Sunday, December 16, 2007

Impact of Mortgage Crisis on Rental Rates

Calculated Risk has a recent post talking about Housing Inventory and Rental Units. The bottom line of the piece is that most people's estimates of excess housing inventory are too low because they don't consider vacant rental units. It also contains the assertion that home builders have built too many homes. I have a different viewpoint.

A housing unit, rental or ownership, is a housing unit. Most housing units are in 1-4 unit structures, and it is very easy for these units to move from rental to ownership and back again. In recent years large numbers of rental units in even 5+ unit multifamily structures converted to ownership as the buildings were converted to condos. When you talk about overall supply you really need to talk about the whole picture; trying to parse what's a rental and what's ownership is an exercise in futility.

"Too many" residential units happens when there are not enough households to occupy what's been built. It's a topic for a separate post, but I argue that housing demand is closely correlated with employment, and in recent years the number of residential units built has been generally in balance with employment growth. Yes, there are too many homes built in the sense that they're not selling and builders are continuing to add to supply as they work through their pipeline. However, this is a price issue created by the loose underwriting bubble popping. There are still plenty of households who need housing at the right rental rate or the right price and debt structure. Prices will adjust to the necessary levels.

The availability of cheap, loosely underwritten financing unquestionably drew a number of renters to home ownership from rental units (although not as many as you might think, because home values inflated rapidly to accommodate the increased demand such that many renters continued to be priced out of the market). You would expect this would result in more vacant rental units and reduced rental rates. To a certain extent this happened, but the effect was dampened because at the same time some rental units were converted to ownership units, reducing the rental unit supply.

Now, the reverse is occurring; a certain number of owners are losing their homes and becoming renters again. You would expect this would result in reduced rental vacancies and rising rental rates, and to a certain extent it is. However, the effect is dampened because ownership units are being converted to rental units, increasing the rental unit supply.

This interpretation is supported by the Census Median Asking Rent data. This data bounces around a lot and is seasonal, so I think the most helpful way to look at it is as percentage change over a rolling four quarter moving average. It looks like this:

Because this is a rolling average it lags, but what it shows is rent growth decelerated from 2001 through 2004. I believe this started out as a recession effect and continued as renters shifted to ownership. Keep in mind this was not a huge shift, rent growth was only negative three quarters of this period. Since then rent increases have accelerated as owners have shifted to renters, but again the effect is not huge. In fact, a large part of the increase is a reflection of a spike in 4th Quarter 2006 which looks like an anomaly.

My bottom line is the current situation is less about supply and demand and more about a price bubble created by leverage popping.