Housing: Part 353 - The Seemingly Strange Case of Nashville

There are two core constructed details that have formed a basis for much of my analysis about the 21st century housing market and the financial crisis.

• Price/rent ratios tend to rise as rents rise, but at some point in each metropolitan market they reach a ceiling.  This means that (1) excessive price appreciation in low tier homes during the housing boom in cities like LA and NYC was mostly a product of rising rents. and (2) The core error of the FCIC and most analysis of the crisis was missing this fact and blaming rising prices on aggressive credit markets instead.
• In most cities, rents were moderate enough that there was not an unusual rise in low tier home prices from this effect, but after the boom, when credit was greatly tightened, low tier prices were decimated, frequently falling more than 20% compared to high tier prices.

This first graph basically tells that story (PS: Many thanks to Zillow.com for making so much price and rent data public):

idiosyncraticwhisk.com 2019
Data from Zillow

LA is highly unusual, both for having such high price appreciation and for having such a divergence between the high and low end during the boom.  These are related.  They both come from the extreme shortage of supply relative to demand for housing in LA.

Seattle is more expensive than Atlanta because incomes are higher there and supply of housing is more constrained, though much better than LA.  So, you see a bit of difference between Seattle and Atlanta during the boom, but little difference between the top and low tier of each city.

Then, during the bust, bottom tier home prices in both Seattle and Atlanta collapse, to the point where low tier prices in Seattle had total appreciation that was no more than high tier appreciation in Atlanta.

idiosyncraticwhisk.com 2019
Data from Zillow

I recently had occasion to look up data in Tennessee.  I have gotten so used to seeing this pattern that running the numbers has become rote.  Almost every city looks something like Seattle and Atlanta.  So, I was quite surprised when Nashville looked like this:

Nashville looks like Atlanta before the crisis and Seattle after the crisis, and it doesn't have the lagging low tier price appreciation of either of those cities.  In fact, it is high tier prices that have been lower in recent years.

What gives?

It turns out that in recent years, Nashville has been on fire, economically.  Population growth, in-migration, rising incomes.  Things are going really well there.  Things are going so well that housing supply pressures are making it look more like a Closed Access city.  Well, it's more the case that there are two Nashvilles.  The top half of the housing market operates like an open access city before the crisis.  The bottom half of the housing market operates like a closed access city because new tighter lending standards are preventing owner-occupiers from buying homes in those sub-markets.  This has compressed price/rent ratios so that yields are high enough to induce buying by landlords.  This can happen through lower prices or by rising rents.  In practice, it can be a little bit of both.  In Nashville, it appears that economic success has led especially to rising rents, because pressure for residency in Nashville is pushing up demand for Nashville housing.  At the top end, this leads to more supply.  But, that demand pressure also appears to be seeping into the low tier, where it can only push up rents, because buying pressure is limited mostly to landlords and they are still mostly just buying up the existing stock, apparently at price points that still can't induce much new supply.

Here is a Fred chart of housing permits in Nashville.  The red line is single family homes and the blue line is multi-unit homes.  Both are very healthy.  Pre-crisis Nashville had strong rates of new home building.  It may be unique among cities where building was well above the national average before the crisis and has recovered to those pre-crisis levels.  You just don't see this in other cities.

I presume that eventually, rents will rise high enough to trigger even more building at the low end, putting a stop to excessive rent inflation.  But, it hasn't happened yet.  Though, multi-unit starts are very strong.  To the extent that investors will build new stock, it will tend to be multi-unit.

idiosyncraticwhisk.com 2019
Data from Zillow

Here is a graph of median rent and mortgage affordability in Nashville and in the US over time.  (Again, all hail Zillow.)  The national story here is that rent affordability has been high (though it has moderated recently) but that mortgage affordability has never been better.  There has never been more reason to loosen lending standards.  This is basically why the low tier of most cities is lagging in price and supply with rising rents, because we have financial gatekeepers preventing potential low-tier buyers from closing this financial arbitrage gap.  Price is not the moderating factor keeping mortgage expenses so low.

