On paper, deciding whether to rent or sell a property may seem like a simple evaluation of numbers, but this decision is actually far more complicated when you are looking at a real city with real people who are making important decisions about their own lives. These decisions are what drive a market, especially one as complex as Chicago, where a combination of factors, including soaring rent and home prices as well as weakening market demand, are putting traditional investment strategies into question.

A conscious property investor might have been alerted by December’s announcement from the National Association of Realtors (NAR) that the Chicago submarket is expected to be one of the weakest out of 100 US metropolitan areas in terms of growth, making it seem like prime time to leave. But it is more complicated than that. Though renters and buyers are both facing ever-increasing cost pressures which can impair their living standards and negatively affect the demand side of the market, it’s also due to these very pressures that there are significant opportunities to boost your ROI by investing in properties that could be sold or rented out at below-market rates.

When developing a sound investment strategy, you should bear in mind that near-term profitability and longer-term ROI differ between the selling and renting segments of the housing market. In the case with the Chicago submarket, there are several market indicators that can help you decide whether to invest into properties for sale or to rent. It comes down to another decidedly human factor: the investor’s preferred timeline of the pay-back period.

Affordability Issues: Robust Demand or Dismal Incomes?

The acute housing affordability concerns in the Chicago area (with a notable exception of Lake County) present a two-pronged challenge to understanding the situation of one of the largest US real estate submarkets. On the one hand, the gains in home prices and rents reflect the robust demand for housing, driven by the solid labor market in the area and the still highly affordable credit.

But that certainly doesn’t mean there is across-the-board prosperity. Stickiness in salaries and wages, persistent in the US economy since the 1990s, impact housing affordability, forcing larger amounts of tenants and homebuyers to downgrade their housing preferences in terms of unit size, amenities, neighborhood choices, and other factors.

The combination of these factors are what we might call the “mechanics of affordability.” Understanding them helps you improve your market positioning, so it is in your best interest to keep an eye on numbers that reflect the most recent developments in the Chicago submarket:

• In October (the most recent data available), single-family residential property prices in the Chicago submarket gained 3.9% year-on-year, according to the S&P CoreLogic Case-Shiller Indices. This is a fair warning to investors that the market is already expensive, so you should think twice before allocating capital in residential development for sale.
• To properly evaluate the demand side of the market, you might want to look at the labor market in the area. The unemployment rate in the Chicago Metro dropped to 5.3% in November from 6.5% in April the previous year, according to Bureau of Labor Statistics (BLS), a positive sign.
• Median annual pay in Chicago increased 2.8% year-on-year to $55,864, according to a report by Glassdoor Economic Research. Gains in wages outpaced inflation, which stood at 1.69% year-on-year in November.
• Another determinant for the demand side is credit affordability, dictated by the Federal Reserve’s interest rate, which investors are watching closely. The Fed still holds its base interest rates at very low levels and 0.25-0.5% throughout most of the past year. This makes average mortgage credit costs consumer-friendly, at 4.42% for a 30-year fixed mortgage, according to Bloomberg data.

You may infer from this data that the demand side of the housing market is enough to absorb the supply in current construction. However, the longer-term profitability differs between the construction for sale and for lease, and our goal is to find out which of these two segments will ensure the longer-term sustainability of your investment.

Opportunities and Challenges for Home-Sellers

Gains in Chicago home prices have outpaced the increases in disposable incomes and this trend is likely to continue in the near-to-medium-term. Mortgage rates have also increased. This situation appears to be rather encouraging for the investors seeking to allocate their capital into the development of housing for sale. However, in order to avoid hasty decisions, you should pay attention to the signs of overheating in Chicago-area home sales.

Home prices cannot keep outpacing gains in effective incomes and inflation forever. Once the market becomes too expensive for an average homebuyer, slower home sales, declines in mortgage issuance, and, ultimately, sliding housing prices will ensue.

Given that home prices in Chicago are already high, it would be most prudent for an investor to limit their appetite for allocating capital in the development of homes for sale to the projects with an anticipated completion date no later than mid-late next year.

Landlord’s Crisis Hedge

Building-to-rent can deter investors due to its lower immediate ROI. However, considering the mounting risks to home sales, investing in units to rent does promise greater ROI in the longer term.

You should bear in mind that a median listed home value in Chicago is currently $264,750, according to data by Zillow, and the median Chicago Metro area rent is $1,600. For investors, this means that investing in construction for lease will generate greater returns in the long-term perspective compared to investing in projects for sale.

You might have noticed that many would-be homebuyers have already been diverted into renting by prohibitively high home prices. Amidst the affordability pressures, credit squeeze, and shifts in market demand, property investors will be allocating more capital in building to rent when these signs become more prominent later this year. Investing in building to rent at this point will allow you to be ahead of your competitors who will jump on the bandwagon later amid the rising competition. Moreover, Chicago area rentals will gain substantial support from the buoyant labor market as jobs attract workers who require accommodation.

Sell Now or Keep to Rent

The current conditions in the Chicago residential submarket and broader US macroeconomic indicators suggest that if you are seeking greater near-term ROI, then investing in building-to-sell will be the most profitable strategy. Bear in mind, however, the already high home prices, and signs of market volatility and potential bubbles, might undermine the quality of your portfolio.

If you are looking at a timeline that exceeds the period of the coming two years and count in the risks to macroeconomic stability, cyclical crises, and policy challenges, employing best practices for renting out your investment property is your safe-haven option.

If you are ready to dive into the Chicago real estate market either investing to sell or investing to rent, HomeVestors® can give you the tools and resources you need to get started and remain successful. Contact us today for more information, or request consideration to become a franchisee.

Each franchise office is independently owned and operated.

Image Source | Flickr user Mariano Mantel