One of the main contentions of the bearish argument is that house prices are overvalued. To determine whether or not that premise is true, there must be some way to appraise the fundamental value of a house. Once determined, this fundamental value serves as a point of comparison to the prices at which houses are currently being bought and sold. If current prices are shown to be above fundamental value, it establishes that house prices are inflated, and it also provides a measure of the degree of that inflation.
The corollary argument made by housing bears is that inflated housing prices have not historically remained inflated and have for good reason fallen back to fundamental valuations at each market decline. If this corollary argument can also be demonstrated to be true, it provides a way of projecting the market decline we can expect to see in the future.
The fundamental value of all housing prices is comparative rents. Rents define the fundamental value of real estate because rental is a direct proxy for ownership; both rental and ownership provide for possession of property. In a normal real estate market, when prices go up and the cost of ownership exceeds the cost of rental, people choose to rent rather than own, and the resulting drop in demand depresses home prices: The inverse is also true. Therefore, the proxy relationship between rental and ownership generally keeps home prices tethered to rental rates.
Rental rates tend to keep pace with wages because you normally pay rent out of current income. As people make more money, they compete for the available rentals and drive prices up at a rate about 1% greater than the overall rate of inflation. There are times when supply and demand issues in local markets create fluctuations in this relationship, but as a rule, rents track wages pretty closely.
Since house prices are tied to rents, and rents are tied to wages, house prices are indirectly tied to wages. When house prices increase faster than wage growth, the price levels become unsustainable, and if the differential is too great, you get a bubble.
Two Levels of Buyer Support
There are two categories of buyers that will enter the market and purchase real estate without regard to appreciation: Rent Savers and Cashflow Investors. These are the buyers that will buy houses even if prices are declining; therefore, they are the ones who call the bottom. Rent Savers are buyers, like me, who enter the market when it is less expensive to own than to rent. It doesn’t matter to these people what houses trade for in the market in the future. They are not buying with fantasies of appreciation. They just know they are saving money over renting, and that is good enough for them.
Cashflow Investors have a different agenda; they want to turn a monthly profit from ownership. For them, the cost of ownership must be less than prevailing rent for them to make a return on their equity investment. Cashflow Investors form a durable bottom. If prices drop low enough for this group to get into the market, the influx of investment capital can be extraordinary.
In a declining market, a market where by definition there is more must-sell inventory than there are buyers to absorb it, it takes an influx of new buyers to restore balance. Since it is foolish to buy with the expectation of appreciation in a declining market, the buyers who were frantically bidding up the values of properties in the rally are notably absent from the market. With the exception of the occasional knife-catcher, these potential buyers simply do not buy. This absence of buyers perpetuates the decline once it starts. Add to that the inevitable foreclosures in a price decline, and you have an unending downward spiral. It takes Rent Savers and Cashflow Investors to enter the market to provide support, break the cycle and create a bottom.
Calculating a House’s Fundamental Value
Let’s evaluate the fundamental value of a house I found at 51 Sanctuary with a rental rate of $5,000 a month and a purchase asking price of $1,589,000. Assuming both the rental rate and the asking price are reasonable in today’s market, how much could you afford to pay and keep the cost of ownership to $5,000 a month using a conventional 30-year mortgage? The first debatable, simplifying assumption I am going to make is that the income tax savings will offset the cost of taxes, insurance and HOA fees. The second debatable, simplifying assumption I am going to make is that you could obtain 100% financing at 6% interest. IMO, both of these assumptions do not change the math significantly except in cases of exceptionally high HOA fees. To end up with a monthly payment of $5,000, you would be limited to a mortgage of $834,000. If you were willing to put up a 20% downpayment (and give up your interest at the bank) to purchase this property, you could pay $1,000,000. How does this house price compare to its fundamental value? If you factor in a dead-money downpayment, this house is overvalued by 58.9%. If you assume 100% financing, this house is overvalued by 90.5%. If mortgage interest rates rise, the numbers get even worse. At 7% interest, which is closer to historic norms, the mortgage is limited to $750,000 making this house more than 100% overvalued.
