High rental yield markets in the USA
4 comments so far
Towards the end of the year 2010, I started putting together operational numbers (income and expenses) for my two condos. I will publish them in one of the next posts at Buying Property in USA blog. However what I observed was the unfortunate fact – that the positive cashflow I was expecting didn’t appear that big in the end. In fact I am glad to even be breaking even on the properties. So I started rethinking my original strategy from more than a year ago.
I previously chose to buy Condominiums, because I thought I would have more maintenance and repair expenses on a single family house. That was a mistake, because first, I am paying very high HOA fees every month, which would easily cover roof repairs once in 5-10 years, etc. Second, I am paying a property manager, who would take care of the maintenance for me. The property managers are charging the same 10% of rents for a Condo or single family house (even though they have more work with single family houses). Also Condos tend to take longer to rent out.
Next thought was about the actual markets I chose. I looked into the biggest price-drop states in the country. Then I compared the rental yields and chose 3 markets: Nevada (Las Vegas), Arizona (Phoenix) and Illinois (Chicago). I purchased condos in the first two (Las Vegas and Phoenix). My vision was, to have positive cashflow and also I was hoping for huge appreciation – return to the prices of 2005-2006. Unfortunately, the positive cashflow is just breaking even in the end and the appreciation didn’t even start in these markets yet. In fact, in Las Vegas the median house prices went even a few percent lower.
That made me to think, maybe there are actually better markets to invest. Not markets, where we would expect double digit appreciation, but rather markets with high rental yields, where positive cash flow will create high return on investment, from year one.
I happened to be in Kansas two times this year, and have studied the market there a bit. Kansas real estate market hasn’t dropped 40% like in Nevada, but just around 5-10%. Therefore I never considered it before. On the other hand, it is a very healthy and stable market with a great rental yield (price to rent ratio).
Definition of Price to Rent Ratio
Price to rent ratio (P/R) is a great and simple calculation showing the attractiveness of a certain Real Estate market or area. It compares median house price and median rent in that market. This ratio actually says how many annual rents would have to be spent for buying an average house. Some markets with very high ratio (i.e. California P/R is 25) do not show such a good opportunity for an investment, because the return on investment would be most probably low. This ratio can help an investor to decide which market to invest in.
I have done a quick calculation of the price to rent ratio (rental yield) for Nevada and Kansas. For the price data, I have used Median Price Asked for Housing Units from Trulia and for the rent, I have used “Fair Market Rents” estimated by HUD, for section 8 tenants . I have taken a median of the 2-bedroom apartments as a benchmark and decreased them by 20%, because the section 8 rents are always higher than the real market rents. I do realize that these numbers are not totally accurate, but they are good enough for a comparison.
Price to rent index for Nevada
P/R = $142,500 / ($659.2 * 12) = 18.01
Price to rent index for Kansas
P/R = $48,500 / ($455.2 * 12) = 8.88
As you can see, the P/R ratio for Kansas is more than twice smaller (better). It actually means that an average house in Kansas cost approx. 9 years of average rents. Or it can take approx. 9 years to pay off this investment property from the rental income (this is a very rough estimation, taxes, financing, expenses, etc. isn’t included).
This whole article should just show the opportunities of investing in these high rental yield markets. These markets are especially great for long term (or forever) holding strategies, without high appreciation expectations. I will try to put together a table of the P/R ratio for all the states or possibly even some counties / metros and post it within a few weeks on Buying Property in USA blog.
Tuesday, December 28th, 2010 at 3:36 am and is filed under buying property in usa, General Education. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.
I like your PR index!
Great idea to workout if a deal or market is a viable investment.
My first pair of investments in TN have a PR or 3.2.
Do you find your properties at retail/wholesale or foreclosure level?
Thanks for the article – Just 1 question, How much are you paying for HOA fees? -wondering what a fair amount to pay per month is. Thanks.
Hi Iain,
for the condo in Las Vegas, I am paying $160 per month and the one in Phoenix $190. The more vacant condos are in the Association, the more they increase the HOA fees unfortunately. I hope it will go lower in Phoenix, because from the rent I get $580 and a third of it goes for the fees. ;o(
Those HOA fees can be real rent killers.
I am just wondering whether you have done any analysis on the tax situation the you would be liable for if and when the HOA fees don’t eat all your profits?