“What if housing markets collapse?”
It’s a common fear we hear from our students. After all, no investment is 100 percent guaranteed, right? Stocks, mutual funds, ETFs, real estate values – all of them can go down as well as up.
Occasionally, even rents dip under the right (or wrong) conditions.
While most cities, suburbs, and rural areas nationwide are seeing rents rise, we’re experiencing a surprise drop in the most expensive cities. But after years of unsustainable growth, is it really so surprising?
Here’s what’s happening in the nation’s largest cities, and perhaps more importantly, why it’s happening.
Rents Are Declining in Top-Tier Cities
According to Zumper’s September rent report, seven of the 10 most expensive cities in the country have seen rents decline from peaks in 2015 and 2016.
Of the three cities where rent hasn’t declined, two cities’ rents only rose by a fraction of 1 percent.
Here’s a list of these most-expensive cities, and how rents have changed — both year-over-year and since their peaks:
Chicago rents fell so far that the city — the third largest in America — is no longer even on the top-10 list (more on Chicago later). Rent for a 2-bedroom apartment in New York City fell almost 20 percent from its peak last year. Honolulu saw 2-bedroom rents plummet nearly 23 percent from its peak in 2015.
Meanwhile, home prices have continued to rise. San Francisco saw home values rise 10 percent over the last year, even as rents fell. New York City saw a similarly strong 9.3 percent rise in values. Honolulu saw a solid 4.8 percent rise in housing values.
In other words, rents and prices are diverging in these most-expensive cities, and not in the right direction for investors.
The Rise of Mid-Tier Cities
Don’t get too terrified about rental investing just yet. Nationwide, asking rents are up 3.2 percent year-over-year.
Not only is the rest of the country seeing rents rise, rents are rising significantly enough to counterbalance the rent collapse in the largest cities.
Even among other large cities, rents are performing better outside of the top 10. Among the 11th–25th most-expensive cities, most saw rents rise year-over-year:
And once you get into the 26th–50th most-expensive cities, nearly all of them saw rents rise, many with double-digit growth:
Alongside rents, home values nationwide are also on the rise — up 6.8 percent over the last year according to Zillow.
Why Are Rents Falling in Top-Tier Cities?
Let’s start with the simplest answer – some of these cities were previously experiencing a rent bubble.
Look no further than the Bay Area. From 2010 to late 2015, San Francisco’s rents skyrocketed an alarming 68 percent, from $1,900 to $3,200. In San Jose, they leapt 75 percent, from $1,600 to $2,800.
And now the piper has come calling.
Look at how top-heavy the rents are, among the most expensive cities. The rent for a 2-bedroom apartment in San Francisco is double that of a 2-bedroom apartment in the 10th-most expensive city, San Diego. And in turn, a 2-bedroom in San Diego is nearly twice as expensive as a 2-bedroom in the 25th most expensive city, Madison, Wisconsin.
Outside the top-10 list, rents remain far more affordable, even in the nation’s other major cities. In Philadelphia, a 2-bedroom apartment averages $800–$1,600 per person. Atlanta 2-bedroom apartments average $1,690; Denver, $1,800; Baltimore, $1,500; Pittsburgh, $1,330.
Demand has started shifting from desperately expensive cities like San Francisco and New York. Millennials — who for a decade led the resurgence in demand for urban living in the nation’s largest cities — have been dispersing to mid-tier cities. In doing so, they’ve been driving demand and rents up in these cities, while rents collapse in the overpriced top-tier cities.
Millennials aren’t just leaving the largest cities for mid-range cities; they’re also moving out to the suburbs.
The Second Wave of Suburbanization
Last year, among homebuyers, millennials comprised the largest cohort at 42 percent. And guess what? They were overwhelmingly moving to the suburbs, not to cities.
Nearly half of millennial homebuyers bought in the suburbs. A third who bought in urban neighborhoods. The remaining 20 percent bought in rural areas.
This trend doesn’t only exist as a blip in a few numbers. Industry analysts have noticed the suburban trend as well, based on a wide range of anecdotal and statistical evidence.
Why are millennials moving to the suburbs? For many of the same reasons their parents and grandparents did: they’re having kids, they want more room, they have pets, they want a yard, they want better schools.
Another unfortunate reason is that violent-crime rates have spiked in cities since 2014 and 2015, following more than 25 years of decline.
And of course, tax burdens tend to be much higher in cities. In my home city of Baltimore, the property-tax rate is double that of the surrounding county. The City of Baltimore also imposes a higher income tax, unlike most nearby counties.
I love urban living, but many of America’s largest cities don’t offer much of a sales pitch. Who wants to pay higher taxes to live in less-safe neighborhoods with shoddier schools? Fewer and fewer millennials, apparently.
Case Study: Chicago
Consider the nation’s third-largest city.
Chicago saw its population drop by 9,000 people last year. At the same time, over 26,000 new rental units were built in the multifamily industry alone. This does not include new single-family rentals, or derelict properties that were renovated and put back the market, or for-sale new homes and condos.
As mentioned above, violent crimes spiked in the meantime. Chicago saw 11.4 percent more homicides last year than in 2015.
In other words, demand is down and supply is up. And it’s evident in Chicago’s rents: since peaking in 2015, asking rents for a 1-bedroom apartment have plummeted by an unprecedented 26 percent, according to the Zumper data.
Chicago, like many large U.S. cities, finds itself mired in a fiscal swamp of its own making. Chicago’s pension debt alone is $33.8 billion. The city’s bonds are rated junk status by Moody’s. They’re raising taxes in every conceivable way, resulting in the average Chicago family paying $1,692 more per year than they did just five years ago.
Is it any wonder its residents are fleeing to the suburbs — or to cheaper, safer cities?
So What’s a Rental Investor to Do?
What demographic changes are taking place in your city?
Are young adults moving in or moving out? Are violent crime rates rising or falling? How are taxes — compared with surrounding counties and comparable cities?
Remember, rents are rising almost everywhere nationwide. If you live in one of the handful of larger cities where rents are slipping, start looking elsewhere.
The U.S. is chock full of excellent markets to invest in. These markets may not be just around the corner from your home, but that doesn’t mean there are no opportunities. You may just have to look outside your own backyard to see them.
What have you seen in your city? Are rents rising or falling? Why?
Where are you considering investing, if not in your home city?