So what about the Cashflow Investor, how low do prices have to go before they buy? They can borrow $580,000 at 6% with a $3,500 a month payment. This leaves $500 a month for vacancy loss and expenses and $1000 a month to provide a return on their investment. If they put $120,000 down, they would be getting a 10% return on their money ($12,000 / $120,000 = 10%). This puts the purchase price at $700,000. To the cashflow investor, this house is 127% overvalued.
As you can see there are two price areas where new buyers enter the market, depending on the assumptions used and the costs specific to the property, these numbers can vary, but they will fall within general ranges. Rent Savers will pay from 180 to 150 times monthly rent, and Cashflow Investors will pay from 120 to 150 times monthly rent based on today’s financing terms. If credit tightens, and mortgage interest rates go up, these ranges will decline making prices seem even more inflated.
In summary, I would argue that house prices in Irvine are at least 60% overvalued and probably closer to 100%. Price declines of 35% to 50% are required to bring prices back in alignment with their fundamental values. Since price declines of this magnitude will take time, and since rents and wages will continue to rise while home prices are declining, expect price declines of 30% to 40% over the next three to five years before new buyers will enter the market and form a durable bottom.
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Well-written post. But with all due respect, dont you think you’re cherry picking the example?
I gave an example of a $450k Bowen Court/Vientos vs. Woodbury Place rental for $2400 in the forum. The net monthly cost of ownership with 10% down is apprx the same as renting.
Probably a better example would be a median home at $650k in Irvine. You can purchase a brand new detach condo in Portola Springs Decada Plan 4 1750sqft 4 bed/3 bath. This is similar to San Simeon tract in Northpark, and the rent for Plan 4 is apprx. $3000.
So I agree the price is somewhat overpriced but it is not that bad especially for new home market. If there’s a massive foreclosure or recession then I agree the downturn may overshoot on the way down but this is only a speculation at this point.
For serious buyers buying as a place to live, there are decent deal out there. People in the know should educate the risk of price drop but should not instill fear.
These are no longer on the market, but they were in January:
82 Townsend, a rental at $3000 a month, and 58 Townsend the same model for sale for $875,000. Price/rent ratio = 291
1 Fern Canyon, Irvine, a rental at $2,500 or for sale at $711,800. Price/rent ratio = 284
2 Gainesmill, Irvine, a rental at $2,400 or for sale at $699,000. Price/rent ratio = 291
The rental I moved into in January was also for sale at the time with a price/rent ratio of 314 (which may explain why it didn’t sell).
If anyone can find any other properties that are both for rent and for sale so we can calculate a median price/rent ratio in Irvine, it will either bolster the argument or defeat it. I am open to see the results.
If we want to look at more abstract numbers, I read the median family income in Irvine was $84,000, and the median home price is $687,000. A family making $84,000 would take home about $55,000 after taxes or about $4550 a month. If this household put 50% toward a payment (which is very high), they can afford a payment of $2275 per month. This leaves a price/rent or price/payment ratio of 301 which is consistent with other data I have found.
Irvine median income source:
http://www.bestplaces.net/city/Irvine_CA-ECONOMY-0636770020.aspx
Irvine median home cost source:
http://www.bestplaces.net/city/Irvine_CA-0636770000.aspx
Great post! I’m a big fan of simple back of the envelope calculations. They are extremely powerful! Three comments:
1) Being originally from LA, I’m certainly not going to disagree that housing is way over priced… however, let’s take your 60% overpriced number. Do you expect prices in LA to drop 60% anytime soon? Even over years and years, I can’t see prices dropping 60% (even allowing inflation to “devalue” a fixed price). With that said, what conclusions can we take away? (1) Don’t buy in LA? Only rent? (2) If you don’t live in LA… don’t move there?!?
