Why Rising Rents is Not Necessarily Good News for Home Prices

For most of the past decade, renting a home has been a smarter move than buying one in most areas of the United States. The cost of renting a similar home has been far less than owning one, even after things like mortgage interest tax deductions are taken into account.

Home For Rent
Home For Rent
Home For Rent

Many believed that falling home prices would change this reality. As home prices fell, buying a home would seem more attractive. What’s more, foreclosures would push former owners into rental apartments—driving up rental rates and making home-buying even more attractive.

The end result—at least according to the conventional wisdom—was that rising rents would provide a floor to falling home prices. Eventually—fingers crossed—rising rents could even lead home prices to rise if the balance between renting and buying swung too far in the opposite direction.

As it turned out, this was way too rosy of a scenario. Even after the housing bubble deflated, the Rent Ratio—the purchase price of a house divided by the annual cost of renting a similar one—remained elevated in much of the country. It was still better to rent than to buy in most places.

What happened was that the fall in home prices was accompanied by a fall in rental rates. As the economy sputtered and unemployment climed, rental vacancy rates rose. Post-collegiate workers delayed getting a place of their own—what the professionals call “household formation”—in favor of living with roommates or parents.

Housing—ownership and renting—wound up like a game of ring around the rosy: we all fell down.

The situation may be changing now. As my colleague Diana Olick explains over at Realty Check, vacancy rates in rental apartments are declining. At 7.2 percent, they are still far above the 5.5% reached in 2008. In fact, we were at 7.2 percent back in April of 2009. But a year and half ago we were hitting 7.2 percent and climbing. Now we’re on the way back down.

Rents haven’t increased that much—only 0.6 percent. But Lawrence Yun, the chief economist for National Association of Realtors, predicts rents will rise one to two percent next year.

So what’s driving down vacancies and driving up rents? One factor is demographics: an “echo-boom” of young adults reaching prime renting age is increasing demand. Another factor is a change in consumer preferences: the pain inflicted by the housing boom and bust has a lot of people now convinced that renting can be a safer option than buying. Finally, as the economy picks up, household formation should pick up.

If these predictions about the rental market recovering are right, they will finally bring about the shift in the Rent Ratio. But the change in the Rent Ratio may not provide the boost for home prices that some are predicting.

Here’s Olick:

Rents may be rising, which means Realtors will offer ever-more charts comparing home affordability to the deteriorating economics of renting.

But it's not about affordability anymore; it's about investing, and a home still isn't a great investment right now. Even the rich are turning to rentals now, according to a report by my CNBC.com colleague, Joseph Pisani. High-end investors would rather put their cash somewhere other than real estate right now, after so many lost so much during the housing bust.

While the housing market is cyclical, and prices will arguably rise again, this latest, unprecedented housing crash changed the fundamental perception of housing for good. As Americans are bombarded with news reports and entertainment shows teaching real estate negotiation, comparison, upgrades and income opportunities, they now understand the economics of housing, and increasingly consider a home's investment value over its basic purpose. Fewer Americans take pride in home ownership. Realtors will tell you it is still your most emotional purchase, but I believe it has become a far more studied and calculated investment than ever before.

I completely agree with that analysis. But I’d go even further. I think that the housing boom and bust has changed attitudes toward borrowing in a way that will make many people hesitant to take out mortgages. What we learned is that buying a house with borrowed money makes you financially fragile: you can lose not only your house but your entire investment due to economic circumstances beyond your control. Living in a rental makes you more robust, better able to handle economic shocks.

What’s more, the threat of increased taxes or inflation to handle future debt—possibilities that the public is very aware of in the age of Tea Party politics—and the fear of diminished economic prosperity in the future, has many people doubtful that they will be much wealthier in the future than they are now. These decreased expectation of future wealth discourages spending on indivisible, illiquid investments like homes. The old style aspirational home purchase is not coming back any time soon.


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