Forget Boise. Buy Rental Properties in These Cities.

There's a lot of competition right now for single-family homes across the U.S. — from buyers hunting for new primary living spaces to institutional investors looking to capitalize on limited supply.

It can feel overwhelming if you're in between: An amateur real estate investor looking to put extra cash to work by acquiring a second or third home to rent out.

Rest assured, as the spring selling season kicks off, it's still a good time to invest in a home for the usual reasons. Done correctly, real estate can diversify a portfolio and act as a hedge against inflation. Plus, given the difficulties would-be first-time homebuyers are facing, and the desire for more space spurred by the pandemic, demand for renting houses is likely to stay high. 

Not surprisingly, a Google search for “invest in real estate” is the highest it's been since 2004, Freddie Mac's deputy chief economist Len Kiefer noted on Twitter recently.

Still, given how hot the housing market is nationwide, and the rapid, eye-popping price jumps in some cities, investors need to proceed with caution. The best places for long-term investment are ones where home price growth and volatility aren't outliers compared with national averages, and offer some kind of stability on their own, such as universities, or some type of commerce. Buying close to home has practical advantages and may feel safer, but it may not be the smartest investment.

Here are a few examples of cities to consider, and one to avoid, using data provided by Zillow.

Nashville: The allure of this Tennessee city and its amenities isn't new, but now may be a particularly good time to invest. Home values over the past 12 months ending in February have increased 9.6% relative to the national average of 9.9%. Prepare to spend several hundred thousand dollars, as the average home price in Nashville is about $311,000, compared with the national average of $272,000. Also, year-over-year rent growth slowed for most of 2020, but seems to have bottomed out in January, ticking back up by 1.6% in February to $1,600, slightly below the typical rent nationally of $1,700.

Birmingham: It's the most populous city in Alabama, and home to several colleges, law schools and a robust health-care industry. The draw here is its stability and affordability. Birmingham's year-over-year rent growth stayed relatively constant, even as it softened during the pandemic in other parts of the country. The typical rent is $1,140.

Salt Lake City: Utah's capital has one of the nation’s largest population shares of Generation Z — those in their teenage years and early 20s — who are likely to rent now or start renting in a few years. Companies including Zions Bank and Overstock are headquartered there, and many more corporations have outposts in the region. Home prices have jumped quite a bit this year — 15% — and the typical home is valued at $440,100. But that's well below the average in other Western metro areas that have attracted Bay Area transplants, such as Denver and Portland. If Salt Lake still feels overpriced, consider the nearby cities of Provo (where Brigham Young University is located) and Ogden, which are cheaper.

Boise: Idaho's capital is the city to be wary of unless you're intent on moving there yourself. It leads the nation's top 100 metro areas in rent growth and home value growth. Rents are up 12.6%, and home values have jumped 26.5% as of February, compared with a year earlier. (Spokane is No. 2 for rent growth at 10.6%, and Phoenix is No. 2 for home value growth at 18.3%) While rents are still relatively affordable in Boise at $1,470, homes are now hovering around $411,000. Such rapid growth seems unsustainable, especially as questions about the permanence of working from home are raised.

Of course, there are options besides cities and suburbs. And figuring out the where is just half of it; investors then also have to think about the neighborhood, says Steven McCord, a real estate investor who co-founded Locate Alpha, which provides city and sub-city analyses.

There are a few other things to keep in mind when weighing a residential real estate investment. It's probably best to avoid beach towns given the maintenance involved, the potential for weather damage (meaning, high insurance costs) and short-term tenants who may not treat the property as well as long-term renters would.

Also, make sure you're aware of the local laws and how friendly they are to renters, as well as property tax liabilities. Decide whether you want to be in charge of maintaining the property (and fielding late-night calls about hot water problems) or if you'll tap a property manager. If the latter, figure that will eat up as much as 20% of your income stream.

Finally, remember that interest rates, while still historically low, are likely to rise. That tends to have a delayed, negative effect on home prices, which makes choosing the right city to buy a home to rent out even more important.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Alexis Leondis is a Bloomberg Opinion columnist covering personal finance. Previously, she wrote about personal finance, asset management and mortgages, and oversaw tax coverage for Bloomberg News.

©2021 Bloomberg L.P.

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