The rising long-term bond yields are stirring significant challenges for real estate investors, as the 10-year US treasury surpasses the cap rate, or net profit percentage, derived from rental properties. With US government bonds now matching the returns from buying and renting out houses, the incentive for real estate investment diminishes sharply.
This shift has led to a noticeable drop in investor purchases, with a growing trend of institutional investors offloading their holdings. To grasp the extent of the issue facing aspiring investors, consider a straightforward calculation: the average monthly rent for a single-family home in the US is $2,174, equating to an annual gross rent of $26,088. After expenses, this results in a net income of $16,957, or a 65% margin. Dividing this by the typical price of a single-family home, $357,000, yields a cap rate of merely 4.76%.
Such a rate is unattractive for two primary reasons. Firstly, it offers no premium over the 10-year US government bond, prompting investors to question the rationale of undertaking the risks and hassles of property management when a risk-free asset provides a comparable return. Secondly, the cap rate of 4.76% is unleveraged and doesn’t factor in debt. With prevailing mortgage rates for investors ranging between 6-7%, new investment properties are likely to be loss-making after interest payments are considered.
The current scenario is starkly different from four years ago. Back then, an aspiring single-family investor could secure a property at prevailing prices, rents, and rates, and earn over $2,226 in annual net profit. Fast forward to 2025, and the same investor would face a loss of $5,657 annually after accounting for interest payments. Consequently, investor purchases have plunged, with data from Redfin indicating a 40% drop from their 2021 peak.
Investor activity today mirrors the levels of 2017, with investors buying about 16% of all homes sold in Q3 2024. This percentage, while lower, hasn’t declined as steeply as expected, suggesting that smaller, less-informed investors might still be active. Data from CoreLogic shows that institutional investors have significantly reduced their buying, while smaller investors have remained more consistent.
In markets like Tampa, nearly 80% of investor purchases were made by smaller investors, with major players from Wall Street largely absent. This trend is observable in Florida, where most seasoned investors have stepped back, yet many individuals with regular jobs are attempting to enter the market. The resilience of amateur investors, however, may wane as the reality of negative cash flow becomes apparent.
To achieve positive cash flow in Florida, investors need to purchase properties 20-30% below the after-repair value (ARV). Such deals are rare, making profitable investments increasingly elusive. A potential solution to the unprofitable nature of current real estate investment could be a significant drop in home prices by 20-30%, making rentals more affordable and enticing a new wave of investors into the market.
Until such market adjustments occur, real estate investors must be selective about their investment locations. In 2025, cash flow will be paramount, and markets with higher cap rates, affordability, and growth prospects are likely to perform better.
