Thursday, May 08, 2008

What's Up (Down) with Rents?

Here's my answer to the cliche that "all real estate is local." Yes, but the economy is global. And isn't every local market tied to the actual economy? And if the economy is global, then isn't every leafy tree-lined neighborhood also tied to the global economy of depreciating currencies, oil price hikes and job losses?

Though the answer is "yes," housing and rents remain heavily influenced by local conditions. Nothing highlights this better than the fact that rents are falling in some parts of the U.S. even as they're rising elsewhere.

Knowledgeable reader Tom B. pointed out the conundrum of rents rising even as hundreds of thousands of houses are being vacated via foreclosures:

Today an article appeared in the Wall Street Journal, The Accidental Renters. It says that due to foreclosures, rents are rising in many markets. People getting kicked out of their houses are driving up the price of rentals. This does not comport with my recollection of the 1980s. In our crash, many multi-family buildings, particularly four-plexes went into foreclosure and the savvy investors who bought them on the cheap were able to rent them by dropping the rent, and offering incentives like three months free rent, free cable TV etc. Investors also bought condos and single family homes to rent.

Shouldn't rents fall in this downturn eventually? Is what's happening in the WSJ article just a due to a delay in the time it takes for properties to enter foreclosure and then be used as rentals?

Excellent question, Tom, and let's look at the factors influencing rents.
Let's start with a look at the truly insane rents being demanded of those who want to live in San Francisco. Rents are so high, they're attracting con artists: Housing scams adding insult to misery for those seeking rentals (S.F. Chronicle)

Meanwhile, on the other coast, overbuilt Miami is experiencing the opposite: plummeting rents: Rental Rates Begin To Drop With Home Prices

If one were to describe house prices to falling rocks, then, it would be safe to say that rents in South Florida are dropping like boulders.

Rents didn't exactly stand still during the housing bubble; as correspondent Viperbear recently reported:
In my area of Los Angeles, 3 bedroom 2 bath homes were renting for $1200.00 a month in 1996. Today the same 3 + 2 is renting for $2100.00.

A large number of factors are playing into the rental markets--local and global. Let's start with the basics, which are supply and demand.

1. Areas which were overbuilt in the bubble have more dwellings than people who want to live there. Miami is a good example of this, as thousands of condos were constructed and purchased by speculators, many of whom are now trying to rent out their albatross units.

Conversely, built-out urban locales like San Francisco which did not experience a building boom that exceeded demand are still experiencing a demand-supply imbalance: the number of people who want to live there exceeds the supply of housing.

2. Rents are tied to jobs which are tied to the global economy. During the dot-com bust, San Francisco lost about 50,000 residents as the dot-com jobs dried up and blew away. S.F. is currently awash with wealth from Web2.0 companies and a robust tourist trade fed by the cheap U.S. dollar and a U.S. economy which until recently enabled folks to borrow and spend very freely on luxuries like a week in pricey San Francisco.

Miami's tourist economy is doing well on the cheap dollar, too, but not well enough to draw in another 50,000 residents who will rent all those empty units.

But what happens as the global economy slows and air travel becomes ever more costly? What happens when "Web2.0" is revealed as mostly hype and sizzle? What happens when the "slowdown" (don't call it a recession!) causes businesses to lay off employees, even in "bulletproof" cities like S.F., New York and Seattle? And what if the dollar confounds everyone by actually rising, making the U.S. a somewhat costlier destination?

Real estate may be local, but jobs are global and national. If the easy money dries up, then 50,000 people can lose their jobs very quickly in any of these "bulletproof" cities.
Rents are ultimately tied to both demand and incomes. At some point those who lost their jobs will be forced by high rents to either "double up" or move away. Vacancies will eventually force rents down.

3. Demographics and wealth disparities are feeding urban in-migrations. As noted here many times, wage and asset growth of the bottom 75% of American families has been flat to mediocre over the past 25 years of "prosperity." Wealth has flowed to the top 5% of the U.S. families, and these folks tend to enjoy the "good life" of walkable cities with numerous cultural activities. There are plenty of people who can plunk down $1 million for a condo in downtown San Francisco or a flat in Manhattan or a loft in Seattle.

