Affording Rent is Becoming More and More Difficult – Could This be a Warning of Another Crash?

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It’s easy to get the impression that it’s a great time to be a home buyer right now.

APRs are still quite low, home prices are rising slowly but are still relatively low as well. The National Association of Realtors touts the awesome opportunities every other week in some news release. And generally, when the housing market is low, rents are low to go with them — after all, we have to stay competitive with the cost of a mortgage, right?

An Opaque Market

Well, actually, there’s several fascinating reasons why things aren’t as clear as that these days.

That’s because in recent decades, the APR has been the single largest limiting factor that kept people from getting mortgages. But with the introduction of a few new regulations that went into effect on January of this year, that’s no longer the case.

The ‘Qualified Mortgage’ regulations state that mortgages given to people for whom their mortgage costs will drive their monthly debt load up above 43% of their monthly income are not ‘qualified’ and thus will not receive certain important legal protections that ‘qualified’ mortgages do receive.

In short, that regulation made mortgage companies all over the country warm up their underwriters’ [Denied] stamps — and hundreds of thousands of homes that would have been sold to individuals with ordinary incomes weren’t.

Pair that up with the fact that average mortgage payments rose by 21% in Q4 of 2013 while average wages rose only 2%, and you can see that many families are rapidly getting priced out of the mortgage market by the new rules, even if by traditional credit standards they’re not doing that badly.

(It’s worthy of note that the QM rules are hardly the only factor forming our current market; they’re just one of the least understood and thus worthy of a bit of extra explanation here.)

The ‘Rent Bubble’?

So we have a strange new market where houses are unaffordable not because families can’t afford them, but because the laws don’t allow them to get credit even though they can.

Naturally, every family that can’t get a mortgage has to choose between moving in with Mom — and renting. That, in turn, has driven demand for rentals up — which is presumably one of the background reasons why you’re reading this right now: we’re all in the business of making money, and right now the money is in owning rentals.

But there are already articles being posted about the ‘rent bubble’, and how even the middle class can’t afford rent in some cities. And that’s why the National Mortgage Professional trade journal released a rather grimly-titled article: “American Renters Facing Tough Affordability Issues.”

Related: Its 2014: Rents and Acquisitions on the Rise

In other words, the Qualified Mortgage rules have triggered a rise in rental demand, which has triggered a rise in rental prices, which has in turn triggered a financial crisis on the part of many low-income American renters. They’re having to cut back on basics like healthcare and food costs in order to keep up.

According to the report “America’s Rental Housing: Evolving Markets and Needs” by the Harvard Joint Center for Housing Studies, more than half of all US renters currently pay more than 30% of their income in rent — up a massive 12% from just a decade ago. Fully 29% of all renters are paying more than half of their income in rent.

That’s up a jawdropping 50% from 2004, when only 19% of renters were in that condition, and it was already considered “very alarming” by rental trade organizations.

Compounding that problem is the fact that the percentage of Americans that are renting has increased from 31% in 2004 to 36% today. In fact, the last decade has marked the greatest growth in renting households since the Great Depression — and the market has responded. More than three million homes have been switched from being owned-and-occupied to being rented just in the past four years.

What Does This Mean for Us?

A lot of us are here at BiggerPockets because we own and/or manage one or several of those homes.

But it’s not wise of us to stick our heads in the sand and pretend that this is going to last forever. If we don’t understand the market that’s bringing us all of this lovely money, we’re going to get caught off guard when the curtain is pulled back and the Wizard is revealed as a fraud.

Best-case scenario, something changes and there’s a profound rebound in employment and a robust increase in wages coming into tenant’s pockets, turning them into buyers and allowing landlords to cash out.

Related: Is Economic Pessimism Holding Back the Housing Market?

Worse-case the economy tanks again and real estate prices fall again, this time taking rent prices with them. Sound somewhat familiar? History does repeat itself, the question is have real estate investors been paying attention?

We’re not trying to be doomsayers, here — just the voice of reason. All of these reports and statistics and opinion pieces have been out there for months if not years. We just don’t plan to get caught with our pants down, and neither should you.

How do you think we can plan for the best but prepare for the worst as real estate investors?

Be sure to leave your comments below!

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About Author

Drew is the manager of Royal Rose Property Management, a fairly high-tech solution for Detroit Metro area property owners & investors.

32 Comments

  1. I make it a point to not rent to people if the rent is more than 25% of their income. Also, there is enough net profit built into my per unit income to cover a pull back in rents. Lastly, I routinely provide the nicest product in my market – thus, making the demand for my units higher than the rest of the garbage that is out there. I am not saying that I am protected 100% here, but if you provide a great product at a fair price in a market where people want to live, you will have a steady stream of qualified and quality tenants even in a downturn. The market can tank and eventually will one day again, but what is the alternative here? Sit on the sidelines worried about what could happen? Or, roll up your sleeves, get to work, buy underperforming distressed assets and improve them – thus improving their income, their neighborhood, and the health of the overall market. Worry about what you can control and plan for what you cannot.

