As long as there has been talk of the housing bubble popping, there has been talk of rents skyrocketing to meet the falling prices. This is all part of the “buy now or priced out forever” tack that infected any discussions with potential homebuyers from about 2003 to 2007.
I clearly debunked this myth (and drew criticism from Robert Coté, now RobDawg of exurbannation.blogspot.com fame) back in my “John Doe” days early on in the nether regions of 2006. To understand the point of difference between Rob and I, he argued that rents were more driven by costs to the landlord while I argued it was purely a housing stock supply/demand curve. Clearly, I believe I won that argument.
A recent article from PE.com expands on that notion and comes to the same conclusion that I did… I believe we have massively overbuilt for the prices being entertained. Only the raging California economy has bolstered the rents here (they have risen quite robustly in the past 10 years), and the weaking credit markets will put downward pressure on rents (or at least stagnating them). This is not just wishful thinking on my part as I’m a renter, it’s real out there, having been able to pay the same rent for the past 3 years. The fact that this article is set in the Inland Empire, doesn’t negate the validity of the argument, it only provides us insight into the future of more central areas.
There are so many Inland homes for sale, that even if no more come on the market, it will take more than two years to sell the houses available, according to the California Association of Realtors.
That’s just the beginning, for those considering renting out their homes, it also looks bad.
“People who can’t sell their homes have two choices,” said John Denver, owner of Perris-based John Denver Realty. “They can stop payments and let them go back to the bank or rent them out.”
Most will take a financial loss as landlords, he said, because the monthly mortgage payments are greater than the rent they can get. Bill Santoro, owner of 1st Rate Rentals, a rental management company with properties throughout most of Riverside County, said the monthly shortfall averages $500. Denver said he is seeing some landlords taking monthly losses of as much as $1,000.
“It is a good time to be a renter and a lousy time to become a landlord,” said Denver. He said in the past six months, the average time it takes to rent out a house in Perris has lengthened from two or three weeks to two months. Rents have fallen about 5 percent. He said the average monthly rent has slipped to $1,100 in Perris.
This imbalance is caused because not only has the housing market weakened, so has the job market. Most notably in Orange County, the center of the universe in the now almost entirely imploded subprime mortgage lending environment. The now defunct employers were formerly the who’s who of local businesses. Even Option One (the subprime arm of H&R Block) had hoped to seal the already pre-implosion deal sale to Cerberus which unraveled this week amid the decision to simply shut down and lay everyone off. And to imagine that the original deal was for more than $1Billion. What was once an asset is now a liability.
The same could be said about owning a property. It’s very likely that housing prices will slam back to 2002-2003 pricing levels before the end of 2008, much faster than I had previously believed possible. In fact, I would argue that the problems of the local housing market are so bad and visible, you can nearly taste it in every neighborhood. They all have a house or two or three or dozen that cannot sell at the prices offered. Watch for the special series on this type of house.
In other comments at that time, I stated:
However, just as importantly, the shortage of construction labor has increased construction costs about 25% in the past 5 years. Hardly huge, but I believe after you see an easing of building due to overbuilding in the US, we will have substantially cheaper construction costs due to cheaper inputs (materials and labor).
My last post stated as a quote from Fortune Magazine:
The cost of construction has gone down around 35%, from $85 to $54 per square foot. “Developers can now sell their houses for at least 20% less than a year ago and still make decent margins,” says Phillips.
That’s deflation defined. It would be good to read through a previous post about inflation.
Then it happens.
The bubble pops. It becomes self evident that the prices moves were irrational, and it painfully returns to it’s longer-term trend. Bubbles are not price inflation, they are driven by inflation. The only way that bubbles can form is by a single enabling forces: monetary inflation. Instead of the money chasing a fixed set of goods and inflating their prices, humans instead choose to purchase assets. That’s not inflation. It may look like it, but it’s only temporary, not systemic.
Before you begin to think that I am a current FED apologist, consider what I believe to be the root of financial bubbles… monetary inflation. That is controlled by the Federal Reserve.
With all of that ground covered… if we are experiencing inflation, why are labor costs coming down? If we are experiencing deflation, why are metals prices going up? The answer is simple. The world has too much productive capacity and too much money. One’s deflationary, the other’s inflationary. Like giant gods battling each other, noone can be sure of the eventual winner, but we can be sure of the losers, non-dieties. The common man in the US will have to eventually match the quality of life of the common man elsewhere in the world if we develop a global economy (arguably already here).
Are rents going up? In the long run. In the long run we are all dead.
