Rents accelerate 13%, is this a warning sign?

Would-be home buyers priced out of the sales market are finding little consolation when they turn instead to the single-family rental market. Prices are soaring there as well. What is causing the large surge in rents? How is this related to housing prices? Will the jump in rents cause a real estate correction? What can we learn from a federal reserver study on the correlation between rents and values? Are the increases in prices and rents transitory? What does the large jump in rents mean for future real estate values?

What was in the data Regarding rental rate growth?

“Single-family rent growth showed a strong rebound in April 2021 with all price tiers back above their pre-pandemic rent growth rate,” said Molly Boesel, principal economist at CoreLogic. “While rent growth slowed last April at the start of the pandemic, the rate of rent growth this April was running above pre-pandemic levels even when compared with 2019 and shows no signs of diminishing.”

Detached single-family rent growth was up more than 3.5 times the rate of attached single-family rentals in April
While rent growth dipped significantly last April at the start of the pandemic, rising affordability issues and supply shortages in the for-sale housing market and ongoing demographic pressure from aging millennials have continued to place upward pressure on the single-family rental market — leading to the largest annual rent price increase in nearly 15 years in April 2021.
Rents for single-family detached homes (not townhomes), were up an even stronger 7.9% compared with a year ago, as millennials seek more outdoor space.

What is causing the huge jumps in rental rates?

Demand: Covid led to huge increases in demand from Coastal markets for more space
Supply: At the same time Demand has spiked, supply has not come even close to keeping up which has led to huge imbalances in the market
Cost to Build: Build costs have skyrocketed for both labor and materials which has focused more building on the upper end with higher rents. This has essentially “pulled” up rents on lower priced properties.
Cost to maintain: Along with build costs, the daily maintenance costs have also increased from roofing, flooring, appliances, maintenance staff, etc.. All these increases are getting passed on to the renters.
Taxes: Property taxes in Denver are predicted to increase about 36%; these costs are being passed on to renters.

Will the large jumps in rental rates continue?

I think we are at the beginning of rent increases as rents have a bit more catching up to the huge increase in prices. Furthermore, I don’t see much changing with the five variables above to substantially change the dynamic of rent growth. The one item that will eventually slow rent growth is that wages will not be able to keep up with the huge increase in rental payments. The rent prices at some point will slow unto themselves for this reason. Unfortunately, it is hard to predict when this will exactly occur, but I would assume sometime in the next year or so.

What does this mean for real estate values?

Rent rates are a lagging indicator of values. As values have increased rents rise to “catch up” with the values. What does this mean for future value? The federal reserve did a great study on this in 2004 to see what impacts rent growth had on future appreciation. Here is what the study finds.

My main findings are that periods in which house prices are high relative to rents appear to be followed by periods in which real rent growth is faster than usual, and real house-price growth is slower than usual, and that the response of prices dominates that of rents. The third analysis provided the most conclusive evidence that house prices correct back to rents.

Essentially the study found that in rapidly appreciating markets, like we are seeing throughout Colorado and many parts of the country it takes some time for rents to catch up to values. Why do rents take time to increase? Many leases are at least a year which insulates the existing tenant from large increases. As the leases renew the increases begin to occur. This whole process could take years to filter through the rental market depending on the lease renewals and turnover of tenants.

We are just seeing the beginning of this trend as prices of real estate really started to take off about 18 months ago. The Federal reserve study confirms that there is an intrinsic relationship between rent growth and price growth of real estate. As rents make large jumps, prices will “correct”. This means that prices will best case stay constant, worst-case fall. Furthermore, the study found that prices were unlikely to continue the rapid appreciation as rents at some point cannot rise enough to justify the values. Long and short, the two scenarios are prices will stabilize or fall.

Summary

The federal reserve study shows that there is a historical correlation between rents and prices. The huge jump in rents is a warning sign for the real estate market. As rents jump prices will in the best-case scenario flatten. Wage growth is not coming even close to keeping up with the increases in rents. The median wage in Denver rose only 4.3% while at the same time rents jumped almost 20%. This is clearly not sustainable.

Unfortunately, the huge rise in rents signify that the real estate party is almost over. The one question remaining is if there will be a crash or merely a stabilization in prices. If appreciation continues unabated rents will not be able to keep up and a crash will be in the offing!

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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine, The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.

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