But, note what the Nashville story is here.  It has traditionally been an exceptionally affordable city, in terms of rent.  But during the housing boom and after, that gap has closed, and Nashville isn't particularly affordable any more.

idiosyncraticwhisk.com 2019
Data from Zillow

Because of these high-tier vs. low-tier supply issues, this affordability problem is especially pronounced in low-tier Nashville neighborhoods.  Zillow only has rent data from 2010, but here is a graph comparing aggregate median rent levels in each zip code in Nashville from 2011 to 2019.  The x-axis measures the starting median rent and the y-axis measures how much rent has increased in that zip code since then.

More affordable areas have experienced rising rents much higher than more expensive areas.  So, the median rent affordability measure above really splits a divide between top-tier areas where rent affordability has remained low and low-tier areas where it has moved up more.  In Nashville, this has been strong enough factor to swamp the compression of price/rent ratios.



idiosyncraticwhisk.com 2019
Data from Zillow

And, this brings us back to the bullet points at the beginning.  The counterintuitive issue at the core of the question of rising home prices is that rising rents cause price/rent ratios to rise.  Here is a comparison of rents and price/rent ratios in zip codes in Nashville in 2011 (blue) and in 2019 (red).  As we can see, the typical pattern holds.  Price/rent ratios rise as rents rise, up to a point, where they level out.  At the top end of the market in Nashville, price/rent ratios have increased since the market bottomed, and top end price/rent ratios now average around 17x or so, up from around 14x in 2011.

One would think that price/rent ratios at the bottom end would have to have expanded at least that much, because prices have appreciated at least as much at the bottom.  I have added linear trendlines here, reflecting the portions of Nashville that are not at the peak price/rent level.  As you can see, that relationship hasn't changed much since 2011.  A typical unit renting for $1,200 has a price/rent ratio that is right at the same level it would have been in 2011.  But, rising rents have pushed all housing units up this price/rent ratio incline.  This is basically the same effect that was happening in places like LA before the financial crisis.

The long and short of it is that there are zip codes in Nashville where rents might have been $1,000 per month and looser lending may have pushed price/rent ratios up from 10x to 12x.  The trend line in this graph would have moved up.  Instead, because of tight lending, rents in those zip codes are more like $1,200 with price/rent ratios around 12x.  The trendline hasn't moved at all, yet this doesn't make housing more affordable.  This is one of many reasons why the focus on affordability should be on rent, not price.  Rent is the coherent source of information for that question.

I have concluded that the relative rise in low-tier prices in cities like LA during the bubble was unrelated to loose lending markets.  That is a tough argument to make, because it coincided with loose lending markets, and it just seems to make sense that loose lending would create new buyer demand that might push prices up.  But, here, in Nashville, we can see the same effect, and here, the effect coincides with tight lending.  In both cases, however, rising rents and rising price/rents coincide with limited supply.

Tight lending standards have created the same context in the rest of the country that supply constraints in Closed Access cities had created before the crisis.  Any positive economic developments will create a side effect of pushing up the cost of living for families with the lowest incomes.  Eventually, I presume, Nashville will hit a rent level that pushes prices high enough to induce enough investor building to level off rent inflation.  There will be a new normal, where the level of rents will be higher for low-tier tenants relative to where they used to be, but once we hit that level, the rate of change in rents should level out.

There is no rule here that points us to the correct place.  Maybe access to mortgages should be tightly regulated and housing should be more expensive than it used to be for low-tier tenants.  An advantage of that market norm would be lower rates of mortgage defaults, etc.  It would be a safer equilibrium with less volatility and less punctuated distress.  But, the cost of that safety comes at the expense of low-tier tenants.  They replace less punctuated distress with more chronic distress.  And, if prices are going to be depressed by limiting access to capital, then that means, mathematically, that we are enforcing a system of inflated returns to those who happen to have capital.  Again, maybe that's ok.  We just need to be honest about the implications of these lending norms.

If this is the new normal, then most cities have a few decades to look forward to that look like Nashville today.  Economic success will mostly simply mean rising cost of living for households with lower incomes.  This will be blamed on all sorts of supposed problems with laissez-faire markets, but most of it lays at the feet of a national consensus that has supported an extreme regime shift meant to make real estate markets less volatile.  Supporting an economic structure that benefits all Americans will require coming to terms with the pros and cons of that consensus.


Follow up.