2) I think you need a third group of buyers. You basically said a rent saver would buy if it is cheaper month-to-month to buy (and pay a mortgage) instead of rent. There is another group that only trades off money lost each month. The interest in a mortgage is truly lost money, right? So perhaps another comparison is rent amount (money lost) versus interest on a mortgage (money lost). Of course, the person would need an income capable of paying the full mortgage.
3) Also, what’s hard about finding a fundamental value for a house (and you indirectly capture this in your math) is that the “value” of the house changes with the interest rate! How can the true worth of a house change based only on interest rates? Well, as your math shows, the real question to the buyer is NOT the pruchase price of a house, but rather the monthly cost to mortgage a house. And the difference between the two is that the latter includes interest… which obviously varies with the interest rates!
Anyway, good post… obviously made me think a lot!
I love reading your posts! They’ve all been well thought out, well written and informative. The graphs are great! They really show the story. Thanks to all of you (Zovall, Irvine Single Mom, and Irvine Renter) for this great blog and the forum!
Again great post irvine renter. However, one thing I must disagree with you is the time it will take for this decline. As you mentioned in your previous post, the fuel that kept the bubble rising further and further away from its fundamental, is the advent of the “subprime loans.” With the logarithmic rise in foreclosures flooding the market I think the decline will be much quicker than 3-5 years. We can already see this in the San Diego market–prices are dropping precipitously. From what I’ve read they are only about 1 year ahead of us on the bubble front. I just want to know your reasoning for picking 3-5 year time frame?
ocprince,
I plan to go into detail on my reasoning for the timing and depth of the decline in my next post. In short, I think it will take so long because it has so far to fall, but if there are enough foreclosures, it certainly could happen more quickly.
IrvineRenter,
Keep up the good work….you’re giving me the strength to hold onto my hard earned downpayment money and rent for the time being.
As a young couple just starting out down here in California…My wife and I (and our future children’s college fund) thank you!
Kevin
Irvine Renter,
You mentioned “subprime loan” as fuel; is it not these loans are limit to under $1M? If so, what fuels the $1M+ market?
I think the subprime lenders were expanding their lending limits past 1M at the peak. I had lenders tell me they could offer 1.2M and above using stated/stated. Also, I know many of the 1M and 1.5M spec purchases did involve some down payment and with the smallest down payments money was flowing very easy.
I guess Orange County is different, another subprime lender is gonna going to die:
Analysts warn New Century may not survive
http://tinyurl.com/2wlafo
As a engineer, these back of the envelope or cocktail napkin calculation are where its at. They provide a sanity check and tell you if you’re headed in the right direction.
Nice work, I’m giving it another year and then we can happly put down 30-50%. Hopefully that will be enough to bring us to sanity levels.
-bix
IrvineMom,
The real estate market is a chain of move-ups. Even if the sub-prime lending did not directly impact the higher end homes to any great extent, it allowed move-up buyers to ripple through the system and pushed people up into these high-end homes. This is also why the implosion of sub-prime is going to hurt the market so much because the entry-level buyers are being removed from the market, and the entire chain of move-ups is disrupted.
Thanks for writing these clear headed, rational blogs! I have been reading all the other blogs and still stunned at how stupid this market is.
I am still amazed at how basic “napkin economics” figures out how out of whack the SoCal market is, yet the sellers refuse to acknowledge this and the real estate agents continue to act as if everything is still chuggin’ along. Everybody’s rose colored glasses are awfully fogged up and when it crashed, there will be no soft landing….but a gigantic crater from this meteor sized bubble bust.
I shoulda moved to SoCal and sold mortgages or Mercedes Benzes about 5 years ago….
IrvineRenter, you may be right many resale home ASKING price / rental ratio is close to 300 especially during the peak.
But I’d like to point out that for those who need to buy now, I think you can find decent deal out there espeicially in the new home market which has been trough significant correction recently.
I think the new home price/rental ratio is close to 200 now. Just check it out yourself you dont really need anyone to tell you what is the ratio. Just go shop for a new home and find a comparable rental in the neighborhood. Of course there’s a risk of price declining further and that is defintely something to consider when making the decision.