Chuck,
I can back up your rent statement. I am in S.W. Florida and my family has a number of large rental units in Cape Coral. As of last month our rents have fallen to 95-96 levels and our occupancy is running well below 80%(I mean WELL below).
All our units are paid for so we will not lose em anytine soon,but i have no freakin idea how people are hanging on who only put 3-20% down…
Fyi,I was stationed at MCAS El Toro in the late 80′s-early 90′s so i lived that real estate bubble. I won’t say what friends bought for in 94-95 cause it might really scare people…
From what I see in S.W. Florida the coming R.E. market will make the SoCal mid 90′s market look like a walk in the park !!!!!
Chris
Merry Christmas!!!Happy Chanukah!!!
I’m trying to stay a little more upbeat and look at this as the end to the affordability crisis. Many of us will learn the lessons of patience, hard work, savings and value.
It’s all good.
Besides the surfs up!
Chuck,
During the boom in the Inland Empire, we owned many rentals (now just one out here). As more and more investors came into the area, our rents were driven down because of the large supply. In the last downturn of the market (early to mid-90′s), I noticed rents in San Diego rising because there were less first-time homebuyers. However, your explanation also makes sense.
Now, if there are fewer buyers (or maybe there are the same number of buyers, but just more inventory–although, I think not), then where are they, and those who are moving due to foreclosure, living? Wouldn’t it be rentals? Since there are less small-time investors in the market, then would it make sense that there would be a smaller supply of rentals? That has been my experience.
Also, have you ever owned real estate?
“Overcoming Real Estate Losses” at http://WhineCountryRealEstate.blogspot.com/
Chuck,
It sounds like your “law of unintended consequences” is about to kick in.
The freeze will make the banks even weaker. Credit will tighten more and the banks will have trouble getting capital.
Or we will have massive inflation.
LAEF2
I’m 100% confident that the proposed plan will make it much harder to obtain financing in the future, and at higher rates. Spreads are widening.
The Chuck Ponzi Law of Unintended Consequences is at work here, and will be restricting more and more people from buying homes. I don’ think we’ll see the bottom of buying until next year late. It’s bad out there, but we’ve still got a ways to fall now that the Socal job market is encountering turbulent seas due to the lending downturn.
Chuck Ponzi
I think you’ve misinterpreted my thesis.
First, rents have gone up. Right?
Los Angeles County (Census Bureau):
Median Rent:
2005: $918
2004: $873
2003: $821
2002: $768
I don’t have it handy but trust me that trend continued to at least Q1 07.
That said, look at my posts. And better look at my actions. Any rent increases of the last month at the “froth” or if you prefer the “death throes” of rent increases for the forseeable future. I thought I was clear that some f’d speculators and even just stuck movers would put their POS overpriced crackerboxes up for rent at high prices and a very few would get some high prices. When I said rents will rise to meet costs I was talking about post bubble not in the middle of the popping. It is still too soon to say I was wrong.
As to my actions? I sold all my rental properties by Apr ’06. I didn’t want to get stuck and it has worked out pretty good eh?
Comment by Rob Dawg
First, rents have gone up. Right?
Los Angeles County (Census Bureau):
Median Rent:
2005: $918
2004: $873
2003: $821
2002: $768
_____________________________________
So with inflation, rents rose $40 or 5% in five years – this without hundred of thousands of condos, townhouses and housing coming online. You really believe that trend can cause/will cause skyrocketing inflation post-bubble?
Your math is wrong. $768 to $918 in 4 years is 20% in a period when inflation was ~9%-10%.
Regardless you are still not understanding the issues. People cannot rent out their properties for long at below cost. Over time we are losing the older lower cost basis properties to resale, conversion, etc. That is the underlying long term trend that will ultimately return rents to higher levels AFTER we have this period of froth followed by wildly differing (high and low) prices.
Rob,
This is exactly where I disagree with you. It seems you believe that long-term costs will raise rents. I believe it is only supply/demand. I believe you are misplacing the pressure. The fact that rents move with prices long-term is more a matter of interchangeability (substitution). That rents go up in an area (due to monetary inflation and core demand) only stimulates investment in rental properties, not the other way around. There are conceivable situations where no new investment would be made because the demand for rentals is too low due to the lack of transience. SoCal has a high degree of transience, making purchase transactional costs high in overall relationship to long-term ownership costs. All “rental” investment does is shift the externality of purchase transactional cost from the user to the investor. This is the whole concept of efficient rental markets. You can see situations like what I described in rural America. The demand for transience is so low that there is no need for rentals. Hence, the supply is poorly developed since any returns would be “lumpy”.
