How Lower Rents Can Affect Sales Prices

A: Its a very interesting topic for debate, something I really want to get into UrbanDigs much more during 2007. That is, debating the changing fundamentals of NYC real estate with hopefully some guest speakers with different views than mine. So much goes into the changing dynamic of housing markets including monetary policy, economic strength, inflation pressure, rental costs, lending standards, etc., that I now think its time to look at the rental equation. For this post, I want to discuss the possibility of 'lower rental costs' in NYC during the course of 2007 and what that might or mght not mean for housing prices heading into this kind of trend.

2006 was clearly a landlords market! Vacancy rate dropped to record lows and renters got squeezed into much higher living costs as many would be homebuyers got priced out of the market and added to the rental demand. Add in the conversions of many rental buildings to condos to take advantage of market trends and all of a sudden supply slips; some of these conversions include Century Tower & Wellington Towers.

Now that we head into 2007, I believe we are starting to hit a peak in rental increases as some new developments decide to hold of selling all units and go rental, or partly rental, such as One Carnegie Hill over on 96th street between 2nd & 3rd avenue. Also, think about how many frustrated sellers there must be out there in NYC that decide to take their unit off the market and try to rent it out to take advantage of rental trends that currently favor landlords. Calculated Risk, a absolutely-must daily read (written by a senior executive, retired from a public company, with a background in investing, finance and economics) has a peice today about this very topic and was motivation for my post here today. From todays article in The Washington Post:

As home sellers grew more frustrated with the slow local real estate market in recent months, they abandoned their for-sale signs and put their homes up for rent. That has increased choices and cooled prices for tenants in one of the tightest and most expensive parts of the country. "This is the first sign that the cooling housing market is having an impact on the rental market," said Gregory H. Leisch, chief executive of Delta Associates, an Alexandria research firm that is scheduled to release a report today showing more vacancies in the region's apartment complexes.

Some developers who planned condos are switching their buildings to rentals. In the fourth quarter, developers announced they have or will switch 5,915 such units, according to Delta.

Condos aren't the only part of the market where there are more rentals. According to Delta, the number of condos, townhouses and houses listed for rent rose 23 percent in November from a year earlier on the region's multiple listing service, commonly used for for-sale properties but also for rentals handled by real estate agents.

It's an interesting fundamental to watch as we head through the year. If true, NYC should start to see similar trends as some new developments turn rental and frustrated sellers/flippers decide to rent out their units for a few years waiting for better times to sell. And if this happens, the data on the rental side is almost certain to change dramatically from what we have seen in the past 1-2 years. That is, one would expect rental inventory to correct to the upside, more choices for tennants, and lower rents in the years to come.

This is all speculation at the moment as it hasn't happened yet and right now NYC vacancy rate is still very low, rents higher yet showings signs of peaking, and still a lack of quality inventory for renters to choose from. But if the trend I discuss proves true here in NYC, what would you expect to happen to the housing market and specifically prices; a few things come to mind:

1. Rents Will Decrease Maintaining or Slightly Increasing Demand - Economics 101. Right now, its fair to say that many renters facing lease renewals and rent hikes (remember, this post is speculating about future rents decreasing which hasn't been proven by any data yet) who are ABLE TO PURCHASE, are seriously considering buying into NYC real estate in anticipation of their lease expiration. The combination of our strong economy, strong salary's, buyers' market where negotiations are taking place, and rental hikes coming on lease renewals are causing some renters to enter the marketplace for starter apartments. This is a fair anaylsis of what is happening now and a fair decision for those renters soon-to-be- homeowners as long as they meet the proper guidelines of buying (timeline to own, liquid assets, and salary).

But what if rental inventory rises and rental costs start coming down as a result of the inventory shift? Well, rental costs will decrease causing a shift in psychology amongst renters considering buying their first apartment on lease expiration! If rental costs for existing homeowners stay the same, and rental costs overall for new leases decrease as inventory and competition rises, more renters will stay put and remain RENTERS. And the # of those doing buy vs. rent anaylsis will probably lean towards renting for the short term.

2. Housing Demand May Dampen & Prices Correct As Rental Costs Correct - This is where I expect many of you to have either strong agreement or disagreement with my thoughts. If rental trends in NYC change to show increasing supply and decreasing prices, than house prices will likely follow the same path!

The theory is that renting all of a sudden makes more financial sense. Now, that doesn't mean buying is bad! Its very important you don't misinterpret what I'm saying here; as if your timeline to own is 4 to 5 years or higher and your financially able, then buying is the wiser choice. But for those that are considering converting from renters to buyers, albeit not a huge target audience, will likely continue to rent. House prices will have to follow rental prices as the gap in living costs is a metric most people use when crunching the numbers to make their financial decisions. If buying costs WAY more than renting, well what would you do? If we look at recent history over the past 5 years, it is clear that as housing prices rose so did rental prices. Well, what if rental prices come down first moving forward; will that drag down housing prices too?

On the Calculated Risk comment thread, Robert Cambell (San Diego developer and author of 'Timing The Real Estate Market') wrote a comment that made alot of sense to me. He stated:

If you study classic real estate cycle history, peaks in the building cycle tend to precede economic recessions and depressions. Driven primarly by rising land values during the boom - as the economic model goes - rents and housing prices rise to levels that are economically unsustainable for long periods into the future.

Then when the real estate cycle reverses, rents and prices follow suit. This theory was first proposed by Henry George in 1879, and has been well studied and expanded upon to this very day.

Well I don't know about Henry George so I'm only assuming he is correct on this statement, but the rest of the comment makes great sense to me and was more motivation for this post.

Conclusions: 2003-2006 proved to show marketing trends of rental conversions to condos and plenty of new development to take advantage of the incredible housing boom that was taking place. The result was a restriction of rental supply and increase in rental demand as buyers got priced out of the market; bringing rental costs back to where they were in the dot com boom of 1999 & 2000. Now we are seeing more conversions to rentals to take advantage of rental trends which could ultimately cause an increase in inventory, an increase in demand, and a subsequent decrease in prices. The question is, will housing prices follow suit? I put my thoughts out there, what are yours?

• Add to del.icio.us
• Digg this!
• Add to Technorati
• Add to Reddit