Rents Dip Below Inflation, Home Appreciation Slows: Are Markets Cooling Off?

by | BiggerPockets.com

Over the last year, rents nationwide grew at a pace of 0.7%. By contrast, inflation last year was 2.4%.

That’s a far cry from the double-digit rent ascent we were seeing just a few years ago. In fact, it’s the slowest pace we’ve seen in over five years.

Home values rose a solid 6.8% over the last year, but they too appear to be slowing. Zillow projects only 2.6% growth over the next year.

Are real estate markets cooling off? Let’s take a look at the big picture, from housing inventory to wage growth to nationwide population movement and beyond.

Housing Inventory

Before anyone gets too carried away with the idea that real estate markets are about to crash, it’s worth pausing to note just how low housing inventory is at the moment.

In fact, “low” is an understatement. The inventory of homes for sale reached an all-time low in the first quarter of 2017.

The problem is particularly bad for starter homes. Developers just aren’t building enough of them, largely because the margins aren’t as high as with luxury homes.

And it’s not just the sales side of the market, either. Rental inventory has been plunging for years.

Still, it’s possible that vacant rental inventory has reached its bottom; after thudding to a post-recession low in 2016, available rental inventory climbed in the first quarter of 2017 to its highest point since mid-2015.

Zillow’s chief economist Svenja Gudell believes rental construction is catching up with demand: “The slowdown in rental appreciating is mainly due to new construction finally meeting demand and even outpacing demand in some areas.”

Related: How Legalized Marijuana is Impacting the Colorado Real Estate Market

In a surprising twist, more renters are actually saying they plan to continue renting, rather than trying to buy. But more on that later.

Average Americans Doing Better Financially

According to a Freddie Mac survey of renters released last month, 41% of renters now say they have enough money to last beyond their next paycheck, up from 34% only last autumn.

The number of households who report being unable to afford essentials also fell significantly, from 20% to 14%.

(Of course, the other way of looking at this data is “Holy cow, 59% of American renters are living paycheck-to-paycheck!” They clearly didn’t tried the 7 financial fixes that take 30 minutes or less! But I digress.)

This improving financial health is in line with the wage and job growth we’ve seen in the last year. The U.S. also boasts an extremely low unemployment rate of 4.5%, its lowest in 10 years.

As mentioned at the start of the article, U.S. consumers have also benefitted from a low inflation rate over the last five years, ranging from 0.7-2.4%.

Even the personal savings rate is on the rise. Over the last few years, it’s been marching toward 6%, if not always steadily.

So, Why Aren’t More Americans Buying Homes?

The homeownership rate reached a 50-year low (!) last year, at 62.9%. In fact, according to the Freddie Mac study above, 59% of renters say they have no intention to buy their next home, but plan on continuing to rent. That’s up from 55% last September.

Why? Why aren’t more people interested in becoming homeowners?

Perhaps it has something to do with the fact that rents rose only 0.7% last year, while home prices climbed 6.8%.

Then there are rising interest rates. As the Federal Reserve continues to raise rates for the foreseeable future, home affordability will likely drop as interest rates rise.

But that’s not the crux of the matter, according to renters. In a recent survey of renters, Zillow found that nearly 7 in 10 renters reported that saving for a down payment was the biggest hurdle to homeownership. Other top concerns included high debts and qualifying for a mortgage. (Although they may be in luck for that latter; some renters will see an artificial boost to their credit score this summer).

For renters serious about buying a home, they’ll need to save more than the average personal savings rate. They’ll also need to get serious about paying down debts.

Uneven Demand for Housing

These nationwide numbers don’t tell the whole story, of course. In the wake of the Recession, there was a mass movement from rural areas toward metro areas. Rent growth and home appreciation have disproportionately happened in cities, rather than rural areas.

There has also been a general migration south and west in the United States. Some can be attributed to retirement migration, some to Americans leaving high-tax states in favor of lower taxes, and hey, the weather is better in the south and west.

Related: No Inventory? Deals Can Be Made in Any Market. Here’s How.

In the last year, rents rose by 6.7% in Seattle, 4.7% in Sacramento, 4.6% in Portland, and 4.4% in Los Angeles. They dropped by 4.6% in Pittsburgh, 1.9% in Chicago, and 1.3% in New York City and North Jersey.

The fact that rents rose nationwide by 0.7% is simply an average of a thousand local-market trends around the country. Real estate is, at its core, a local phenomenon.

So, Markets Cooling?

On the national level, U.S. housing markets do appear to be cooling slightly. Zillow certainly thinks so, with its slower appreciation forecast for the next 12 months. Rising interest rates will likely have a cooling effect as well.

But with inventory remaining so low, don’t expect a housing collapse any time soon.

We looked in March at whether the United States is entering another housing bubble. While select cities may be overpriced, low inventory and a dearth of affordable housing and starter homes will continue to dominate housing trends for several years to come. The macro-trends of where Americans are moving will also affect housing markets. As we found when looking at state migration data, the states with the highest inbound migration rates have seen much better housing appreciation over the last five years.

What does it all mean for real estate investors?

Keep an eye on development and new construction in your area. Are home prices outpacing rents? If so, that can spell trouble for buy-and-hold investors. Still, keep in mind that in most U.S. markets, there are far too few affordable/starter homes available. If you can find a way to profitably provide affordable homes, you can take advantage of this housing market’s imbalances.

Where do you think housing markets are headed? Opinions? Thoughts? Funny but only mildly-relevant anecdotes?