    And one more question… You mentioned new buyers coming into the market so you can sell your assets… Why have the goal to sell? Unless you do a 1031 exchange for another property, selling will create a taxable event. Keep the properties, maintain them properly, and you will have an asset that will provide regular cashflow and even regular nontaxable REFI cashouts for decades… Look at all of the big boys (Rudin, Fischer Bro.s, Etc), this is what they do – they never ever sell… The assets stays within their family trusts forever.

    • Joshua: thanks for the passionate reply! Regarding why consider selling – if you bought low and could time a sale to sell high and then you could theoretically buy the exact same asset back at the low-end again, why wouldn’t that make business sense? If there’s enough difference between the buy & sell prices, there’ll be room to offset any taxes.

      Can it be realistically done? 1) We think the smaller the asset the easier it is to do this. 2) For it to make business sense you don’t have to buy back the same asset, or even something similar, it’s more about maximizing your ROI. 3) You can still buy low & sell high and use 1031 Tax Deferred Exchanges.

      Whether we agree or disagree, we’ve all gained from the thought-provoking discussion:)

  2. I make it a point to not rent to people if the rent is more than 25% of their income. Also, there is enough net profit built into my per unit income to cover a pull back in rents. Lastly, I routinely provide the nicest product in my market – thus, making the demand for my units higher than the rest of the garbage that is out there. I am not saying that I am protected 100% here, but if you provide a great product at a fair price in a market where people want to live, you will have a steady stream of qualified and quality tenants even in a downturn. The market can tank and eventually will one day again, but what is the alternative here? Sit on the sidelines worried about what could happen? Or, roll up your sleeves, get to work, buy underperforming distressed assets and improve them – thus improving their income, their neighborhood, and the health of the overall market. Worry about what you can control and plan for what you cannot.

    And one more question… You mentioned new buyers coming into the market so you can sell your assets… Why have the goal to sell? Unless you do a 1031 exchange for another property, selling will create a taxable event. Keep the properties, maintain them properly, and you will have an asset that will provide regular cashflow and even regular nontaxable REFI cashouts for decades… Look at all of the big boys (Rudin, Fischer Bro.s, Etc), this is what they do – they never ever sell… The assets stays within their family trusts forever.

  3. The median family income curve is in a straight line …. Down for 15 years now. Economic analysis we read says this won’t change.

    We have adapted by serving the low end of rent to own where we do owner financing. 3 for me 3 for my wife same for our IRAs etc using LMLO’s to originate. A few more steps to be Dodd Frank compliant. Just doing what’s hated becoming the areas expert.

  4. Great article and a good reminder to expect the best, but prepare for the worst. Don’t know where housing prices are headed, but its good to make educated predications on what could happen. My main concern is what will happen when Equity funds cash out. Will the market risen enough for them not drop prices by selling all of their properties?
    There are a lot of young singles in the areas I rent and though I choose ones with good credit they have a ton of student debt.

    • KEVIN: great question! Hedge/Equity funds like Blackrock, that have bought 5000+ SFR’s (there are several this big) don’t seem like long-term holders of their rental acquisitions. There are plenty of online horror stories of how they are struggling to manage their spread out portfolios. At some point they will liquidate, the question is why & how?

      WHY – 1) They perceive it’s time to reap their rewards 2) They realize it’s time to cut their headaches (maybe losses).

      H0W – 1) They dump them on the general market skewing supply & demand 2) They sell them in packages to regional companies better able to manage the rentals.

      There will probably be combinations of the above depending on the fund. There’s no history to guide us on this one so it will be interesting…

      • Rob Fitzpatrick on

        It is my understanding that hedge funds will not liquidate by selling the inventory but transition from property owners to paper holders by selling to the current tenants the home they are renting and holding the notes. This way they can protect their price and not cause a dramatic drop in price.

  5. I could never see a logical connection between an economic crisis and the rents going down. In my opinion the rents will go down when there is no demand. There will be no demand to rent when people will be able to afford to buy (wouldn’t happen in a crisis), or when there are no jobs at all and everyone moves out completely.

    Even if everyone moves out completely, you should not sell your rentals, but you should buy from everyone else in the area (provided, this is not your only investment) and, with a natural population growth and immigration, people will start coming back in a few years. Then, when the economy improves in the area, you are the monopolist landlord. This is how millions are made overnight.

    In cases when people cannot afford to rent with their current salary, they can get another job, move to a place that has lower rent, or rent with a roommate. But I don’t see this as a factor that affects the rent itself. What affects the rent is the competition in the area, not a minimal salary in the area.

