect, older millennials are moving out but younger generations are moving into rental properties at higher rates. It’s easier to raise rates on a new tenant than a prior one.
COVID-19 has caused more people to work from home – requiring additional space in their home to do so comfortably while also making it a separate space from where they spend their leisure time. Home life has seen a growing share of people’s lives. Upsizing, moving away from crowded apartments, or getting their dream set-up is causing homes to become more and more important.
Source: White Hutchinson
The trend over the last decade has been a steady rise in the time spent at home each day. However, COVID-19 has turned time spent at home to a whole new level, with shutdowns, self isolation, and most out-of-home entertainment being closed or limited. Enjoying your home has become even more important.
This bodes well for residential REITs that have focused on keeping modern properties.
Real Estate As an Inflation Hedge
We’ve been highlighting the coming risks of inflation. The economy has seen unprecedented levels of new cash infused into it by the government and central banks across the globe to fight the economic impact of the pandemic. Someone will have to foot this big bill in the future. This excess liquidity will most likely cause high inflation in the next two to three years. Some investors already have found refuge in gold (GLD) with gold prices soaring. However, we will argue in a future report (to be posted soon) that real estate is a much better hedge against inflation than gold. Homes as a real estate investment offer a great hedge, and will see rising values as inflation occurs.
Furthermore, gold, silver, and other precious metals which are viewed as inflationary hedges lack the versatility or usefulness of a home. You can live in a home when inflation hits. It’s hard to live in your gold bars.
Real estate also is an income-producing asset while precious metals are not. Most importantly, gold is very expensive today based on historical valuations, but real estate is not. Investors can feel confident that by buying real estate today, they are not overpaying based on excessive valuations.
Even factoring the large hit to home values during the Great Financial Crisis, home values have strongly outpaced inflation. Likewise, for investing in rental properties, you can see above from an earlier example that rent prices rise historically above inflation as well. This ensures your income continues strongly.
Buy Homes or Invest in Property REITs
When you consider taking advantage of this unique time, you have a few choices. A retiree can either buy up lots of properties and manage them yourself, or you can invest in REITs.
When you do this you get multiple benefits:
- No fixing the toilets
- No managing upset tenants
- No figuring out property and other taxes
So buying a REIT means you also are buying into or hiring their management as well. REITs make it easier to turn your invested capital back to cash quickly. This is a major benefit if an unexpected life event occurs. The downside to this is that you are exposed to the varied market values of your REIT picks vs. the insulation of not knowing your properties’ value day to day.
The best choice a REIT investor can make is to largely ignore the market value of their investment if the income is still flowing and the fundamentals remain sound. You don’t daily have your home appraised and likewise do not need to fret the daily fluctuations of your REIT investments. Property and residential REITs are trading at extremely attractive prices, often you are buying into properties at a discount to their actual value.
Not too Cold, Not too Hot, It’s Just Right.
For most retirees, they get worried when yields are too high and an investment it too volatile. In essence, that investment it too hot!
Likewise, an investment that offers a yield so low you can’t survive on it is too cold. You might feel it is a SWAN – Sleep Well at Night – but if you can’t get enough income to put food on the table, you won’t sleep at night at all due to hunger pains!
Looking at a rare confluence of events, property and residential REITs are in a just-right zone to bring strong income and total returns. As discussed above, these are a combination of cheap money, excess liquidity, lack of income-producing investment opportunities, inflation risks, and the COVID-19 impact making home more sacred. All of these factors together are creating the perfect storm to see soaring prices for homes and residential REITs over the next few year.
As income investors, real estate provides an excellent source of strong income, capital preservation, and stability. While many cannot buy up low-priced homes in their neighborhood, you can invest in real estate via property REITs that are doing so with great success. Currently we are recommending an allocation to of 20% to 25% to members of our investment community.
It’s a great time to be an investor in rental residential properties. Residential REITs make a great addition to your high dividend portfolio.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Treading Softly, Beyond Saving, Trapping Value, PendragonY, Preferred Stock Trader, and Long Player all are supporting contributors for High Dividend Opportunities.