In the strict confines of Socal (ceteris paribus), one would expect that rising rents would further stimulate investment, not the other way around. Those who made bad investments don’t get to “recoup” losses by charging higher than market rates. If for some reason humans suddenly disliked living near the ocean and having lots of sun, or if local industry took a severe hit long-term, nearly all transience could be removed and rents (along with future investment) would fall indefinitely. Eventually, owners with cost bases too high for productive use as a rental and it would revert to a lower cost basis either as another rental or owned dwelling at the lower cost basis.
One final note… every owner can become a landlord. It is this transformability that makes rents less sticky than prices. They fall and rise more connected with actual demand, not with speculative demand. Therefore, many owners have low costs bases and could therefore drive rents much lower than the last few years or current prices would allow. I’m sure you already knew that.
I don’t doubt your wisdom. However, making the right decision for the wrong reason is just narrowly better than making the wrong decision.
Chuck Ponzi
Does anyone know if the foreclosed houses are selling in the inland empire? I was talking with somebody yesterday who has a house in the desert close to Edwards. He said that even the foreclosures hadn’t been sold off. So I’m curious if there’s still some activity in the inland empire or has it come to a dead halt.
“Close to Edwards” == Mohave, Tehachapi, Lancaster and Palmdale.
Your friend is right. It literally is not worth it to contract a sales agent to dispose of these properties. $20 in gas just to put a lock box on the door? $200 to initiate a listing? Analysts to set the price? 2% to the agent on close? And if they sell they record a massive loss.
Even people who invested are not renting because it costs money up front to establish the relationship and then it becomes harder to sell. This is one of the reasons rents haven’t fallen yet. I saw this coming. Capitulation, maybe as early as this spring will flood the market with rental properties.
There’s a problem with this reasoning.
Yes, Inland Empire is massively overbuilt. San Diego and LA are only mildly overbuilt, for the simple reason that there’s not much buildable land in either of those two areas.
Right now Inland Empire is experiencing a fluke decline in rents because many properties in IE are investment properties and many people, especially investors, are deciding to rent those out (for less than their mortgage payments) in order to improve their balance sheets. They are doing this under the assumption that current housing market troubles are temporary, they need to wait it out, and in 2-3 years their properties will be in the black again. In essence, properties that used to be empty are entering the market.
The same mechanism wouldn’t work so well in SD because there are fewer investment properties there.
Fast forward to late 2008. Inland Empire is down 20%, and it’s finally clear that no rebound to 2005 prices is going to happen any time soon. Are those investors going to keep renting? Of course not. They will mail their keys to the bank. In addition, many families who bought their houses in 2004-2006 to live in will foreclose and switch to renting. We’ll see a considerable increase in rental demand. At the same time, large numbers of bank-owned houses will be sitting empty. Rising demand + falling supply = higher rents until prices fall low enough for the REO inventory to start dissipating.
Have you noticed those tall buildings in downtown San Diego? Imagine those were filled with these things we call “condos”
That might cause a slight glitch in supply.
The other thing that is happening is out migration. Socal is nice but people get sick of it and move away.
That is what we are seeing. People moving away.
There are just a lot of time constants associated with that Mr Scientist. So it will be a while before the losses build up.
Two years ago when I would “troll” (i.e., post negative messages about housing) Craig’s List, I’d receive dozens of replies from people who were convinced that rents would go up as more people were foreclosed on. Their argument still makes no damn sense. Millions of houses are vacant. The “owners” need cash. Of course rents are gonna drop with that much unused real estate.
Most of those houses are not rented out. Look at the historically high housing vacancy rate. Repos don’t rent. Hoping for a quick sale houses don’t rent. Vacation houses rarely rent. McMansions don’t rent , wrong product.
Imagine those were filled with these things we call “condos”
You’re missing my point. You can build 100 condo towers in downtown San Diego and it wouldn’t matter as long as they are all standing empty gathering dust as REOs. Banks are not in the business of being landlords.
Between 2000 and 2006, the number of SFRs in San Diego county went up 10% and the number of apartments/condos went up 6.5%. That’s barely enough to cover normal population growth. Population of San Diego county proper grew slower than average (4.5%) but there was a lot of spillover into south Riverside county. All these failed homeowners will be coming back. $1000/month mortgage differential and $1.5 gas might justify the commute, but $300/month rent differential and $3.5 gas won’t.
Out migration from SoCal is a real mechanism. How strong is it, remains to be seen.
I think many of those condos will convert into apartments.
The failed homeowners will leave REO in their wake. That will drive down the cost of living in places like Riverside. So the homes will be bought up and many used as rentals.