    • GALYA: How is, “When there are no jobs at all” NOT an economic crises? The previous crash proved that people buy/rent property based on payments.

      People used low interest rates initially to take out bigger mortgages for bigger homes, than switched to interest-only mortgages and finally chased negative amortizing loans. The one consistency in that trend was people chasing a payment they could “afford.” (We’ll leave the no income verification loans out of this discussion!)

      So, if the economy sneezes and unemployment increases or median income drops, how can that not affect what people can afford to pay in rent?

      Yes people can get 2nd jobs and roommates, but if they move to a place with lower rent – who’s going to move into the higher rent home they just vacated? How does such a trend not put downward pressure on rental rates?

      Please respond and keep adding to the discussion as it should be making readers think!

      • I didn’t say no jobs at all isn’t an economic crisis, no, this is a crisis. Not sure where you got that. Not sure what “payments” you’re referring to.

        Not sure where interest rate connects to whatever I wrote.

        As I wrote, people can always move to cheaper places, have roommates and so on.

        Places that have higher rents would be occupied by people who can afford those places. Those same people will either find an additional source of income or get roommates, or learn to budget, if not, they would find cheaper places. One thing is for sure, people have to live somewhere, if the only available places they cannot afford, they need to come up with the income. And the fact is, every year there are more renters than before, just because of the natural population increase and immigration to the US. And they all have to live somewhere. Demand comes not from the median income, but from the population growth.

        I know it’s hard to think about other countries, when you only know one, but in other countries rents are much higher than the median income and people still rent, just because there are 10 applicants for a place.

  6. You’re not saying it’s time already for the 7 year cycle are you? Joshua and I are pretty much on the same page except when it comes to selling. I would sell but, there is NO better investment that can give the guaranteed returns or the tax benefits that RE gives. I as well is in it for life.

    I rode out the last bubble without a hitch, even bought more thanks to the wanna bees that thought they knew what they were doing.

    • JAMES: we’re not market timers, just trying to get investors to be attentive and act accordingly! As you rode out the last downturn, you must have been attentive:)

    • So here is my dilemma. I like the idea of holding Rental property forever. I have a property with an 18% ROI, but with a crazy resell value. My profit from selling is equal to 10 years of rental profit. I’m following the business plan of renting but you have to wonder.

    • Don’t focus too much on macro-trends. Maybe 5% on macro-trends and 95% on running your business. You can never predict them so its pointless. Yes, the 5% on macro-trends might have helped a savvy investor steer clear from buying over-priced homes in 2006-2009. But, for the most part, its so hard to predict what will happen with the economy, with rental rates, with when 1st time home buyers start coming back again, etc.

      Just buy good properties, in good locations. Make sure they cash-flow. Maintain them well and really focus on getting good tenants and keeping good tenants. In the long run that will be a winning formula.

  7. DAVE: What would you tell all the small investors that lost their properties in the 2006-2009 down-turn you reference because they only focused 5% on the macro-trends? Yes, many of them didn’t invest wisely to begin with, but many did follow the generally accepted investment guidelines of the times yet still lost everything when values dropped over 50% in some areas.

    We’re not advocating going to the other extreme of focusing 95% on macro-trends, but it should probably be more than 5%.

    Thanks for sharing your viewpoint and giving us more to think about!

    • I’d say to those the people that that sux that you lost your homes. Pick yourself up and start over again. Or, if you were patient and you bought in the right areas, most homes are close to their values back in pre-2009.

      Remember, investing is a game of constant learning and constant change. If you made the mistake of getting caught up in the madness of 2003-2006, then you deserve to lose money. Next time the madness comes, you will be wiser. It takes 5% of your time to recognize whether we are in a bubble or not. It takes 95% of your time running your daily business, making sure you are buying in good areas, staying on top of your tenants, keeping the property in good condition, making sure you have excellent repair people who won’t screw you, etc.

  8. I have always been a stock investor; I’m just coming around to the benefits of real estate, but the mantra has always been “buy low, sell high”. That sounds so obvious, right? Than why do so many people lose their shirts in the stock market? Because they buy high when the market is zooming, and there is lots of hype over the next big IPO, then when it’s reported that the company missed earnings and the stock tanks the next day people sell in panic – at a low. Crazy!

    What I learned over the year, the hard way, is that you watch for deals patiently, buy value, keep money aside for rainy days, and when the market (real estate or stocks) takes it’s next 10% dip! you swoop in and pick up a new investment.

    My 2 cents.

  9. James Evertson on

    Question: if one was to take a quantitative analysis approach on deciding when to buy and sell properties, what indicators/reports would you look at? My assumption is that the costs to buy or sell a property make it really difficult to profit from this in a short time horizon (less than 2 years) but I’m sure it’s possible in a 3+ year time horizon if you’re looking at the right indicators.

