red flag for crashing market: rising rents
I know we have discussed rents on other threads, but I wanted to focus a topic on the theory that rising rents are actually a sign that the over-all real-estate market in a given region is about to crash.
The theory is as follows:
- As real-estate prices are in the midst of a boom (with substantial appreciation), rents remain low as increasing numbers of renters decide to rush out and buy (i.e. there are few renters fighting for the rental inventory). There is lots of easy money enticing renters to buy as a bubble grows, and the massive appreciation provides loads of incentive to buy since no one wants to lose out on their chance to get rich.
- The only time rental rates actually go up is right at the tip-top of a given real-estate market. It is at this apex of the market where we start to see increasing numbers of people decide not to buy the now over-priced homes, as well as a dwindling rental inventory as many landlords have finally decided to try and cash-out on the boom by selling (e.g. condo conversions, SFH sales, etc).
- After the real-estate market has turned south, with substantial depreciation, we now see rents decline again. Many homes come back onto the shadow rental market now that owners find they can't find buyers at the prices they need (to pay the mortgage) and decide to stop the bleeding through renting. We also see rental demand start to decline as people increasingly begin to find alternative living arrangements to save money. We see people who were burnt with home-ownership going back to live with parents, doubling up with relatives, etc. Some people simply pack-up and leave the high rent regions altogether when the availability of real-estate industrial complex jobs becomes tough (e.g. mortgage brokers, construction workers, home-depot staff).
From what I can tell we have seen this pattern (i.e. of rising rents right before real-estate markets crash) play out in many regions of the US. We saw this in Miami, San Diego, Las Vegas, Phoenix, and many other locales.
The moral of the story is this: the very last thing someone should do is run out and buy a home when rents start to rise.
The theory is as follows:
- As real-estate prices are in the midst of a boom (with substantial appreciation), rents remain low as increasing numbers of renters decide to rush out and buy (i.e. there are few renters fighting for the rental inventory). There is lots of easy money enticing renters to buy as a bubble grows, and the massive appreciation provides loads of incentive to buy since no one wants to lose out on their chance to get rich.
- The only time rental rates actually go up is right at the tip-top of a given real-estate market. It is at this apex of the market where we start to see increasing numbers of people decide not to buy the now over-priced homes, as well as a dwindling rental inventory as many landlords have finally decided to try and cash-out on the boom by selling (e.g. condo conversions, SFH sales, etc).
- After the real-estate market has turned south, with substantial depreciation, we now see rents decline again. Many homes come back onto the shadow rental market now that owners find they can't find buyers at the prices they need (to pay the mortgage) and decide to stop the bleeding through renting. We also see rental demand start to decline as people increasingly begin to find alternative living arrangements to save money. We see people who were burnt with home-ownership going back to live with parents, doubling up with relatives, etc. Some people simply pack-up and leave the high rent regions altogether when the availability of real-estate industrial complex jobs becomes tough (e.g. mortgage brokers, construction workers, home-depot staff).
From what I can tell we have seen this pattern (i.e. of rising rents right before real-estate markets crash) play out in many regions of the US. We saw this in Miami, San Diego, Las Vegas, Phoenix, and many other locales.
The moral of the story is this: the very last thing someone should do is run out and buy a home when rents start to rise.
Comments
http://www.newsobserver.com/business/story/1065073.html
We are just behind in the downturn in the Seattle area. Depreciation has only now begun, which will slowly lead to a pick up in foreclosures (i.e. since equity poor home-owners won't be able to sell if they run into financial trouble).
I know major holders of multi-unit 50+ apartments, rentals (1500+ units). In the peak of the market from end of 2005-mid 2007, they had to cut rents, advertise, and give out first month free in order to get rents, their vacancy rates were astounding.
Now they are raising rents every single renewal by a good margin, and people are signing renewals and not moving out.
Another associate owns duplexes around Seattle/Shoreline, over 30 of them. He has raised his last 5 renewals by $100 a month each and everybody signed.
Our area is far very far from 20% foreclosure rate. And even at that people need to live, and they definately can't afford to buy, they go rent and pay someones mortgage for them.