IrvineRenter – The ripple effect analogy sounds very logical. Thank you. I have seen this effect in real life.
red – I think you forgot to mention the added cost of buying a new home (basic upgrades & landscapings & down-time) – a 10-20% add-on cost.
IrvineMom – First of all, I think most upgrades is probably 10% or less, defintely not 20%.
Also, builders are now offering incentive for upgrades & lender fees on top of the reduced price. That’s why I said if you’re serious buyers you should check it out yourself and see if it makes sense for you. The post is excellent because it covers the fundamental and the risk, I just dont like the example used. Thanks.
IrvineRenter,
Thanks for the interesting post.
Quick questions: When you say that “expect price declines of 30% to 40% over the next three to five years before new buyers will enter the market and form a durable bottom.” What “Price” are you refereing to? Are you refering to the asking price or you are refereing to the price that similar houses ARE TRANSACTING NOW?
Use your 51 Santuary as an example. We all know the seller won’t get the asking price. By looking at what has been tranacating in that track with the builder (most recent COMPS), the going price is about $250K to $300K below their asking price. So are you saying the price will decline 30% to 40% from the most RECET COMPS or you are just saying that the asking price should go down 30% to 40% to reach a “bottom”?
Thanks!
IrvineRenter,
Since we are talking about prices, I’d like to know your opinion on the following: the median prices does not accurately reflect the price decline.
Since the “median price” is simply the mid-point of the sale transactions in a particular month, it merely reflects what people are spending on homes for that month.
Consider the following hypothetical scenario, which captures typical middle class behavior:
Let’s say John Doe & his wife are planning to buy a $700K house. While house-hunting, they notice that the market is “soft” and decide to wait 6 months.
Let’s say that 6 months later, they notice that the “formerly $700K homes” are now $650K. They have 2 choices: to buy at $650K or buy something better at $700K. Most people would choose the latter.
In general, people tend to buy at the “top of their price range”. When prices go down, they don’t spend less. The “median-price” simply reflects what people actually spend, it fails to capture:
– demand vs. supply
– the fact that people may get more for what they spend.
For example, here in San Diego, the homes that went for $1Mil. in 2004 (in 4S Ranch) can now be had for around $800k. So, that’s a 20% drop. But, the median price does not show a 20% drop.
Also keep in mind that rent multipliers will differ for the various segments of the marketplace. IMHO, the properties with prices which are the least detached from rent fundamentals are the tiny 1br’s and studios. Not because they have a rational price based on incomes but because rents are quite high on these units. The rent multipliers seem to get worse the further you go up the condo food chain.
If this situation continues, 1br’s might cash-flow as rentals before anything else does. It’ll be fascinating to see how all this shakes out.
Inre the above discussion, those GRM’s in the high 200’s agree with what I’ve been finding in Irvine. My 2br Westpark condo rental is 308 but it’s an outlier as my rental rate is below market.
red,
I agree that price/rent ratios are improving for new homes. The builders are lowering their prices. I don’ see them near 200 though. I have found a few where the price/ ASKING rent is near 200 or even below, but I doubt they will find renters at those asking prices.
(Look up 2122 Scholarship. Sales price $521,000 and asking rent of $2,800 for a ratio of 186. If they actually get that rent, then new homes are getting closer to bottom. Given that you could rent a comparable property from the Irvine Company for under $2000, I doubt they will get that rental rate.)
Actually the phenonmenon you are noting of the builders leading the charge to the bottom is to be expected. They have must-sell inventory and they will lower prices to whatever level they need to in order to close sales.
Irvine 123,
I believe prices will decline until price/rent ratios get close to 150. I estimate this will be about a 40% decline from the peak. It is hard to tell where we are right now. Orange County median hit a peak in June 2006 and matched it in December 2006 before dropping off dramatically in January 2007.
gn,
You are correct that move-up buyers mask the effect of nominal price declines. The median never moves down as much as real prices do for that reason. With the reduction/elimination of sub-prime lending and the tightening of credit standards, I think the median will also drop significantly. People will lose their ability to finance 10 time earnings to buy properties.
oc_fliptrack,
I was thinking the opposite based on some of the posts on your site. With 1 bedroom units going for $400,000, the price/rent ratio would have to be over 300. Where are you seeing these smaller units going for near rental values? RSM maybe?