There will be a lag before the effect gets felt near the coast.
I’m in LA and in a highly paid profession. Buzz through out the office from many is about leaving the area. Quality of life for families is not very good here. Crime/open space/traffic and costs all say move.
Lots of people are thinking about this. Putting up with seasons isn’t sounding all that bad. The house prices elsewhere all look more attractive.
So its a real effect. As the bust continues and prices lag (don’t fall much) expect the outward movement to continue. I expect a lot of the failed homowners in Riverside/IE to move back East.
I second that.
It seems like everyone is moving out of state. Big destination now is Texas as near as I can tell.
I’d look for their landing to be relatively soft due to immigration.
Ours will be a hard landing due to emigration based on job losses (esp OC)
Next year will be brutal.
Chuck Ponzi
I lived in the south bay in Torrance, west of Hawthorne Bld for three years from 2003 to 2006. I’m currently in Maryland near Baltimore. Change of seasons? Kind of nice but…(!) It’s in the mid 30s for the high today. Be careful what you wish for! I look forward to April when it will certainly be warmer. January is the coldest month in this area. You don’t want to worry about icy roads do you?
Anyone here know how the “Beach City Bungalows” on Torrance Blvd by the Del Amo Mall is doing? Prices were in the high 600s last time I checked a year ago. I was renting a studio for $1000 per month laughing at that construction every day I drove past it. High priced and along the noisiest street in Torrance! My bet is they have lots of vacant units left still.
New household formation has done a major about-face over the last few years. Adult kids are staying on with mom and pop, or mom and pop are bunking up with their adult kids. That’s probably a sign that people can’t afford housing (NAR likes to call this “pent up buying demand”).
When I check the south bay section of rentals on Los Angeles Craigslist, it’s obvious that a number of these beach cities Bubbleminium owners are renting out rooms. On the other hand, anybody who is in over their heads on a mortgage and tries to rent out their entire property for many thousands a month will in no way be able to collect enough rent to cover that mortgage, so that rental avenue is practically dead.
This kind of has me thinking, young single people may be better equipped to tough things out by renting a room, but a young family with no other relatives with which to share housing could have a harder go of finding affordable housing. They may get fed up and leave the area – I know of at least one family that did just that.
If roommates are bunking up together to save on rent, and young families either leave the area because they can’t afford to rent or buy a house, or bunk up with mom and pop, those factors may keep rent increases in check.
There is a relevant article in the L.A. Times today:
“Apartments are very much available,” said John Schulhof, president of the Apartment Assn. of Greater Los Angeles and president of First Charter Capital Inc. “Our vacancy rate is averaging about 5%, about the same as a year ago.”
Karen Fricke, executive director of the Apartment Assn. Greater Inland Empire, said members are experiencing the first wave of sub-prime foreclosure renters now returning to the rental market.
rental welcome mat is out – for some
And we learned today rents in the Southland rose the 4th fastest in the nation over the last year. Hmmm. Perhaps Mr. Doe is ready to tone down his clear belief that he won the argument?
Yup, guess you’re right. That 4.7% increase in rents is definitely strong rate increases.
You won this round, you with those meddlesome kids and their dog.
Chuck Ponzi
PS. Wait until next year hits. mid ’06 to mid ’07 was a decent move up. I have a good friend who runs the Irvine Company’s apartments here in OC. He says the market is “very soft” and appearing to get softer. He said they are mulling rent decreases for the first time since 1997. The argument was always that rents would catch up to housing prices. That’s clearly not the case when rents are already breaking the bank for many. We’ll see some strong outmigration in the near future in SoCal
http://www.msnbc.msn.com/id/22266961/
Besides, my disagreement was the cause, not the effect. Reread my last comment and you’ll see what I mean
But Chuck, “Wait until next year hits” is EXACTLY what I was talking about two years ago. All the recent investors are going to get flushed out and those left will have much lower cost basis and while rents will go lower they will make gobs of money on the spread. Their long term costs allow them to charge less. After a short time however , and this is the subtle part, substitution occurs. In Apr ’06 I sold my $1400/year cost basis rental to someone who’s basis was $1400/month. I could have made money at $300/mo rent. They couldn’t make money at $900/mo. The property is currently for sale at a loss. Their rent increase didn’t work out. See yet? Rents went up because of costs. And next rents will go down as the great investor flushing occurs. Now the final wave; there are not enough rentals of the old type. Rents are set on the margins. As more and more rentals reflect current costs rents will more and more reflect those costs. That means inflation and fewer long term ownership property basises keeping pricing down.
