The Economic Collapse of the Middle Class

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This summer, I’ve been renovating a beachfront rental property that I own. The returns are fantastic … the rental income is more than three times the sum of my financing costs, local taxes and the management fees I pay to a local agent. After the renovations are done, I’m planning to eliminate the balance of the mortgage in about 18 months. After that, the rent is pure profit.

The tenant is a great guy, thrilled to be renting a delightful old farmhouse in such a unique location near the sea. He’s conscientious, paying every month ahead of time.

But here’s the odd thing … he’s an adjunct college professor.

If you follow the news on my tenant’s profession, as I do since I used to work in that sector, you’ll find that the average annual income of an adjunct professor is about $22,000. You read that right … about $1,800 a month before taxes. And no benefits or job security.

So what’s this poor guy doing in my seaside house, you may ask? Simple … my house isn’t in America, and neither is my tenant…

“Ineffective” Demand for Rental Housing

When it comes to rental properties, the question you should be asking yourself is: If I build (or buy) it, will they come?

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In the U.S., the answer is increasingly “no.” The economic collapse of the middle class is destroying the incomes of potential tenants, wreaking havoc in rental markets. For good returns with less hassle, you want to look overseas, as I do.

The paradox is that people are as desperate as ever for affordable rental housing. But every child learns early in life that there’s a difference between wanting something and having the means to obtain it. It’s a tough lesson, but fundamental to economic life. Without money, your demand for something is “ineffective,” to use the economic term.

All across the U.S., lack of middle-class income means homeownership is completely out of reach for many people. As a result, ownership has continued to decline, dropping to 63.8% in the first quarter of 2015. That’s down from 68.5% in the first quarter of 2007.

Rental households, by contrast, have grown by an average of 770,000 annually over the past decade. That’s far faster than the increase of new rental stock, so supply is tightening: Rental vacancy rates dipped to 7.1% in the first quarter of 2015, down from 8.3% a year earlier — near the lowest level in two decades.

Building for the Money, Not the Need

This gradual economic collapse of the middle class if going to get worse: About 59% of the 22 million new households that form between 2010 and 2030 will rent, while just 41% will buy their homes.

Sure, builders are adding apartments rapidly … but they are concentrating on the higher end of the market, with little new stock for those in the middle and bottom. Under current economic and financial conditions, there’s no reason for developers to target the dying U.S. middle class.

So rents for middle-class folks are rising rapidly, and renters in the middle of the market are under severe financial pressure. The share of renters paying more than 30% of their income on rent — defined as “cost burdened” — is at near-record highs. In 2013, almost half of all U.S. renters fell into that category. The share of cost-burdened renters is growing most rapidly among people who earn from $30,000 to $75,000 a year.

Now, all this may make it sound like a great time to be a landlord. In some cases, that’s true. But what happens when renters can no longer afford sky-high rents? When that happens, demand for rentals won’t be “effective.” People will want to rent, but they won’t be able to. Rents must fall, and so will returns to owners of such properties.

The Offshore Option

My rental property happens to be in Cape Town, but there are plenty of other places around the world where a savvy investor can earn outstanding returns in stable, growing economies.

In places like the beachfront areas to the north of Punta del Este, Uruguay, for example, it’s possible to acquire decent properties for as little as $200,000. Long-term annual rental returns on such investments are around 10%. That’s right … 10%. Where else on Earth can you get that kind of yield?

Investing in offshore property isn’t as difficult as you may think. And as an added bonus, foreign real estate owned in your own name isn’t reportable to the IRS.

So before you decide to invest in a rental property, look abroad. I guarantee you’ll be glad you did.

Kind regards,
Ted Baumann Sovereign Investor
Ted Baumann
Offshore and Asset Protection Editor