One example I found is from this website posted by Zovall Oct 10 2006.
https://www.irvinehousingblog.com/2006/10/10/bad-investment-fraud-or-what/
“The property we’ll start with is 39 Modesto which is a detached condo in the San Simeon tract in Northpark. It was purchased using 100% financing on 7/31/2006 for $720,000 and rented out for $2850/month on 8/23/2006.”
San Simeon is the same tract as Decada in Portola Springs and the neighborhood is comparabe with similar property tax rate. This unit is a Plan 2 which is now priced at $600,000. Price/Rental ratio is 210.
red – You are all right. I never bought a home where the builder gave any incentives. I kept forgetting we are in a different market. Thank you.
red – I rent in the neighborhood for a while. Someone showed me 39 Modesto when it was for rent. It was a fixer. I thought the fair market for this house was more like $660K top at that time. It’s now in pre-foreclosure.
red,
If I am hearing what you are saying, you are not disagreeing that prices have to drop 40% from the peak (the P/R of 250 in your example dropping to 150). You are saying that prices of new homes have already dropped 20% in some areas and the new P/R ratio in the market is closer to 210. I would love to see a 20% drop in the median or some other statistic to corroborate your observations. If you personally are buying a house that you know you could rent at a ratio near 200, then you have found a great deal in this market.
Since rental rates for new housing is harder to verify, I can’t dispute your observations. In January, I remember seeing a new rental in Woodbury at 53 Canal with an asking rent of $2,550. This same model could be purchased from the builder for $620,000 for a ratio of 243. Also new (from my previous post) was 82 Townsend, a rental at $3000 a month, and 58 Townsend the same model for sale for $875,000. Price/rent ratio = 291. The builder may have dropped the price since then. I don’t know.
I would note that the ratios are higher for the resale market, but that is probably why they aren’t selling too many.
I was thinking the opposite based on some of the posts on your site. With 1 bedroom units going for $400,000, the price/rent ratio would have to be over 300. Where are you seeing these smaller units going for near rental values? RSM maybe?
RSM and other outlier areas. Irvine has some 1brs with a GRM under 250 but you likely won’t find them in Brio (the tract that I feature quite often). I pick on Brio because the 1br’s were driven over $500/sq ft in the run-up and they’re ripe for some schadenfreude goodness.
near rental values
Oh, I should clarify that the prices are still way out of whack with rental values. They just seem a little less detached from reality than the larger units.
IrvineRenter – I own a rental property (not in Irvine) and the P/R ratio is less than 150 and the rent covers PITI. So I certainly understand your point about cashflow. This is a great post that explains the fundamental and many people would benefit.
But after this credit bubble I dont know whether we will hit 150 ratio again in Irvine. Mortgage rate may stay relatively low for a while. People may start get comfortable with exotic loan. Some tax laws may change to benefit homeowners. Who knows. Even after dotcom bust certain creative innovative things were here to stay.
Perhaps P/R 150 will happen one day but not sure how long you have to wait. Could be 5 years and in the mean time your rents maybe rising. There might be dead cat bounces in the price along the way. So it could be mentally exhausting you just have to be prepared.
That’s why I suggest eveyone do their homework and make up their mind on what is their comfort zone in buying a house.
red,
“Perhaps P/R 150 will happen one day but not sure how long you have to wait. Could be 5 years and in the mean time your rents maybe rising. There might be dead cat bounces in the price along the way. So it could be mentally exhausting you just have to be prepared.”
On this point we agree totally. Look for this is future posts.
red,
with all respect, u remind me of Irving Fisher’s remark just a few days before the Stock Market Crash of 1929:
“Stock prices have reached what looks like a permanently high plateau.”
