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The Vicious Circle That Is Sending Rents Spiraling Higher
jones_supa writes: Skyrocketing rents and multiple roommates — these are the kinds of war stories you expect to hear in space-constrained cities such as New York and San Francisco. But the rental crunch has been steadily creeping inland from coastal cities and up the economic ladder. Bloomberg takes a look at the vicious cycle that keeps rents spiraling higher. People paying high rents have a harder time saving for a down payment, preventing tenants from exiting the rental market. Low vacancy rates let landlords raise rents still higher. Developers who know they can command high rents (and sales prices) are spurred to spend more to acquire developable land. Finally, higher land costs can force builders to target the higher end of the market. The interesting question is how long can this last before we reach a level that is not affordable to the majority of the demographic that is being serviced.
And I have the cheapest rent on a two-bedroom apartment in a 20 mile radius. I couldn't save for a down payment if I tried. Colorado's average vacancy rate is less than 5%. What is the market doing in response to this? Multi-state property management companies are buying up everything on the market. You can list your property and expect a solid offer at above-market pricing within 48 hours. Rental listings last for mere hours. Developers are building new apartments as fast as they can--luxury apartments that charge higher than market rates, further inflating the market.
I have a condo I rent out. Laws in California make it almost impossible to get rid of bad tenants. I go out of my way to find good tenants and then I go out of my way to keep them. I have not raised the rent on my current family for 5 years now. I charge $1400 and the condo next door is renting for $1900. Of course, I am not in it to make money. I am in it to break even and sell in 10 years when my boy goes to college. Gotta keep the place nice to sell well.
This alleged vicious circle is partially wrong. The rents are driven by the property prices, which are driven by the interest rates. The lower the interest rates, the cheaper the mortgages, the easier it is to afford a property. But the number of properties does not rise, so then the prices of the properties rise instead. But this will slowly pull you out of the recession. While the recession increases the ratio of renters, the rich always have enough money to participate in the game, and at low interests and low wages (due to the recession) they will start building more houses and become landlords. This will employ construction workers and start a cycle of economic expansion. Rents will come down, salaries will go up, and more people will afford a down payment and abandon the rent market, further lowering the rent levels. But increased activity combined with high property prices will set inflation in motion, driving up the interest rates. Rising interest rates will destroy the finances of the most precarious borrowers leading to series of crises and busts along the road.
There is no substitute for common sense. Especially, no body of rules will do.
I don't think it's as simple as rent control, it's property value and population density. For example:
San Francisco, median income $81K, median house cost $900K (according to Forbes), population density 17K/sq mi (20th in country)
Houston, median income $60K, median house cost $180K (according to Forbes), population density 3.5K/sq mile. (88th in country).
Property costs substantially more in San Francisco because there's nearly 5 times the demand per square mile. Similar factors hold true for Boston, New York and other densely populated areas.
An Irish language documentary broke the news on the US Mortgage Backed Security driven property bubble back in 2005 so why doesn't it surprise me that another foreign news source is the first to piss off US real-estate corporations and reveal that rental backed securities are also teetering on the brink of disaster? Here we go again, another replay of tulip madness. In the words of Yogi Berra, it's Deja-vu all over again.
The real problem is that boom-bust cycles driven by loose monetary policy (whether it be Reagan's trickle down or Greenspan's helicopter drops) help those with deep pockets. Playing with matches around the global economic gas-tank eventually causes an explosion and as John Maynard Keynes put it, "Markets can remain irrational longer than you can remain solvent." (unless you happen to be a corporate slumlord.)
I'll note that, for years, I worked on developing new financial products sold to mortgage lenders (post crisis). I've spent a fair amount of time studying trends in US housing prices. I'm not well versed on other countries so my comments are US-centric. I've left this VERY high level, but wanted to note a few concepts and why they answers aren't super easy.
