Rents Not Measuring Up?
Chuck Ponzi January 19th, 2007
Some time ago, we debunked the myth of rising rents in Southern California due to the housing Bubble. The title of our post was Rents to Follow For Sale Housing Trends?
We hypothesized that this was merely a scare tactic by RE professionals to buy now or be priced out forever. I said:
What this theory portends is that rents will drive inflation through the stratosphere because housing prices which have doubled in the last few years need to catch up to resolve the imbalance between rent/buy.
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However this tactic is long on fear, it is decidedly short on logic; at least the old one had “demographic statistics” and some historical context to try to back it up. No, this one makes no sense if you think about it more than the writer wants you to.
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The truth, unfortunately for these schadenfreude hopefuls, is much less stranger than fiction. Like many on the “rent” side who are not so quietly enjoying the demise of overextended homebuyers, there are a great number of homeowners who would love nothing more than to stick it to these snobby renters if their housing ATM goes in the toilet.
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Sorry, no deal. The housing bubble was an appirition that will disappear as mysteriously as it arrived; it was psychology to begin with and that is how it will end.
If rents rise, it is due to rental stock vs. housing demand, not what the investor paid for it and needs to cover each month. Rents cannot be financed and must be paid monthly from cash and income, and therefore cannot be delayed for the future like many of the more recent purchasers have done with interest only or neg-am products.
Indeed, we learned recently that Landlords Lowering Apartment Rates, Offering Incentives as if this was news and none of us saw it coming. The article quotes John Husing (we all know who he is)…
But “there’s a point at which you push beyond where people can afford the price and you run into resistance,” John Husing of the consulting firm Economics & Politics Inc. in Riverside told The Times. “In supply and demand terms, the sign that the price has gotten too high is when you start seeing vacancies go up in the rental market, and inventories go up in the housing market.”
Back in our original discussion, Robert Cote’ and I got into a discussion of the debate between supply & demand of housing stock (my thesis) and basis costs (Robert’s thesis at least at the time) Robert, have you changed your mind yet on this?
It all goes back to the concept of supply/demand lags. For those of us who in college played “the Beer Game”. (Note I didn’t play this until my MBA days since I went to a religious university for my BS where drinking was prohibited). It pits suppliers with lag times from a manufacturer to deal with demand changes and an unclear order/order cancellation process. Kinda sounds like our homebuilder scenarios.
Essentially, what happens is that people on the retail side signal an slight increase in demand which gets amplified throughout the supply chain. Since the short-term shortage signals a much larger demand (if you can’t get Budweiser at your local 7-11, you go to Ralphs, and both 7-11 and Ralphs place an order) and the lag time between increasing supply in the supply chain and delivering it to the market can be as much as years, you can very easily oversupply a market. This is what happened in the early 1990’s in California, and it’s happening again. The only difference now is the bagholder. In the past cycle, there were a very large number of spec homes held by builders. This time around, the speculation was democratized through rampant and pervasive poor lending practices. Either way, we will revert to the mean.
In another article, we learn from the Pasadena Star that overbuilding was indeed the mantra since the turn of the century (at least and probably well into the future as well). There Ismael Abidi from the A. Gary Center for Economic Research at Chapman University tells us:
California gained 723,000 jobs and built 851,000 homes from 2000 to 2005, a ratio of 0.8 jobs created for each homebuilding permit issued, he said.
The long-term ratio of jobs to homes from 1980 to 2000 is 1.7, he said.
“We built too much for the job growth,” he said.
No kidding, Sherlock.
So, what does the future bring?
Personally, I believe we have already reached a cap on rents that cannot increase much (rents must be paid from cash unlike housing prices that can be financed on exotic terms), and that we are at best likely to see rents at the inflation rate (1 to 3% for much of the Southland). That’s if we don’t see a major recession in the next year which according to several leading indicators is not only possible, but likely as well.
I’ll probably get clobbered for putting any faith in anecdotes, but what the hell — I have a blog dedicated to exactly that.
I’ve been digging around the rentals on OC Craigslist and I do see a trend of more realistic pricing. Additionally, I do *not* see IAC rents skyrocketing. I think the floppers are finally coming around and realizing that nobody wants to help them feed thier alligators at prevailing rents plus 10-20%.