Leave it all below!

About Author

Brian Davis

Brian is a rental investor with 15 income properties, who provides free video training to help everyday people start earning passive income at SnapLandlord.com. He's also the co-founder of SparkRental.com, which provides free services & education for landlords. His rental management is almost completely automated by now, allowing him to travel the world (his current home base: Abu Dhabi).

26 Comments

  1. Giovanni Isaksen

    Great article Brian. I think history will show that very much like in the last depression, young people coming of age during the Great Recession will carry the psychological scars for a long time and that will affect every financial decision they make for the rest of their lives. This combined with the enormous amounts of student debt they carry will keep homeownership among young people much lower for much longer than many housing industry experts expect, including Zillow.

    It’s interesting how the stats vary by source. I was just reading a Yardi report that showed nationally rents grew 3.8% over the last 12 months. Granted Yardi’s data is for apartments only but that would seem to indicate that the biggest deceleration in rents came in the single family sector. And since Yardi’s platform serves mainly professional property managers you could say that the 3.8% was for professionally managed apartments so a large part of the slowdown in growth was in non-professionally managed rentals. But that just reinforces my core strategy; a deal isn’t a deal if it doesn’t work with professional property management.

    • Brian Davis

      Thanks Giovanni, and great point about deals only working if they still cashflow well with property management included. That’s something we tell our students repeatedly: always include property management fees in your cashflow calculations, because even if you manage the property yourself, it’s still a labor cost.

      • Giovanni Isaksen

        Exactly, with you 100% on that. I would say that if you’re managing your own properties you’re not an investor even but in the landlord business and from that prospective all the basic small business principles apply. Especially not working for free in your own company because not only do you own a job (and not a business at that point) but you’re not even getting paid to do that job.

        Now once the portfolio grows large enough many operators bring property management in-house but they do that as a subsidiary or separate department with its own staff and not as a function of ownership.

      • Pavel K.

        Very Helpful feedback….. is the goal to make sure that after property management expenses are bundled in that basically you are not falling into negative cash flow and the property sustains itself even with small cash flow or should your goal be still hitting strong IRR and COC with that expense in place?

        • Giovanni Isaksen

          Pavel, that depends on the investment objective. Beyond a debt coverage ratio (DCR) of 1.25 or higher which provides a margin of safety (or a 15%+ cash flow margin no debt) you aim to hit your target return whether that’s IRR for a syndication with a hurdle or the COC for retirement income… or any other goal you have for the property.

  2. Christopher Smith

    I have two groups of SFRs in two very different areas of the country. Both areas remain quite strong with sizable rental increases. However, its good to keep your ear to the tracks just in case we need to start getting defensive so thanks for sending out some early alert signals .

    • Brian Davis

      Glad to hear your portfolio is performing well Christopher! But like you said, always good to keep a sense for what’s going on nationally, not just locally. Will be interesting to see how markets react to higher interest rates.

  3. Ray G.

    I’ve been watching these statistics for some time now and its definitely cooling. I’m taking my riskier appreciating assets off the board and moving them to cash flowing assets for the time being. I also don’t think drop is in order and don’t recommend a re prioritization of a portfolio, but maybe just the riskier asset reallocation might be in order.

  4. Paoola Sefair

    Hello Brian, Thank you for putting this article together. I completed a similar analysis for my local market and reading through your article gave me ideas of additional data points to look for.

    Question, could you please share more context on this statement… “Keep an eye on development and new construction in your area. Are home prices outpacing rents? If so, that can spell trouble for buy-and-hold investors ”

    Thank you….

    • Brian Davis

      Hi Paoola, I simply meant that buy-and-hold investors do best in markets with high rents and low prices. So seeing prices rising faster than rents nationwide is something to keep an eye on. But every local market is different, and at the end of the day it comes down to cashflow for buy-and-hold deals.

  5. Darwin Crawford

    Good article. Personally as a small landlord, with 11 doors of income property, I rent my house, and have not a lot of desire to own. This is due to 1) The god-awful experience I had in the recession, and 2) in my market, investors will take stupidly low rental rates in relation to purchase. Re: cooling markets – we are seeing a few things here that lead me to believe it’ll happen. Appraisals not coming in, and CDOM/DOM going up. My crystal ball is broken this week, so who knows what the future brings. But after leaving the southeast for the southwest, I’ll keep my money and my REI local.

    • Brian Davis

      Thanks Darwin, and I too rent where I live, despite being a landlord. And as mentioned in the article, you certainly aren’t the only one who’s moved west! It sounds like you’ve been wise to keep your money local.

    • Brian Davis

      I agree, they can’t keep sprinting at the pace we’ve seen without collapsing. Still, tight inventory will likely remain a driving factor for several years to come. An interesting tug of war between tepid wage growth and tight inventory, as we move forward.

  6. Marcus Auerbach

    I think it will stay hot – at least as long as inventory is not caught up with demand. Our inventory in the Greater Milwaukee Area is about half of what we would like to see. Buying a nice home is a matter of speed in 2017. Rental growth has been so fast the last years that it needed to slow down: wages simply provide a glass ceiling for rents by limiting afordability. The shortage of starter homes will continue to provide a great opportunity for SFR rentals. Great overview Brian, thanks for the big picture!

    • Brian Davis

      I agree Janet, and I think that makes sense. Homeownership is great, but only if you know you’ll be living in the same place for years (unless you’re up to being a landlord). But I do think that flexibility has a certain value, especially to young adults who are still sorting out their careers.

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