  10. I am hoping we don’t have another big downturn however if we do I’m not terribly worried.

    When a homeowner loses a house during an economic crisis they cannot run out and just buy a cheaper house. A renter however can, at least in the near future, move to a less expensive property. My renters who are currently renting my house for $1350 may not be able to afford it and will have to move into something less expensive. However, at the same time there is a renter who is currently paying $1500-$2000 who will have to move into a less expensive place, something around $1350. I may still have to lower my rent slightly but there is always a class above the people currently renting your property who have to downsize as well.

  11. JAMES E: Great question, thanks for adding to the discussion!

    Indicators: Their are numerous indicators and reports on real estate that you can look at. We feel what’s important is to watch for movement from the norm or mean. The greater the divergence, the more attentive and cautious it makes sense to be.

    We are partial to Rent vs Sales Prices. If you look at the historical numbers for Florida, California, Arizona & Nevada from 2001 to 2008, an obvious trend from the norm is apparent. Hindsight is always 20/20, but we should all learn from history as it does have a high tendency to repeat itself.

    Regarding time horizon to sell, that all depends on your acquisition price. Property flippers and wholesalers hold SFR properties sometimes only for hours, rarely for more than a few months. That’s harder & harder to do as the price of the asset increases and its liquidity decreases and time horizons increase. So, to address your question better you would need to be more specific about the class of real estate you’re referring to!

    EVERYBODY else please jump in and add your thoughts on this great question:)

      • WALTER: we don’t know of any specific place that publishes it regularly. We’ve seen it published periodically by various financial news sources. We’ve also created our own local data, which is what we suggest:)

  12. Rob Fitzpatrick on

    Josh gives great advice and a number of options to be prepared if there is another market correction. Real estate investors need to be nimble and consider their options BEFORE problems arise.

    The article does bring up many investors concerns about another bubble. It is unlikely we are in a bubble but rather we still in market correction. Remember, the price of homes in many areas went down 50% or more. I bought homes that at the peak sold for $240K that 2 years ago I purchased for $80k which is a 70% drop. It would require a 300% increase in prices to return to all time highs again.

    Additionally, more 50% of home purchases in my market (Orlando) are still cash. Until we start seeing more home purchases being made with mortgages, prices will not increase like they did during the bubble.

    Recent home price increases have been driven by largely investors seeing opportunity and driving prices up until rents and cost of holding are so close that there is too small a profit margin. I know in Orlando, hedge funds scooped up thousands of homes driving up prices by 25% or more in one year. There was so much cash sitting on the side-lines it flowed into single family residential because it was low hanging fruit.

    If we enter another recession, rents may have to go down some to compensate for vacancies. But the housing industry is still building slower than the estimates needed for population growth and scrappage, which I have heard needs to be 1.5M units annually. Currently, I believe estimates are in the 900k range and have been there for around 6 years.

    If employment improves, the economy gets cooking again and banks start lending again, then we will see prices increase again. When these three happen again in concert then you need to be prepared for another bubble.

    • ROB: it all does depend on the economy and more importantly the job market. One nuance many miss about the job market is not just the creation of new jobs, but wages. In the Detroit area, the auto industry no longer pays new line workers $20+/hour to start. They start at around $14/hour and they may never see the $30/hour veteran line workers currently can make. So, even though Detroit automakers are hiring again, the lower wages they’re paying will make it difficult for the new workers to be able to afford to recreate what previous workers could : a nice $200k+ suburban home, a $100k cottage up north, 2 nicer cars and either a boat, ATV’s, snowmobiles, etc.

      Wages control housing prices to a large extent. If workers aren’t seeing wage increases then they won’t be able to push housing prices higher – especially since mortgage rates are at historically low levels.

      So, it may be a fool’s errand to compare current housing prices to their peaks without taking into account HOW those peak prices were achieved and what needs to happen to wages to allow history to repeat itself.

  13. I am a new investor with about 4 years exp so I have not seen too many ups and downs. We bought houses in 2010-2011 when the market was down. If the market tanks again I see opportunity to buy discounted houses. If that happens I will buy everything I can. I think the people that get in trouble are people who buy properties at market value. Or they buy properties that don’t cash flow or that cash flow very little and hope that the property will appreciate. If the market tanks then yes those people could be in trouble.

    • ALBERT: thanks for participating. You are correct to a point, but we know investors that bought 20% UNDER market value in 2008 that saw prices plunge 50% or more and they still lost their properties to foreclosure. For some their cashflow couldn’t support their debt, many others just didn’t see the point of holding onto a property that might take 5+ years for the value to get back to what they owed on it.

      It’s just not something that is simple enough to make a generic statement about, which is why it’s been such a great topic to discuss and learn more about:)

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