Why I Dismiss Predictions of Rising Rents

About a month ago the “analysts” at Rent.com came out with a press release stating they expected rent prices to increase by a whopping 10% by the end of 2012. Their press release was picked up and reported across a wide variety of media sources. Even respected financial writer John Mauldin has referenced that number in his past two newsletters.

The problem with the number is it is complete nonsense. To predict rent prices will increase a full 10% by the end of 2012 fails basic arithmetic. It also fails a history lesson we learned just three years ago. I’m going to make the case that rents will NOT increase, and most likely drop as 2012 comes to a close.

What is the current state of the economy?

  1. Fuel prices are rising.
  2. Food prices are rising.
  3. Wages are static or declining.

Is short, there is too little money to support sustained rent increases. You see inflation has all sorts of feedback loops. People can not spend money that they haven’t earned, saved or borrowed. If more money is going towards fuel and food, then less money is available to spend elsewhere. The largest component of “elsewhere” is housing. In 2008, food and fuel spiked in price. Did rent go up? Nope. Rents fell and in some areas they fell hard.

I’m also surprised nobody called out the bias of Rent.com. They are financed by landlords that pay to have their properties listed. Of course landlords want to hear how they can pass on a 10% rent increase. This is just as biased as the predictions put out by the NAR (National Association of Realtors) during the housing boom.

Let us say that landlords read this press release and decided across the board to raise rents by 10%. It is a ludicrous assumption, but lets go with it for this example. What happens next? The same thing that happens whenever rents are too high. This is what happened in 2008.

  1. Young people return home to live with parents. That used to be a stigmatized. Now it is socially acceptable.
  2. People living alone find roommates. With social networking and Craigslist, this is MUCH easier to do than ever before.
  3. Older people on fixed incomes leave rentals and head for more affordable senior living or move in with family members.
  4. Houses that can’t be sold become rental opportunities.

Higher rents lead to higher vacancy which leads to lower rents. All this happened in 2008. Check out my November 2008 post The Softening Seattle Rental Market for a refresher. All throughout 2008, fuel and food prices were spiking. Consumers were forced to find ways to save money. They found cheaper housing. The same story is playing out right now in 2011.

But isn’t unemployment down? The government tells us that the unemployment rate is dropping, which if accurate would indicate a condition for rising rents. Without going into too much detail, that number is understated as workers that can’t find a job drop from the numbers after a while. A better number to look at is the Labor Participation Rate. Take a look that that chart below. It hasn’t stopped dropping since the start of the recession. This means there simply isn’t the wage support to absorb a 10% increase in rents.

Labor Participation Rate 2001-2011 (BLS)

What about rental vacancy rates? Is there reduced vacancy rates that would justify an increase in rents? No. In fact, look at the chart below. Vacancy rates are higher than they were 5 or 10 years ago. This is probably due to excess building and continued fallout from the housing bubble years.

Vacancy Rates
2000
2005
2007
2008
2009
Rental Units8.09.89.710.010.6
Homeowner Units1.61.92.72.82.6

Source: Census.gov Construction and Housing 979

Let me repeat something I’ve said before about inflation. Without a feedback loop to rising wages, inflation is unsustainable. When some prices rise, other will fall. Across the board, I am confidently predicting rent will fall by the end of 2012. Some landlords will raise their rent and they will chase good tenants away. Other landlords will lower their rents to attract those tenants. The net effect will not be an increase in rent.

Not everyone will get lower rent. Some people will be suckered into paying higher rent. Not me. In my next post, I am going to tell you how to get your rent lowered.

 

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Comments

  1. Sheila says

    Very interesting. I like how the topics you write about range from food, coffee, and finance.

  2. says

    @Sheila – You may be one of the few (besides me) that likes the diverse topics. Every few years I lose and rebuild my audience as my interests change.

  3. Lacey Isbell says

    This is an interesting article. How do you account for the increase of folks needing to rent in this market due to the massive increase of nationwide foreclosures and short sales? That means their credit is impacted such that they can’t qualify to purchase anything…therefore they are left to rent. This is why I thought the rental market was increasing and pushing up rental rates all around. Folks don’t have another alternative to renting somewhere if their credit is damaged.