The doorman keeps the riff-raff out and so life is good.

As hospital emergency rooms close down everywhere, wealthy Baby Boomers are returning to the city not just for "culture" and fine dining but to be close to decent medical care.
Meanwhile, the poor have subsidized urban housing and non-wealthy retiring Baby Boomers are selling and moving to cheaper rural areas where they can hope to live on their pension/ Social Security.

These demographic movements will play out (along with immigration) in the larger context of global recession, job losses and an ageing Baby Boom generation.

Speaking of supply and demand--where are all those millions of empty homes?
4. Lenders are holding onto many foreclosed/distressed properties, neither selling nor renting them. Put yourself in the shoes of a lender overwhelmed with properties in the foreclosure pipeline.

a. You simply don't have enough staff to process all these properties.
b. If you dump all the units on the market, two bad things happen: the resulting crash in prices lowers the value of all the other properties which are in the pipeline (soon to be yours) and it exceeds the number of qualified, willing buyers.
c. Auctions are OK but only if you get some minimum price. The pipeline of selling through auctions is a garden hose, and you've got a Hoover Dam full of properties.
d. The legal issues of who actually owns the mortgage (what, a town in Norway?!) are hairy and take time to sort out.
e. The last thing you want is to enter the property management business by renting out these homes.
f. Many of the properties are trashed or in need of repair--expenses you don't want to pay.
g. You'd rather find some private equity suckers, oops we mean buyers, who will take the properties off your hands privately, so the market won't even know what you sold them for.
h. Those mortgages with PMI insurance are actually revenue streams, as the PMI insurers are paying you--at least until they go broke.
i. Better to let the former owners live there for free and not foreclose, as that keeps the property off your balance sheet which is already beyond ugly.
j. If you leave the residents as legal owners of the house, then they're on the hook for the property taxes. If you take the property, then you owe the property taxes.
k. Maybe all the cheerleading pundits will be right and the market has bottomed; waiting it out makes sense as you can sell the properties next year for more than they'd fetch today.
l. You're about to go under and the whole mess will be somebody else's problem.

There may be many more reasons why lenders are holding onto foreclosed/distressed properties, but these are certainly enough to explain why hundreds of thousands of foreclosed/soon to be foreclosed properties are not on the rental market--yet.

Eventually, lenders will realize the bitter truth that the cheerleaders were wrong-- this wasn't the bottom, and their portfolio of properties continue to lose value. Even worse, local governments are passing regulations requiring lenders to maintain and repair the abandoned properties.

As noted here before, when prices drop to the point that it makes business sense to buy a property and rent it out at current market rates (or less), then buyers will appear. But how low is that point?

5. If rents have jumped to the point that they exceed what local incomes can support, then they will decline to historic rent/income ratios. Thus the buyer of a house which rents for $2,100 now, at the very start of a long, painful recession, may think it "pencils out" as a long-term investment. But what if rents slowly but surely decline back to their previous levels of (adjusted for inflation) $1,400/month? At that point, the valuation paid for the income property was way too high; the home will have dropped in value along with the rental revenue stream.

It is too early to say when rents or housing prices have bottomed, but it is clearly foolish to claim that at the very start of a long, debt-bust recession, "this is the bottom"--in either rents or valuations. Real estate may be local, but every locale is now global. And every job--even the most "bulletproof"--ultimately depends on the national economy and forces far beyond the local: currencies, oil, credit, taxation, and even cultural shifts from excess to thrift.

And let's not forget: there's 18.6 million empty dwellings in the U.S. right now, and thousands more being built despite the "slowdown." Please see these entries for more: Is Pessimism Extreme Enough to Mark a Housing Bottom? No. (May 5, 2008)
Inventory and Foreclosures: Is The Bottom Really In? (May 2, 2008)

Two new wonderful recipes have been added to What's for Dinner at Your House?: Simple Chicken Tajine (Morocco) and Beef and Barley Vegetable Soup. Check them out.
Readers Journal has also been updated: new insights and a mysterious, strangely engaging poem.

Thank you, John K. ($15), for your generous contribution to this site. I am greatly honored by your on-going support and readership.

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