In the fog surrounding the commercial sector comes an important and invaluable lesson for home buyers who base the value of any property on its rental returns. While this is a important and critical calculation when buying a rental property, the past few years have taught us:
1. Rents generally rise over time. But there are times too when rents dip.
2. Rents that have recently soared in value are often a red flag that they may have risen too far, too fast: when developers see this happening, many step in and add to the supply which inevitably slows rent escalations, or make rents drop. Rebalancing of rents is inevitable.
3. Rents can come down when there are new geopolitical issues of a longterm nature that encourage people to move out.
4. New local tax policies can eat away profits and compel people to move, thereby reducing demand.
5. New local laws restricting rental policies - especially short term - can shift valuation. Those buying second homes hoping to pay for the annual operating costs by renting a few weeks/months should be aware of this.
6. HOA's can change sub-leasing policies that could impact rental valuations and returns. Some add new fees to discourage sub-leasing and/or 'get their piece of the pie' to pay for stuff..... This usually requires a majority.
7. Adjustable interest rates - or a short term loan - on an investment property can increase your carrying costs - and profitability - when rates rise or when you have to refinance.
8. It's best to have deep pockets when refinancing a property to draw out capital for other investments based on overly ambitious high - and rising - rental returns. If things do not go according to plan, you could end up with negative equity.
When the profitability of rental returns are diminished, or when the rental rates drop, so too can the valuations of the buildings as an investment entity dip. Conservative rental projections are always safest. Conservative projections of vacancies can be helpful too: One month of a vacancy costs a landlord about 8% of annual income and can eat up profit.
The success of real estate investments are often driven by timing: either your ability to buy quality at a fair price, or your ability to weather storms over the longterm. Conservative rental return projections that don't only assume the very best can protect you.