The dynamic nature of housing market, due to life changing events such as job and divorce, doesn’t favor ur reasoning.
I’m pretty cynical about housing affordability going forward. The pressure on Congress to “do something” is going to be too strong to resist. They’re going to tinker with the demand side of the equation, I’m fairly convinced. The effect will be a floor of support under home prices and I think it’ll happen before prices have a chance to fall back to the trendline (in bubble areas at least).
In the longer term? Great Depression part II and Californians become the new Okies. Then house prices will truly fall.
Not yet though. I think the Ponzi economy can keep running for a while.
Red,
I see you posting from time to time and see how your posts aren’t always that popular with the crowd here.
But please go and continue posting, you’re obviously not just a permabull and, although I don’t necessarily agree with all your posts it’s always nice to hear some arguments from the other side of the table (otherwise we’ll have a “bear bubble” over here in these forums!!).
Just don’t want you to give up and then we end up with a whole bunch of permabears here patting each other on the back :-).
Muzie
I like back of the envelope calculations as well – but I think some assumptions are GLARINGLY missing (although I agree with your Tax, HOA, etc. assumptions listed.)
1) After a 30 year mortage – you own the house / a renter owns nothing. So a more honest comparison is an interest-only loan versus rent – although obviously you run the risk/benefit of losing/making money when selling. So then $5000 at 6% gives you $1,000,000 at interest only – still you aren’t saving… BUT –>
2) Rents go up – 30 year mortages stay the same. Based on the chart above – a 20 year period saw a 250% increase in rent price. (30yr = 400% increase) Or about 5% per year. This has to be added to the cost of renting. So that 1,500,000 6% mortgage payment of ~$9,000 will be equal to the rent in 13 years at 5% increases…
To financially analyze whether to rent versus own – you have to compare what you would be spending on the house versus what you would be earning on the money differential. And over a period of 30 years – your interest rate assumptions can have drastic effects. So for the example above – your $5000 rent at 5% increases and the savings invested at 10% returns (pretty good, eh? but remember Uncle Sam wants his cut – so make it 7%) compared to the 30 years of $9,000 payments and the house to boot at the end…
1) renter after 30 years : no house $330,000 left in the bank
(your investments had to start helping in rent after year 13)
2) homebuyer after 30 years : $0 in the bank, but with a house
(so if I the homeowner can sell the house for $330,000 he breaks even with the renter.)
This is not to say the house is worth 1.5M. That is a personal decision that includes factors like : how long you plan to live in the house, how long do you want to wait for prices to drop, how much money you can actually contribute to mortage, etc. etc.
I hope I do not sound like a RE hyper – I am not. I bought my house 2 years ago hoping only that it would maintain its value – which it may very well not do. But I plan to stay in the house long-term and put extra-money against the principal to pay off earlier than 30 years. I look forward to the day when my mortgage is less than rent – but that day will not happen for another 9 years or so.
bought_high,
I don’t think we are that far apart. I agree that in the very long term, you are better off owning than renting. There is always a crossover point where owning saves money (assuming a 30-year fixed-rate mortgage as you have described). The question is whether or not this happens soon enough to make it worth your while. If you are trapped in a starter home for 15 years, that is a bad thing. If you are buying your dream home you plan to own for 20 years, it really doesn’t matter.
I would note that your assumption about rental rate increases is probably too high. Rents increased during the bubble times at 5% a year, but this is higher than historic averages. Rents track wages pretty closely. I don’t think anyone can count on 5% raises every year. 3% is a more realistic number. This subtle change can have a dramatic impact on the crossover point calculations.
My rental rate increase was based on the chart – but had an error…
It looks like only a 2X increase over 20 years which is about 3.8%. So that does affect my cross-over point.
I have a problem with the term ‘starter home.’ I think the RE industry invented it as a way to repeat business. Personally, I don’t want to kick down 3% of $700,000 – $800,000 – $900,000 any less than 10 years apart – ‘starter home’ or not…
Great comments all. As a CPA for over 20 years and specializing in clients owning significant amounts of real estate, I can tell you one thing in which they all believe. Things are bad and getting worse. But they see this as an upcoming opportunity. I run the numbers for my clients and, unless you intend to live in the property (which none of them do), you need to factor in two other significant variables.