Precisely. Rents will start to be seriously impaired when the Seattle area foreclosure rate really picks up, which is slowly gaining steam. It's not at all surprising that rents are rising right now because we are still at the apex of the market cycle. Rents rose in San Diego, Las Vegas, and Boston right at the top of their cycles too.
Don't forget that my point is that the increase of rents is a flashing indicator that the over-all housing market for a given region is about to tank. In fact, you can't have a housing crash without rents first rising. Are rents rising in the Seattle area? Yes! And this is the final warning signal that the broader market is about to head down big-time.
Just wait and see what happens when the foreclosures start picking up in the Puget Sound by the end of 2009. We are about to see a vicious cycle of real-estate now that there is negative appreciation in our area. People with no equity will be forced into foreclosure when they run into financial trouble (they were always able to just sell in past years when there was positive appreciation). This in turn will lead to greater price deprecation and even more foreclosures.
Patience...
Rising rents are not an idicator of a market tanking.
Right, they're an indicator that the market is about to tank. The reasoning goes:
So, what were the rising rents in Miami and San Diego indicative of a few years ago? It certainly wasn't a sign that there was healthy demand for either rental property or purchased homes.
Virtually every market in the US that has seen a significant pick-up in foreclosures and negative appreciation first saw their rents increase. Even if rising rents aren't an "inidicator" that a real estate market will tank, it certainly correlates to such an event in most cases.
Still, I go back to an earlier point I made. There is not one market that has seen rents rise when REO sales reached (or exceeded) 10% of the total residential sales. And since Seattle is well on it's way to reaching the same levels of foreclosures that the rest of the country is seeing, I can't imagine how rents will remain frothy.
Here's what I'm not grasping. Shouldn't rents start to fall after home prices have fallen enough so that people are jumping back into buying?
The only way I can see them both falling at the same time is if unemployment here really took off and people started leaving the area.. That's quite possible too.
Rents will rise and fall based on the simple equation of supply and demand. However, both parts of this equation are much more fungible than generally thought.
Supply can decrease due to things like condo conversions and landlords of condos and SFHs who decide to stop renting in an attempt to sell their properties at high prices. Likewise, supply can increase as investors decide to start renting when they can't find buyers at the prices they need. Supply can also increase when home prices fall so much (with lots of REOs) that some investors come back into the market with the express purpose of aquiring rental properties.
On the demand side, the number of renters can decrease during a boom as increasing numbers of people are imbued with the desire to get rich, and credit becomes loose. Demand can increase as renters decide prices for purchasing are too high and mortgages become harder to obtain. But we can also see demand decrease in these down cycles as more people decide to move in with family, or leave pricy regions altogether to save money.
Jobs and employment are just one of the many factors that go into rental demand and supply. Also, rents might actually go down even during massive real-estate downturns as struggling owners desperately try to rent, and increasing numbers of investors are enticed to buy dirt-cheap rental properties.
That in turn pushes people to rent, which will make rents rise.
Credit tightening also makes it hard for owners of condos and SFHs to sell for the prices they need, and pushes them to rent their properties out which increases supply. Credit contraction also causes greater real estate price depreciation (i.e. since there are fewer buyers), which increases the number of foreclosures and leads to great REO deals for investors looking for rental properties which increases supply.
As I said earlier, there has never been a case where rental rates increased when foreclosures rose substantially.
Majority of the homeowners do not want to rent, will never rent, and do not desire to be landlords. Biggest percentage will stop the sale of their house and take a hold on moving unless they absolutely need to.
REOs and Foreclosures are 5% of the market right now. That is not a big swing of rentals.
True, most people do not want to rent, but the markets are made on the margins. In a depreciating market there will be an increase in the number of struggling equity poor home-owners who MUST sell, but are unable to get the price they need. There is a historically unprecedented number of puget sound home-owners who have no equity, and without appreciation to bail them out they will be forced to either rent their homes or go into foreclosure when they run into trouble. Also keep in mind that we have a higher percentage of unoccupied homes than we've had before which indicates that there are a good number of home-owners who are actually just investing. What are these investors to do when they run into financial trouble and can't sell their condo?
