March 2018 Borrower Newsletter

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 The key question of buying and hold vs. fix and flip has always been up for debate among real estate investors. While flippers are seeing top dollar sales on their exits, landlords are also charging record-breaking rent – and they’re getting it. Will this premium paid last, or are we riding a wave that’s past its peak and due to correct? Aloha sees both of these approaches to exit as equally valid, and ultimately as a decision that should be based on the investors’ own financial situation and goals. While we always like to see our fix and flip investors profit from market trends, we also understand the benefits of building a portfolio for the long term that is geared towards cash flow and consistent returns.

Don’t spend more than 30% of your household income on rent. For many years, this has been standard advice from financial planners.

 But rental rates in the U.S. have risen so much in many parts of the country that the 30% rule of thumb has perhaps become outdated. Today, about half of American rental households pay over 30% of their incomes toward rent. 

The 30 percent ratio can be traced to 1969 when the “Brooke Amendment” capped public housing rent at 25% of a residents’ income. Congress raised the rent ceiling for public housing subsidies to 30% in 1981, where it remains.

 While the 30 percent rule was never intended as more than a rough guideline, these days the guideline is increasingly irrelevant because almost 41 million U.S. households spend more. In the U.S., a quarter of renters now spend more than half of their income on housing, according to the 2017 State of the Nation’s Housing report, published by the Joint Center for Housing Studies of Harvard University. 

And the trend continues. There is a growing shortage of affordable rental housing in the U.S. Yet ironically developers, faced with rising construction costs, are focused on building more profitable luxury apartments. 

Apartment completions reached a 30-year high in 2017 and beat the 2016 level by 30%, according to RealPage. Last year, 364,713 units were completed in the 150 largest U.S. metros, more than doubling the long-term average and growing U.S. apartment stock 2.1%. 

Shockingly, luxury, upscale buildings accounted for between 75 to 80 percent of the new supply last year! The high cost of land, building materials and labor are similar whether you’re building a middle-market or luxury apartment, so not surprisingly, developers most often opt for the more profitable high-end projects. Rents have to be high to support these projects, thus leaving less affluent renters chasing fewer and more expensive rental units.  

 But as we know, U.S. real estate is comprised of regional and local markets with differing characteristics. A disproportionate share of the boom in luxury multifamily construction has occurred in cities with the hottest real estate markets. Cities we’ve referenced previously in this regard, such as:  L.A., San Francisco, N.Y., Portland, Denver, etc. Below is a table using Zillow data that shows the least and most affordable rental markets among the 40 largest markets in the U.S. Affordability is defined as the monthly median rent for a metro area divided by monthly household median income.        

Least Affordable for Renters Most Affordable for Renters 
CityRent/Income RatioCityRent/Income Ratio
Los Angeles, CA48.40%Pittsburgh, PA22.48%
San Francisco, CA42.43%St. Louis, MO23.10%
San Diego, CA42.03%Kansas City, MO23.84%
Miami-Fort Lauderdale, FL40.98%Detroit, MI24.92%
New York, NY39.33%Indianapolis, IN25.34%
San Jose, CA38.47%Cleveland, OH25.54%
Riverside, CA36.72%Columbus, OH25.90%
Boston, MA33.76%Atlanta, GA26.04%
Portland, OR32.53%Washington, DC26.08%
Denver, CO32.37%Minneapolis-St Paul, MN26.65%

                  Source: Zillow 

As you can see, when it comes to renting, the most affordable places to live tend to be cities in the interior of the county that are not “hot” real estate markets (Denver being an obvious exception). It’s also no coincidence that these less trendy markets are where Aloha Capital began its direct lending, and continues to work today. As a lender, we prefer stability to volatility, and though capital appreciation is always a nice bonus, it can be viewed as just that–as long as the cash flow modeling of a rental property is sound.

Some of the markets we have found to be most profitable : Kansas City, Indianapolis, Minneapolis, Columbus, Dayton and Washington DC, are healthy, relatively balanced markets, where residents have stable, rising incomes. Building luxury multi-family properties in cities with saturated high-end markets carries elevated risk. While there is no recession in sight, and 2018 is looking to be a lot like 2017, no one has a crystal ball. As a developer or a real estate lender, the scenario one doesn’t want is flat or declining job growth in a saturated, overbuilt market. The typical properties in the slow but steady cities we favor offer higher gross rental yields for real estate developers and rehabbers.

From our perspective, it’s just better business to operate in places like Kansas City vs. places like L.A. While the old school rule: “don’t spend more than 30% of your income on housing” may be going out of style in some parts of the country, in our markets, most renters are fortunately still able to follow that advice.
Real estate markets are currently serving buy and hold investors well in many cities around the US. 

Aloha Capital can fund your next long term deal, as we have established partnerships with investor-friendly mortgage providers who can readily refinance you out of our short-term loan, post rehab. 

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