As a landlord, I can tell you this. You need to keep the place rented 12 months out of the year. If a Tennant moves out, its going to cost $1,000 in paint and repairs and the place will be vacant for two weeks to a month.
If I was to rent my place for $!,000 per month, it would probably be vacant for 4 months. Divide the rent received for the other months by 12 and you realize an actual rental return of $666 per month. This particular one rents for $800.
What these new landlords don’t realize, is the price charged determines whether it is rented immediately or you have to wait months for a renter. Notice that the number of months the rental is vacant, really determines the actual rental rate of return.
Plus its nice to have 5-10 apps to look through and choose the one with the best credit rating.
A landlords worst nightmare is having a Tennant trash the place and not pay the rent. Evictions cost a lot of money.
just curious what university you got your BS at. wondering if i attended the same one.
Hi Mike,
Without saying it right out since I prefer to stay as anonymous as possible… if they didn’t let you drink, smoke, grow a beard or wear short shorts, yes, that’s the same one.
There are a couple of things I’m begining to wonder about.
We have a couple of things going to happen. Probably significant inflation.
Second tax increases.
Those are both going to stabalize the real estate market as the tax advantages to owning go up.
LAEF2
LAEF2,
Actually, one of the likely ways to increase taxes is to reduce the deduction on houses or offer a fixed percentage or eliminate HELOC deductions… and grandfather current deductions back so it doesn’t hurt until you try to buy or sell a property.
Well Doe,
If they did someting as destructive as getting rid of or lowering the mortgage write off. That would have the opposite effect and decrease the value of owning a property. I follow that.
Even though over investment in real estate and creating an asset bubble is bad. I think discouraging home ownership all together is worse.
Grandfathering in everybody else will also create more of a class division. Not to mention will negativly impact seniors.
Lord is this a mess.
All things considered I’d support some tax increases at the upper income levels. A return to the levels suggested by CH Smith on his site would be ruinous though.
Its also depressing to hear the Democrats early take on social security. Basically they would give you less if you earned a high income. Along with counting more of your personal savings against you at retirement. Things like that really don’t encourage you to work harder. Bad trend of rewarding people for working less.
LAEF2
LAEF2,
True, but Obama’s statements about Boomer’s politics makes me want to vote Democrat.
Still, reducing or limiting deductions is where the real money is at. This is where the wealthy really get away with murder. I personally know some of them deducting personal autos, homes, and all kinds of “business trips” to hawaii and the caribbean.
Makes me sick… whatever happened to honesty in America?
hey john, i’m pretty certain it was the same school. i’d be interested in meeting up some time IRL if you’re up for it. i’m in l.a., we could do lunch or something. email me if you’re interested.
joeblow10@gmail.com
If the housing stock at the present time is mainly held by the investor/owner, builder will not have a problem building. They still need to keep their doors open and they dont care who has inventory as long as its not them. Is that also happening ??? if so, its soon going to be over supplied from all directions.
Cool.
Cow_tipping.
Great post and article.
This is indeed an interesting time in terms of rent costs in OC. I’m expecting a similiar increase in rent as last year, but not too much more. My increase last year was 7.5% for a single family home in Lake Forest, CA.
In my view, renting in OC is ridiculously expensive for what you get, but my frame of reference is the Midwest. Yet, even if homeownership out here in SoCal were within my budget (it’s not), the personal financial risk required to sign a interest only or ARM loan to afford a $450 or more home is not bearable for me and my family.
I read the same sentiment however over and over. “Don’t miss the last train of homeownership”, i.e. from now on it will be impossibly expensive.
I disagree. It is already impossibly expensive for me and thousands like me.
We hypothesized that this was merely a scare tactic by RE professionals to buy now or be priced out forever.
Or, to echo the theme of the Housing Armageddon blog, “BUY NOW! DON’T BE LEFT BEHIND!!!”
In Studio City rents have risen at an unbelievable rate. We rented in 2001 at $1500 a mo. The building that went up two years ago started at $2800 (same quality). Now our building has raised their rates on new rentals to $2500. That’s a massive increase.