Rents Keep Rising
What needs to happen for rents to plateau or drop
A dour report on Wednesday showed overall inflation running at a red hot rate of 9.1% for the month of June, which represented the sharpest increase in consumer prices since 1981. This will absolutely lead to another big hike in interest rates later this month by the Fed, who are desperate to cool things off before inflation spirals completely out of control. Prices were up in virtually all categories of spending including the particularly impactful areas of food, energy, and housing.
I’ve written recently about how I think we are at peak inflation. I still believe that. Keep in mind that Wednesday’s inflation report was about activity during the month of June, and there is already evidence that prices in some key areas are declining in the month of July. Gas prices, for example, have dropped 30 days in a row as of the time of this writing, and economists estimate that Americans are spending $140 million less each day on gas than they were a month ago, per the New York Times. According to AAA, the average price of a gallon of gas nationwide right now is $4.548, down from just over $5.00 one month ago.
Gas is a necessity for people who drive to work or for companies involved with transportation and shipping. But other consumers can and will pull back from travel and other discretionary activities in the face of high prices at the pump. But what about other expenditures that people cannot just pull back from? Like rent. Wednesday’s inflation report showed rents up 5.8% in June over last June, which is a pretty big jump. In 2021, rents were up 10.1%, which was a particularly large one-year increase. A lot of tenants are feeling pinched.
Why Are Rents So High?
There are a number of reasons why rents have surged during the pandemic, much of it pandemic-related but some of it just coincidental timing. Among the current reasons:
Homes are expensive and many renters either do not qualify for a home loan or do not want to be tied to one geographic place at this point in their lives.
America collectively underbuilt on homes and rental units from 2010-2015. We are still trying to catch up.
A good number of rental units have been converted to AirBNBs and vacation rentals, pulling supply out of the market of monthly and longer-term rentals.
There are actually a lot of strong renters financially particularly who are choosing to work-from-home and possibly geographically relocate to do so, and they have driven up rents simply because of their ability to pay. This is particularly notable as people move from high-rent areas like New York and San Francisco where they are accustomed to paying large dollar amounts for rent to smaller cities or more rural areas, where rents have historically been much lower but have now been rising rapidly with the influx of higher income tenants.
Households are getting smaller. More people want to live alone or at least with a fewer number of people. This splits the pool of renters into more units, which represents increased demand.
I wrote more about these variables in the context of the historically low vacancy rate among tenants in May:
What Comes Next
The above are all complicated reasons that contribute together to rising prices and some of these variables will take years to settle themselves out. The problem of renters not qualifying for home loans (if they want to buy a home, that is; not every renter does), is actually only becoming worse due to continued lack of affordability of homes and rapidly rising home prices. A statistic I have referenced before that I find to be particularly telling is that that the average homebuyer has lost over $130,000 of homebuying power on the median home price since January simply due to rising interest rates. A lot of potential homebuyers simply no longer qualify at higher rates, which keeps them in the renter pool, which contributes to strong demand, which leads to ever-rising prices.
Really, however, what it all comes down to is there are simply not enough rental units to meet demand. The solution is clear: we need a massive wave of new building of all types of housing including rentals, single-family homes, multiunit apartment buildings, accessory dwelling units (ADU’s, also sometimes referred to as in-law apartments), and more. Without a significant supply of new housing, demand will continue to outpace supply, and prices are likely to continue to rise. This is good news if you’re a property owner or landlord, but bad news if you’re one of the million of tenants who are currently struggling with ever-increasing rents, particularly as wage growth, though positive, is not as robust right now as inflation.
Increasing the supply of housing needs to be a policy objective at all levels of government starting with how cities and towns look at their codes and ordinances. Local code enforcement officers need to, of course, abide by all life and safety requirements, but they also need to try to make it easy for builders and developers. It can take weeks or even months of meetings with officials, planning boards, local councils and select boards, and others to embark on a significant construction process. It just needs to be faster and easier with fewer fees and less paperwork.
And local officials have to be willing to push back on NIMBY-ism when positive projects come along that would create new housing. New rental units are good for communities as they, first and foremost, provide one of the key necessities of life (housing), but they also are good for the economy as they bring in new people to the community who will spend money, they provide potential workers a place to live, and they create new property tax revenue for the municipality, which helps to pay for services for everyone. And the more new units you have in a community, the less upward pressure there will be on rising rents.
Final Thoughts
There is one other way rents come down and it’s not a pleasant one for anyone, both landlords and tenants alike, and that is if the United States economy enters a significant recession and tenants simply cannot afford to pay their rents. In this scenario property owners will need to drop their rents to meet weaker tenants where they are financially. Both inflation and economic recessions tend to hit lower income workers the hardest as it is the non-discretionary items like food, energy, and housing that are inflating the most right now and if the economy spirals downward it is the lower income jobs that may be the first to be cut (although Professor Scott Galloway, who I enjoy following, has hypothesized that the coming recession will be actually be harder for the white-collar sector):
It feels increasingly likely that the United States (and really, much of the world economy too) is headed for at least a mild recession. The strange thing at the moment is that inflation continues to be running red hot but the labor market has not cooled at all and people are still spending money. But for renters, continually rising rents are putting a real squeeze on monthly budgets.
Ben Sprague lives and works in Bangor, Maine as a Senior V.P./Commercial Lending Officer for Damariscotta-based First National Bank. He previously worked as an investment advisor and graduated from Harvard University in 2006. Ben can be reached at ben.sprague@thefirst.com or bsprague1@gmail.com. Follow Ben on Twitter, Facebook, or Instagram. Opinions and analysis do not represent First National Bank.