First, what is the “opportunity cost” of your money. It’s not enough to make a profit – you have to beat what else your capital could earn. If you can earn 7% in an inflation protected, tax deferred, government guaranteed “iBond,” you better be making 12% on your real estate investment (assuming a 5% risk premium).
Second is inflation. Real estate is expensive, so if you’r underperforming inflation, you’re getting hammered.
So whatever the number prices will drop (say 20% over five years), the real hammer is not just the 20% but the lost “opportunity cost” of 7% compounded for five years.
The smart buyers are either waiting or hammering the seller so they can earn their risk-adjusted 12% on invested capital (assuming their rents are such that they cover their carrying costs).
Thanks for a great read. Could you pass me the calculator you used to figure out the its fundamental value? And the percentage by which it is overvalued?
Thanks in advance.
wow! what a fantastic read, Thank you for sharing your
wisdom.
your articles have the clearest original description I have seen of
of a) fundamental value of housing b) how is a bottom
formed in a housing decline.
As with any other subject, there is so much garbage in the
main stream media that is being fed to the herds, its hard
to discriminate the fundamentals from the fantasies.
Fantasies only last so long, reality has a habit of
biting sooner or later – as always.
New home in Frisco, TX (just north of Dallas) – and you can drive a hard bargain with the builders right now – might set you back $275000 for 3500 sqft with all the upgrades. Rental value is somewhat tough to assess right now but $2000-$2500 per month would fall within reasonable range. Using your assumptions your arguement does not hold true. Those with 20% down would be better off buying.
Irvinerenter,
How does the affect of rising rents affect the equation? (My landlord just raised my rent by 11% on my new lease, and I had to take it because there is nothing cheaper available.)
As the price of homes has been going up, people buy them with the intent to rent them out. And with their large payments, they are asking for high rents. I am in Ventura County. 4 years ago, the rent for an average 3-bedroom house was going for about $1600-$1800/month, but now everything advertised is $2000-$2400/month.
Will the rise in rents help prevent a massive bottoming out of real estate, or will real estate continue to drop and bring down rent prices with it?
House prices will likely bottom out near the rental equivalent value. If the economy stays strong, and unemployment does not become a problem, rents will continue to rise which in turn will support house prices. I suspect the economy will suffer as house prices decline, so rents will probably also be depressed. That has been the historic pattern.
Several comments. Home prices are not necessarily driven, directly or indirectly, by increasing wage rates. There are plenty of folks who buy a new primary residence for retirement. The price they pay is based on the equity they are bringing to the transaction, their preference for location, etc. For other buyers, locations and sometimes non-economic factors (location-related, convenience factors, etc.) are also key. Also, the tendency of homes to rise and fall and at what prices are a function of very localized factors. I think it is meaningless to state that “all” prices are going to fall by X%. Not necessarily so in the “better neighborhoods! That’s why they’re “better”! Also, keep track of the numbers of sales. If there were 80 sales one year and 120 sales the next (assuming these are years when prices are rising), then following by 80 sales the next year and 50 the next, is is bogus and misleading to tell the public that PRICES ARE TANKING. The number of transactions at the various price levels is telling you something. If the number of transactions taking place during periods of falling prices is less than the number of transactions during years of rising prices, you are actually seeing “profit-taking” behavior, just like in the stock market.
I think a big driver behind the soaring rental rates was the very low vacancy. That’s reversing as fallow units come back to the market. Also, don’t be mislead by the asking price “averages”. most rent numbers you see are the landlord’s asking price and not what they actually are renting for.
Combine that with the few properties option renting where a speculator can’t flip it and have it for rent with a wishing price. Unfortunately, real landlords can move their rents much higher, much faster when every other rental that isn’t quickly coming off the market is asking for 25-50% more than they are.
Prices are Tanking