  4. says

    @Lacey – Good question. There was a massive build up in housing supply in the past decade. This increase puts downward pressure on rents. You are correct about how rents went up at the tail end of the housing peak in 2007-2008. People left their homes and flooded the rental market.

    That market is continually adapting as more and more housing units are converting to rentals. Rents have been rising in many cities in the past year. Because there is no increase in employment or wages (in the aggregate), this is unsustainable. At the point rents rise too much, more houses will get converted to rentals. And that will push rents lower.

    In Seattle I am seeing many planned condos that didn’t get built in time to cash in on the bubble are now being built for apartment rentals. A few hundred new rental units will make their way into my zip code in the next 18 months.

    Housing and rentals are not an efficient market like stocks. With stocks you always have a real time quote on what people will buy and sell at. With rentals, information is incomplete and you lock yourself into leases. Also the cost of moving exceeds that of trading a stock. So the process moves much slower. But it does move. People look for better deals. People move. Over time I still predict that rents will get lower. It will be a gradual process interrupted by occasional price hikes, but the trend is lower.

  5. Winston Newbill says

    This is a very insightful piece and it relates to my financial planning process. I too have heard that I should expect rent increases (Dallas Market) from the media. Obviously rents are significantly higher in cities like Seattle where you live Michael than in Dallas. I live in a higher end rental near light rail; it’s a high rise that is well above the average in monthly rent. The advertised rate for this top floor 860 Sq. Ft. apartment was around $2300.00. So when they accepted my offer of $1500.00 per month I nearly fell out of my chair.

    So, I’m trying to figure out how to plan for or predict rent increases, and/or how to negotiate for a longer term flat lease of say two years. My pay is frozen for at least two more years and I’m likely to see some slight pay cuts over that time as well.

    I notice that many of the renters in this building move out and buy homes every year. Presumably, that’s because they can purchase property and lower their monthly payment in a large newer home. It’s a significant percentage. Real estate is astoundingly affordable in this area relative to the rest of the country. You can buy a massive new home in the suburbs for around 300K. But I don’t want to live in the suburbs and I don’t really want to buy property.

    I told the management company when I moved in two years ago that the rent was near the maximum I was willing to pay. The first lease renewal proposal about a year ago was at the same rate for a year with one month free. That’s a pretty great deal.

    I think your analysis is insightful by looking at what income people have to pay for rent v. predictions about cost increases. This is similar to what some people did in determining that housing costs were wildly over priced prior to the collapse of the real estate market. They reasoned, as you have, that actual incomes dictates the ability and willingness of individuals to pay for either rent or a mortgage at a given level. We also now know that the unemployment rate is static at around 9 percent and won’t change significantly in either direction for quite some time. On the other hand inflation for 2011 at 3.9 percent so far is higher than at any time in over 10 years.

    Standard rent increase theory seems to be that rents go up around the rate of inflation every year, but I doubt that’s true. When I compare the BLS rent increase data for Dallas over a long time period, it’s way off what long term renters have seen in terms of increases. I’m guessing that long term renters who are good tenants see significantly lower increases than the rate of inflation but I haven’t seen any data.

    I take it from your opinion that you see the rental market as unable to extract higher rents by virtue of the fundamental underlying buying power of people and their real wages. On the other hand, markets can be micro-markets that behave differently from the overall market. This apartment seems to attract a lot of high rollers, at least by appearance and the cars they drive. What’s your advice on lowering rent or at least keeping the same deal?

  6. says

    @Winston – Thanks for the comment. I love hearing how you turned a $2300 rent into $1500. That made my day.

    I did this post on getting lower rent.
    How To Get Lower Rent

    They can always try and raise rents higher. And it can work for a while, but in the short term the renters will find ways to cut other spending until they see a rise in income. With high unemployment, we can expect on the aggregate wages won’t be rising, so eventually renters will seek out cheaper options.

    It is not an efficient market in short term, but knowing how it works can benefit renters like you and me that willing to negotiate.

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