Real Estate Finance Alerts

In articles and in interviews since 2001, many economists based their argument that home values were too high on the fact that rent rates lagged home prices.  The argument left me confused as I always expected this result when the cost of home ownership decreased relative to the cost of home rental.  Falling interest rates and lose lending standards enabled thousands to qualify for a loan who could not previously do so.  Rising prices did not increase the monthly payments on interest only or negative amortization loans.  As more and more people bought homes and demand for home purchases increased faster than supply, prices rose.  As more renters became buyers and rental demand decreased, rent rates stagnated.  It should not surprise anyone now that the opposite is occurring.

Residential real estate markets slowed, most notably at the middle and lower end of the market, due to a number of factors.  At the same time supply increased dramatically to meet demand as homebuilders set record home starts, lenders tightened lending guidelines due to increased loan foreclosures.  Subprime and alternative lenders literally disappeared overnight.  An entire segment of buyers left the market.  While the nightly news made sure to tell us about the housing Armageddon, residential real estate investors saw the opportunity.

The supply of residential homes is greater than demand resulting in a buyer’s market.  With all of the would-be buyers and foreclosed homeowners now becoming renters, home and apartment rent rates are on the rise.  Furthermore, an entire segment of the rental market is locked in for years since it will take time to repair credit and qualify for tighter lending standards.  Factor in low interest rates, low vacancy rates, and a dysfunctional credit market that will inhibit new apartment construction, and you have a perfect storm for investors.

Investor bears raise several arguments to refute my perfect storm forecast.  First, they argue that rent rates will not rise with the number of new/vacant homes for sale.  The data simply does not support this argument.  While it will take time to work off the inventory, homebuilders are cutting home starts and many new homes were scrapes and not a net gain.  Next, they argue that foreclosed homeowners will simply rent apartments.  I believe many will not chose apartments after living in a single-family home with kids, other family, and/or pets.  A final argument asserts that increased immigration enforcement will reduce demand for housing.  It will take years to implement an enforcement policy to the extent that it could have a meaningful impact on housing demand. 

The residential housing market weakened dramatically in the past year.  For many, increased supply, decreased demand, rising foreclosures and higher lending standards resulted in financial crisis.  However, for investors in many markets, these factors combined with low interest rates and rising rents all converging at once create a perfect storm that will provide a substantial tailwind for their investments for years to come.