The Rent to Value Spread: Where Are We Headed? Part II

So, the relationship between the price of houses and the rent that houses generate has deviated from its historic norms - house prices are up much more than rents - and the question is where we are headed from here. Some economists see house prices coming down to correct the imbalance, as much as 3% a year for the next 5 years. Here are the factors that are going affect housing prices and rent:

The median house price can be affected by more sales of lower priced homes, while the actual values of homes may not change as much. The median is simply the number where half the houses sold for more and half sold for less. The low interest rates and too-easy lending practices on owner occupied housing led a lot of people to buy "McMansions" on loans that were doomed. Now those higher-priced homes are difficult to sell in many areas of the country, while their former occupants will be looking for something more affordable. So, we may see the median price fall while values - especially of the lower cost homes - may not.

Lending may dry up: While I think someone - either a stronger hand, perhaps foreign banks/investors or the government, will step in before letting too many mortgage sources fail, it will be harder for marginal borrowers to get loans. Obviously fewer borrowers means potentially fewer buyers, which can mean lower prices. However, those people have to live somewhere, so they will rent (or move in with family for a while and then rent). That's a lot of new renters coming into the market and it seems to me that as they cause vacancy rates to drop, we may finally see rents pop up for the first time in years. This factor may cause both to happen - prices to drop and rents to increase, but I believe it may bring rents up more than bringing prices down (see Loss Resistance below).

Lower interest rates: traditionally this causes house prices to increase and rents to decrease. All indications are that we will continue to see interest rates fall this year. However, I think it will be different for two reasons: 1) Lower interest rates help get marginal buyers into homes, but tighter lending standards that will occur negate that. 2) We've had lower interest rates for years now, and most of the people who would be helped by lower interest rates have already made the leap into home ownership (and many of those are now in trouble on their mortgages).

Foreclosures: more foreclosures means lower prices. However, I think we may have lower foreclosures than expected because the lenders are being forced to renegotiate loans rather than get eaten alive with an overwhelming foreclosure rate. In most states the foreclosure process takes a long time, 6-18 months, and the time can vary. Not all foreclosures are going to hit the market all at once. The foreclosure effect may be less than people think.

Building starts: Builders are going under left and right, and those surviving have finally realized that building more houses that they don't have people lined up to buy isn't helping. December housing starts saw an extreme dropoff. In the normal course of human events, people tend to let the pendulum swing too far in each direction. Buildiers built too much when times were good, I expect them to reach a point where they are building below demand (much as the airlines in recent years have cut available seats to the point where nearly all flights are full or overbooked). All this translates into some degree of price support on houses, though probably not enough for any near-term significant appreciatation. Eventually, builders will get their inventories under control and the incintives will dry up. At that point, existing housing and may start to look more attractive, giving some price support there.

The taken for granted factor: This is an intangible that takes a little to explain, but can be summed up this way: people notice and complain when prices go up, but simply take it for granted with the prices of things get better. The best recent example is the price of gas. It was just a few years ago that we were seeing prices drop towards a dollar a gallon, even after many years of already failing to keep up with inflation. Instead of enjoying and appreciating that bounty, people took it for granted that it would continue and ran out to buy gas guzzlers. Now we're at $3 a gallon. Rents likewise have taken a recent dip in many areas of the country after years of not keeping up with inflation. People have taken that for granted. Could it be that rent - housing being a commodity just like gas - is about to turn up? It seems these things take place when we've reached to point of taking for granted that they'll stay that way and I think we're at that point on rent.

Loss resistance: This is a common, but also intangible, phenomenon in real estate - a seller (whether owner or bank which has taken it through foreclosure) typically becomes fiercely resitant to taking a loss on the sale. This gets to the point that they would rather take a larger loss, but a month at a time, on the mortgage. I've seen banks take huge losses over time insisting on going through the foreclosure and marketing process rather than sell at a small loss to me early on. Eventually sometimes it will dawn on people if their price is completely unrealistic, but from my experience this is a very long time. The effect of this is that if the majority of sellers are holding on to their pricing ideals, it can create a reality of slowing the downward price drift.

When looking at all these factors, while I agree that the median price will drift down, the actual prices of individual houses on the market may not decline as much as the economists predict, whereas the factors that appear to be ready to finally push rents higher seem to be a greater influence: less building, low interest rates having fewer new buyers to attract, and resistance to lower house prices by sellers. It could well be that it is rent pricing that is the next commodity to move up in the post housing/lending bubble world.