Wednesday, June 27, 2018

Housing: Part 307 - Apartment Supply and Rent Inflation

I have been seeing reports of falling rents in various cities.  Zillow data generally shows a decline in rent inflation over the last couple of years. Here is a report from has a nice report out with data for many cities that also generally shows declining rent inflation.
This is generally attributed to rising supply because of strong multi-unit building.  I don't doubt that this is true to a certain extent.  Seattle seems like an especially good case for this.  Here is a chart of permits issued for multi-unit and single family unit homes, and the Case-Shiller home price index in Seattle.

Single family home building remains low in Seattle while multi-unit building expands at strong rates.  Meanwhile, according to the Seattle Times and, above, rent inflation is declining and according to Case-Shiller, single family home prices are rising.

Looking at the zip code level data from Zillow for either multi-unit or single family, rent inflation appears to be strong in low-tier zip codes and moderating in high-tier zip codes.  But, the rise in single family home prices appears to be concentrated in the high tier zip codes.

I'm not sure what is going on in Seattle, but I think there is more substitution between these markets than is frequently assumed, especially in today's context.  I'm not sure that even in Seattle this is a simple story of apartment supply leading to rent deflation.  Across Seattle, it seems that high end rents are leveling out while low end rents remain strong, yet high end prices are rising more than low end prices.  I haven't spent the effort to get to the bottom of it.

Thinking more broadly, it is interesting that the decline in rent inflation that is showing up at places like isn't showing up in CPI or PCE data.  Here is a graph of the growth in real and nominal tenant housing expenditures.  I have also included the measure of the number of new multi-unit permits here (black dashed line, right hand scale).  Notice that there isn't much of a relationship between the growth in tenant-occupied real housing expenditures and the growth of multi-unit permits.  I think that is because, at least for the last 20 years or so, the growth in tenant-occupied housing expenditures has been largely determined by the shift of single family units between rented and owned.  From 1994 to 2004, the shift was from tenant-occupied to owner-occupied, so while there was a decent growth in multi-unit permits, the rate of tenant-occupied housing expenditures was flat, even though rent inflation was stable and high.  Then, after 2004, there was a shift of single family units back to tenant-occupied, because we killed the mortgage market as part of the moral panic against the housing boom.  So, for several years, new unit growth was low, but tenant-occupied housing expenditures rose.

Now, we have switched back to the pattern that was in place during the boom.  And, it so happens, homeownership rates have begun to rise again.

There are a couple points to consider here:

  • Whether this rise in homeownership will persist remains to be determined.  The level of mortgages outstanding has been growing slowly for a few years, but there hasn't been any shift toward more lending to households with FICO scores below the mid-700s.  If that doesn't happen, then there is a limit to how much homeownership could rise.  There just aren't that many households with FICO scores over 760 who don't already own homes.
  • Rent inflation has been high for the last several years, but one reason it hasn't been higher is that households have been contracting their housing expenditures in the aggregate in order to try to moderate rising housing costs caused by the shortage of housing.  This should put a floor on rent deflation, because even if homeownership expands and single family homebuilding increases as a result, much of that expansion will be accommodating pent up demand.  That isn't a guarantee against declining rents.  Certainly, a fully functional housing market should equate to rent levels on existing units that are relatively lower than they are in today's constrained market. But, while intuition would tell us that rising supply will pull us down the demand curve to a lower price level, in today's context, rising supply will be associated with a demand curve shifting out.  The net effect on price may not be positive, but it will be much higher than it would be with a static demand curve.
In sum, what this suggests is that (1) it is the shift in single family units that will probably affect multi-unit rents more than the direct supply of multi-unit building, (2) for that shift to be significant enough to lower rents, the increase in single family building would probably have to be very large, and (3) an effective hedge against multi-unit rentals would therefore probably be exposure to single family home builders or to prices on owner-occupied units in either single family or multi-unit markets.

This third point is important and contrarian.  Rising supply will be associated with rising price/rent multiples.  If rents decline or stagnate because of rising supply, prices will necessarily be rising, because the lack of single family home expansion has been the result of credit repression that has pushed prices of existing properties below replacement value.  To builders, this looks the same as a market where costs have risen.  In either case, they are unable to compete with existing stock on price.  But, unless interest rates rise significantly, this divergence will have to be solved with rising prices.  And, interest rates are unlikely to rise until trillions of dollars of pent up demand for new homebuilding are unlocked to suck up the low risk savings that are pushing interest rates down.  So, while this may be counterintuitive, the hedge against falling rents now would be a long position on rising prices.


  1. Some more rent info.


    1. The average income of people buying new homes is higher than the average US income, which pushes this ratio up because regulatory limits have shut down new home markets for entry level homes. I'm not sure this is a useful measure.

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