There are a few fundamental flaws in the mortgage system today. The first is that banks generally don't lend their own money (almost all mortgage money in the market comes through government sponsored entities like Fannie Mae, Freddie Mac, or Ginnie Mae). Well technically, it is their money, but realistically, the loans are purchased so quickly by the GSEs that it might as well not be their money. On top of this, the banks receive money from the GSEs for every loan they sell on to the GSEs. In short, the banks are incentivized to make loans.
Second, both the government and the the Federal Reserve seem to want a higher rate of home ownership by Americans. The Fed helps encourage this by keeping rates low (and buying huge amounts of mortgage backed securities from the GSEs). The GSEs encourage it by making loans more accessible (lower down payments, lower credit scores, higher debt-to-income ratios, etc.). The banks like this strategy because it allows them to make lots of new home loans (so they make lots of money with almost no risk) and every time rates drop they get to process lots of refinances (so they make lots of money with almost no risk). It's all good right? I mean, the banks are making lots of money.
Here's the problem: When money is easily available it creates more potential home buyers. When money is cheaper, it increases what people can afford (your $2000 per month payment now covers a 400k loan instead of a 350k loan). This is still good though right? More home for the same money?
Well, more people with more money means that demand for homes increases and, with it, home prices. Khan academy had an amazing set of videos that illustrated the home price bubble, but I can't find them. In summary, the number of homes available for purchase compared to the number of people has remained relatively constant since the 40's - even when adjusted for growth areas (things balance out in the growth areas over time). Home prices, however, have increased dramatically - especially as a percentage of total income. When did this star happening? When money became more accessible. Still good though right!?! I mean, now existing homeowners can sell their homes at a huge profit and people can get into those homes.
Ah, but there's a catch. While average income (inflation adjusted) has remained level and even trended down, home prices have sky rocketed. Eventually, even with low interest loans available, house prices reach a level where purchasing them puts people out of an acceptable debt-to-income ratio. Home prices can't go up to the point where people are spending more than 70% of their income on housing (as an example - this isn't a benchmark number or anything). Things hit a point where new buyers aren't buying anymore. That starts a chain reaction that leads to the bursting of the housing price bubble.
One way to fix this would be to make money harder to get and more expensive to get. It would have an initial downward push on prices, that would eventually level out. It would also stop the major price inflation. Why? Let's say we require a 10% down payment. Suddenly, a bunch of potential buyers are shut out of the market. Home prices stagnate. The responsible buyers (and those who advance in their career) eventually save up the 10% and can get into the market. They're actually able to save the 10% now because the house prices are stagnant and 10% is no longer a moving number. In the mid 2000', house prices were going up faster than people could save. Prices inflate, but the barrier to entry keeps them from going on a roller coaster. Banks, however, hate this because they lose out on all that sweet
The interesting question is how long can this last before we reach a level that is not affordable to the majority of the demographic that is being serviced.
Care to guess what happens at that point? New construction doesn't sell, developers go bankrupt, new construction is sold at auction for lower prices. Then the new units available at lower prices push down prices of other housing, which makes purchase more affordable, which results in renters buying, which curbs rent prices.
Unless of course, large financial companies and well-connected donors are threatened by that circumstance.
Then, the central bank will step in, through its many channels, to put a floor under rental prices ("So I think if we spent enough money, got enough of a hit right now, it would look like a floor on house prices, and we might have something every bit as good as a floor on house prices."). The multiple government housing agencies (Fannie, Freddie, FHA, VA, USDA, etc) can also step in to influence the rental market, as they did the housing market.
Blackstone is a company securitizing rental flows and selling them. They are the largest private equity company in the world ("By both profit measures, the first quarter set quarterly records for Blackstone, the world’s largest private-equity firm").
The former head of the US central bank, Bernanke, is now employed by Citadel, a massive hedge fund.
My point is simply this: house prices did not revert to historical norms because of the big players - donors - that would have been deleteriously impacted by it. With big players moving into the rental market, if something went wrong with their business plan, don't expect them not to use their clout to get the government and central bank to do something about it.