Right. Foreclosures aren't a big part of our market right now, but they will be. Look at San Diego and Orange County, for an example. Foreclosures were really low for a long time and then ballooned all of a sudden once they had negative appreciation for about a year and a half. The Puget Sound just now hit negative appreciation so it will take a while for the impact to be felt in notices of default and foreclosure.
When discussing rent increases, it is important to distingush what types of rentals we are talking about, even at the apartment level. What the rents are for bigger buildings don't correlate with smaller ones. Duplexes/Triplexes don't necessiarily correlate with SFH's.
The Dupree and Scott surveys don't include buildings with less than 20 units, and lots of people don't make that distinction. The in-city rentals are also distorted by what I call the overstated "premium" for living within a 30 min. bus trip downtown. Especially those on the North End that lie south of 85th st.
The rents across the board are increasing, that is certainly not in dispute. When they go down is a much a reflection of which rentals go down, and when, as much as the traditional median per capita income, NOT household income. Far more renters are single, than married in-city. IMO, per capita income has more sway than supply and demand in how rents actually play out and are accepted.
Charging a ton for something that is basically a POS is also skewing the stats, IMO, no matter the location.
Gee, I don't know. 1/20th of the market is comprised of blown deals? It's not gigantic, but that is a significant part of the market. Ask wheat sellers (another commodity) if they would care if 5% of the grain was spoiled. I bet they would.
http://calculatedrisk.blogspot.com/2008/08/downward-pressure-on-rents.html
http://online.wsj.com/article/SB121919861213655575.html?mod=hps_us_inside_today
The other issue is investors with houses they thought they would sell but now much carry the mortgage on, after a few months on the market the ideal of being a landlord becomes a lot more acceptable.
People that actually live in their house and don't need to move aren't going to become landlords, true enough. Those that 'investor's, though, have a different set of problems.
I was renting a brand-new house for a lot below the mortgage (out in Snohomish, Train to work). In my neighborhood there are at least 5 rentals (all houses built after 2005) of something like 24 houses. My landlord didn't raise rent over the last 3 years, and across the street someone rented for the same rate a couple months ago. Big apartment buildings with high occupancy rates can raise their rates ok, but investors with a single house take a large risk to raise rates. I'm now moving due to a job, or I'd have stayed for another year paying the same rate. Of course, I've also kept the house in great condition, which is always a plus for not getting your rates jacked.
More so even than that. You're 18 and just out of high school. Do you live at home or get your own place? Your 22 and just graduated from college...same question. My hunch is that if prices were low enough, you could expand demand by 5% or more in under 3 months. It takes longer to contract demand, but either way there is a lot of flex in the system that is based on prices.
Actually, I know people who have decided to rent out rooms in their homes to help pay the bills. Who knows how many SFHs might turn into boarding houses as people look for creative ways to get by?
None of this changes the fundamental underlying linkage between how much money people have (as determined by their income) and how much they can afford to pay for rent. There is no lending standard or interest rate that comes into play here.
I just love the argument from people who say "well, I'm a landlord and my costs are going up, so I'm raising rents!". Maybe. Maybe not. Maybe you will make money, maybe you will lose money.
The core assumption there is that costs somehow determine rents when precisely the opposite is true. The reductio ad absurdum extension of that logic is that I could pay $5mm for a 1 bedroom condo in kirkland and then rent it out to cover my costs. No, smart investors look at what they can get in rent and then decide what they will pay. And when cap rates are 2%, they put their money elsewhere...
http://www.msnbc.msn.com/id/26776283/
So, if rental demand falls when house prices stop falling, what happens to rents then? And when rents fall, what happens to demand to buy houses? I'd wait to buy until a clear equilibrium is reached. Buying when it's cheaper than renting may be too soon.
Sort of the idea that what you buy your house for is not the sticker price, but the checks you write.
:?
And as Dr. Phil would say, "And how's that working for you"
More of my thought on this is that I believe that inflation is going to be crazy over the next couple years. That means the fed raises and interest rates go up. What if we end up seeing rates in the 9's and 10's again? Being in a 30 year fixed at 5.5% would be pretty sweet.