Rent Bubble = Housing Bubble = Rent Bubble

Here is the conventional narrative about rents and housing valuations:

1. Rents have soared because people can’t afford to buy a house and have to rent

2. Based on soaring rents, housing is fairly valued

In other words, rents and housing are tautological: rents are rational because housing values are rational, and housing values are rational because rents are rational.

Nice, but wrong: rents and housing are self-reinforcing bubbles: rents are soaring because housing is unaffordable, i.e. echo-bubble valuations. Soaring rents then justify bubblicious home prices.

Is the Echo Housing Bubble About to Burst?

One way to establish fair value of a home is to multiply the rental income the house can fetch in the open market. Multiply gross rents (before expenses, property taxes, etc.) by 8 to 15 (depending on the desirability of the locale and property) and you get an investment-based valuation.

So if a property earns $50,000 annually in gross rental income, the property is worth around $500,000, with premiums being added for low vacancy rates, desirable neighborhood, well-maintained home, etc.

Another approach is to calculate the net rent (total rent minus all expenses except mortgage) and base the value on the net rental income. Any property yielding 5% after expenses (i.e. 20 times net income) is an attractive investment in a world of negative short-term interest rates and 3% returns on 30-year bonds.

Rental demand is reflected by vacancy rates; low vacancy rates reflects high demand. Vacancy rates are low, but not at historic lows except in certain high-demand urban zones.

Vacancy rates were much lower in the stagflationary late 1970s – early 1980s. The claim that vacancy rates justify unprecedented rents is at odds with the data. (High-demand, limited-supply areas such as San Francisco are atypical; vacancy rates in these areas tend to be very low, in the 1% -2% range.)

Here is the urban-area consumer price index: it’s up 38% from 2000:

Here is the urban-area rent index: it’s up 56% from 2000–much higher than the rest of consumer prices, and climbing fast.

Here is the Case-Shiller home price index: it’s up 70% from 2000:

Rents were soaring from 2010-2012, while housing prices stagnated. If housing valuations were based on rents, then they should have risen in lockstep with rents. They didn’t.

Housing is in an echo bubble driven by overseas hot money flooding into North America to escape currency devaluations and crackdowns on corruption, and the easy-money policies of the Federal Reserve, which purchased $2 trillion of mortgages (20% of the entire U.S. mortgage market) to push mortgage rates to the floor.

Both bubbles (rents and housing) are vulnerable to popping. The real test of valuation is: what’s it worth in a recession, after all the easy money and the jobs that depended on easy money have vanished?

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  • diogenes

    To put it another way, the “market” for shelter in America is rigged by the 0.01% through the Fed, etc., to extract the maximum from a trapped populace of rent- and mortgage-serfs.

    Reflection, on the other hand, suggests that no person has the right — in fairness, equity, justice, morality, ethics — to own another person’s shelter, any more than to own another person’s body. What we have today in America is shelter slavery, and this is the foundation that maintains the oligarchy that has corrupted, usurped and killed American democracy.

    • jdmeth

      So who is supposed to foot the bill for my shelter? Wood, windows, cement, nails cost money, so do carpenters and plumbers.

      • diogenes

        The problem isn’t paying the builders and suppliers, the problem is paying for private credit created out of nothing by a monopoly that extracts twice the cost of shelter for its purely fictitious “service”. Remove the monopoly usurer and the cost of creating shelter (and paying for it) drops by 70% and more. Shelter is a public necessity and a public utility. There is no reason to shackle 99% of Americans with credit slavery to the 0.1% to pay for it.

  • diogenes

    In 1970 in San Jose a pleasant, large 1-bedroom apartment could be rented for $70 and a four bedroom house for $200. The minimum was was $2/hr. Today the minimum wage is $8/hr (four times higher) and the rents are 20-40 times higher. How does the 1% stay on top and keep getting fatter? Do the math.

  • diogenes

    Three questions for you, Charles Hugh Smith — friendly questions, and genuine. Generally statistics about “home ownership in America” say that over 60% of Americans “own their own homes,” but in fact on the order of half of these homes are really owned by the banks to whom their inhabitants are paying mortgages, so that the real proportion of Americans who actually do own their own homes must be around 30%. My first question is, what is it in fact? My second question is, what proportion of these people, who really do own their own homes, own them only after paying off mortgages — that is, only after the banks extracted their pound of flesh? And third, on average, when a mortgaged home in America has been completely paid off, what portion of the total money spent for it goes to the people who built it, what proportion to the people who supplied the materials, and what proportion to mortgage investors? Need I point out that these are basic questions and that the fact that they are never raised, are always glossed over, suggests that the answers reveal an entirely predatory system fastened on our basic need for human shelter?