I recently had lunch with a nice couple from Pennsylvania. When people find out what I do for a living, they tend to bounce investment ideas off of me. I’m good with it. It comes with the turf.
At any rate, this couple had an interesting dilemma. They owned a multimillion-dollar portfolio of rental properties next to a major university. You’d think something like that would be a goldmine. It has been for a long time.
But things are changing.
The size of the student body hasn’t changed much in recent years and isn’t projected to change moving forward. Yet a massive new supply of premium student housing is coming, with many other projects under construction.
This isn’t Animal House we’re talking about. These are high-rise luxury towers.
We all know how markets work. When demand outstrips supply, prices rise. But when supply outstrips demand, prices fall.
So, it seems clear for this particular college town. Prices for student housing are likely dropping.
This raises several questions.
The first, and most obvious, is: “What idiot thought it was a good idea to slap up a massive new supply of housing in an area that isn’t growing?”
Well, the short answer is Fed Chairman Jerome Powell and his central banker peers. And the long answer is a bit more complicated.
The Real Estate Dumping Grounds
After a decade of ultra-loose monetary policy, the world is awash in so much liquidity that there’s nowhere for it to go.
Bonds yield nothing.
Stocks are near all-time highs and are wildly expensive by virtually every metric.
The IPO market is failing.
So, dumping millions of dollars into student housing in rural Pennsylvania might seem like a good idea. Borrowing costs are so cheap right now, the carrying cost is manageable even if the building sits half empty for years.
And remember, money sloshes across borders. Some of the projects are backed by foreign investors that are even more desperate for a return than American investors. Overbuilding in America seems like a lesser evil than investing in European or Japanese assets.
This brings me back to my Pennsylvania couple.
They’re ready to throw up their hands. The couple has no idea how to react in a world in which their competing landlords don’t seem to care whether or not they make money.
I asked them whether they still had mortgages, and they said no.
That’s good. If the rent dropped a little, at least they wouldn’t have to worry about covering a mortgage. All the same, sagging rents should cause property prices to fall, all else equal.
I asked them how much they were currently collecting in rent, and it worked out to about 5% of the current market value of the properties.
Now, 5% isn’t bad. But they have to work for it. They have to fix toilets, deal with noise complaints, and accept the risk that some college kid might throw a raging party and trash the place.
I told them that, while I’m no expert on the local property market, a 5% unleveraged rental yield wasn’t anything to write home about. Particularly if price appreciation is unlikely over the next several years. Most of the positions in my Peak Income newsletter pay well over 5% in dividends and offer the possibility of decent capital gains to boot.
The Trouble with Rental Properties
I like rental real estate. A lot.
But I don’t like it at any price. And I don’t like it when I see a ton of new money sloshing into it with little regard for profitability.
I’m curious to see what the couple does. They seemed shrewd. This clearly wasn’t their first rodeo, and I bet they end up cashing out. Time will tell…
Regardless, if you own properties of your own, you might want to take a hard look at them. Are they cash flow? Do you have a lot of new competition that could potentially push prices down? And if that were to happen, would you have a hard time breaking even?
If the market in your area is looking frothy, there’s nothing wrong with taking your chips off the table. Even if you don’t think you’re at risk of taking major losses, there are opportunity costs. Your money might get better returns elsewhere.