Rents in the IE are definitely going down. It happened exactly the same in the last downturn, rents fell about 20% in the early 90s. Apartments that had been renting for $900/mo went to $700/mo. My brother in law just rented a nice house with a pool. They wanted $1700/mo but he got it for $1250/mo. Just about every large apartment complex has signs offering incentives (plasma TV, 3 mos free rent etc). This is especially true on the newer units. Rents will continue to fall until the inventory is absorbed.
In the last bust Aerospace might have started it but out here in the IE a bigger problem was all the out of work construction workers. Once the building stopped the trickle down effect started. First construction workers, then retail started to pull back as stores closed (I lost a job as a retail store manager). Many of those people packed up and left the area. I know quite a few that fled north or to Florida. This created a large glut of rental units. I expect the same thing to happen this time. As construction grinds to a halt all those undocumented renters will probably high tail it to greener pastures (or less expensive ones). last time it took several years before all those vacant rental units were filled.
weakness is really starting to show in the los angeles rental market. the whole “shadow inventory” from speculators becoming landlords and failed condo developments/conversions is really putting downward pressure on prices.
with a dismal economic forecast for 2008, more people will double up with roommates. people are leaving california (or already cashed out and moved to a cheaper state).
the commercial market was CHOCK FULL of speculators just like residential, properties in WATTS that went for $200k in 2001 were being listed at $1M in 2006 (without ANY improvements).
take a look at virtually any commercial listing in the past couple of years — buildings with 100% occupancy at $750/month were pitched with outrageous $1600/month “market rents”. HAHAHA!
everyone was betting on those magical pro forma numbers that aren’t materializing.
those suckers who bought the pipe dream with low equity and cheap variable rate debt are *desperate* to unload (with their buildings 1/3rd empty asking the “market rents”).
the same nar lawrence yun style bullshit was/is still going on with commercial.
on virtually every street corner, complex, etc., FOR RENT signs galore. it’s only a matter of time before that market capitulates…
In downtown Valencia (Santa Clarita Valley), rents have have gone up. My 1 bedroom unit is $100-150 (depends on 6 vs. 12 month lease) per month higher in 2008 than it was in 2007. Average 1 bedroom here is going for $1400 per month. I believe 2 bedrooms are getting close to $2000 per month. At the prices of rent around here, you can probably own a townhouse for about the same monthly payment after factoring in mortgage interest tax deductions.
Lotta new retail and office space going up here. No rent control here either. I really hope rent stays the same next year.
Gotta disagree with you. You can see some great rentals in SCV (even in great Valencia areas) for 2+loft for 1800 range. Check SCREM.com.
Don’t forget that the MID only kicks in after your standard deduction has been eaten up. The deductions are often much smaller than you think. Just buy if you think I’m wrong. Historically rents also go down in recessions.
Maybe you forget, but I used to live in Valencia… I know it well enough to know that rents have been stagnant since 2004 when I moved out. Indeed, I would say that they are almost lower now given the available inventory that did not exist then and the selection available now.
I’ll agree that before then, rents rose very rapidly from 1999 to 2004, practically doubled. It was a very healthy economy when many other economies were doing poorly. I never felt a so-called recession that everyone was talking about in 2001.
Chuck Ponzi
My apologies Chuck, I just stumbled onto your blog yesterday so I’m not yet familiar with your background.
I live in a BRE property that was built in 05/06. Maybe I’m getting ripped off, but here are the prices now:
My unit:
760 sq ft. 1/1. $1,555.00-$1,645.00
2 Bedrooms:
1,096 sq ft. 2/2 $1,825.00-$1,925.00
The area and complex is nice, so I haven’t moved. I can save a little and live in the noisier Magic Mountain / Valencia Blvd areas, but not worth it to me. My co-worker got her car stolen there last year.
SCM,
That area is overpriced, no doubt about it. Those rents sound high, but you’ll pay more for renting from a large company, but they frequently offer better deals when you sign new leases (free months are common in soft patches).
Rental housing should be competitive. You’re not buying a lifestyle since there is no long-term reward to renting. That said, the main value in renting is the flexibility that it affords, hence renting usually being more expensive than buying (a bubble is not normal). Even with housing being overpriced, it won’t matter too much whether you buy now or in 2 years if you plan on staying there 15 or more years. With that said, I would not live in SCV for 15 years… you know what I mean if you have lived through an August or 2.
BTW, I have already found a model-match house that is listed for 15% lower than I sold my place in July 2004. Prices are coming down and fast. Make sure your credit is good, and save up a lot of money for a down payment and you’ll be fine.
Chuck