THIS ARTICLE SUMMARIZES KEY DATA RELEVANT TO THE RENTAL PROPERTY INDUSTRY, INCLUDING PROPERTY OPERATING EXPENSE AND HOME VALUE APPRECIATION.
When investing in rental properties, it can be difficult to know what financial returns to expect. It can help to learn about the most important factors that will impact your investment returns and the corresponding historic data from other rental property investments and the industry at large.
This article is meant to consolidate and summarize historical data and studies that can help you understand what you can expect from your investments. It’s important to call out that these historical data points and studies are not guarantees of future returns.
The below article is organized around the three main categories that you should familiarize yourself with 1) Property Income 2) Property Expenses & 3) Property Value Changes.
Once you have a better grasp of these key levers, feel free to visit our investment calculator where you can plug some of these assumptions in to analyze investment scenarios.
Rental prices are highly dependent on the local market, location, and quality of the property. To estimate rental rates for a property, the best method is to view actual market rents for comparable properties in the same neighborhood.
At Arrived, we analyze potential rent estimates in 3 different ways, 1) current and past 6 months of rental listings for comparable properties 2) we consult several professional valuation services and 3) we consult with our experienced property managers that have first hand knowledge of the market.
Once you have determined your estimated rental price at current market rates, the next step is to determine the annual rent growth you believe the rental property will achieve. It can be helpful to use the historical average increase in national rental prices as a guide. Of course it’s important to mention that past historical performance is no guarantee of future performance.
Below we can see a chart from the Federal Reserve Bank that shows that the rent prices across the US have increased 3.55% compounded per year between December 1947 and December 2020.
3.55% Average Yearly Rent Growth Nationally from Dec 1947 to Dec 2020
Source: The Federal reserve, Dec 1947 to Dec 2020 https://fred.stlouisfed.org/series/CUUR0000SEHA#0
Property operating expenses are a critical piece of determining investment returns and consist of any cost related to the continued operation of the property. These include vacancy expenses, property management, property taxes, insurance, HOA fees (if applicable), utility expenses, repairs & maintenance, leasing costs, and marketing expenses.
This metric is typically displayed as a percentage of rent revenue. So if a property has estimated property operating expenses of $760 ($9,120 per year) and it rents for $2,000 ($24,000 per year), then the property operating expense ratio is 38% ($9,120 divided by the yearly $24,000 rent).
It can be difficult to find broad industry data to predict operating expenses. Operating expenses can vary wildly based on the local market dynamics and factors specific to each property. We have done an Arrived case study calculating the property expense ratio for The Lierly and have published the results here. (Last Updated: Feb 23, 2021) It is important to note that historical data is not a guarantee of future performance.
Operating Expense Ratio: 33.9% for Last 6 Months of 2020 for The Lierly Property
The 33.9% expense ratio for The Lierly over the 2nd half of 2020 is excellent. However, it’s important to keep in mind that 6 months is a relatively small sample size. A large unexpected repair can drastically change the expense ratio for a property. Typical expense ratios for single-family homes are somewhere in the range of 30-50%. Where a particular property falls depends on several factors. These can include the location, year the home was built, and the price and quality of the home.
Property Value Changes:
In addition to the cash flow from a rental property, a major driver of investment returns can be any potential change in the property value during the ownership period. These changes in property values do not impact the cash returns and are only realized if and when the property is eventually sold.
Luckily, there are plenty of very useful historical data both at the national and local levels that can help real estate investors understand the historical changes in the property values. Of course it is important to note that while it is useful to analyze historical data, it is in no way a guarantee of future performance.
Below we can see a chart from the Federal Reserve that shows that median house prices across the United States have increased by 4.22% compounded per year during the last 40 years.
4.22% Home Price Appreciation from Q4 1980 to Q4 2020
Source: The Federal reserve, Q4 1980 to Q4 2020. https://fred.stlouisfed.org/series/MSPUS#0
Additionally, in cases where the property is purchased with mortgage financing, that leverage will magnify any increase or decrease in value to equity investors. For example if a property is purchased with 80% financing (and 20% down payment), and that property value increases by 5% in the first year, the increase in equity value will actually be 25% in that year. Similarly a 5% decrease in the property value will decrease equity by 25%.
In addition to the above historical rental property industry data, we have several other resources that can be helpful as you navigate through projecting returns for your investment.
- Property Investment Calculator – We created an investment calculator so that users can play with key assumptions and see the projected investment outcomes.
- Arrived Property Performance – The Lierly Case Study – In this Arrived Learning Section article you can find the historical performance for two of our properties, The Lierly and The Soapstone.
- Understanding A Real Estate Pro Forma – This article from our Arrived Learning Section goes through a single family property Pro Forma statement and defines each item.