New Home Sales, Essentially Flat, Crush Expectations

I believe that rents will not fall for lack of qualified renters. The residential RE market does not operate on supply and demand as textbooks tell us the rest of the economy does. Landlords have fixed overhead that is HUGE compared to most businesses that have a lot more categories of overhead and thus more places they can make cuts when demand hits a rough spot. If demand starts drying up for landlords they have no choice but to raise rents on those units that are occupied in order to generate the revenue they need to remain a going concern. So it is one sector of the economy that not only does not respond to supply and demand in the intuitive way you think, it is actually the opposite.

If landlords are convinced that there will be serious demand disruption that threatens their business and ability to pay the overhead they will not just rent empty units at a lower cost that does not support their own costs, they will sell the units. There will always be a buyer for their RE out there at a given price level, and they simply would lower the price to attract offers if they can’t get the original asking price. That does not translate to lower rents, the new buyer would simply be able to stay afloat even with the empty units, even if that is speculated to be a temporary situation, they will run the losses till the economy recovers. Having bought the units at a discount they can afford to do that.

What I am saying is that RE owners can/will take a temporary hit to the unrealized new values on their properties as long as they can, but once the property is threatened say with foreclosure because the rental income is insufficient to cover the mortgage they will sell at a discount rather than have their credit impaired. The new value remains unrealized till sale of the property. When they do sell at that new value the new owners will not lower the rents to reflect the lower amount paid just because the mortgage payments are lower than the sellers were. After all it was the lower rental revenue that drove the sale in the first place, so the new owners will keep the rent steady (or raise them) till they can remain solvent given the lower occupancy rate.

This is all because the renters of a property are the ones actually paying the mortgage if any on the property, the taxes and insurance, the upkeep and any profit the landlords are making. In fact what most people don’t know is that renting out residential real estate has traditionally been a negative cash flow business. Landlords try to have rents cover the hard cost overhead they can’t get out from under, but rents rarely have been enough to pay all expenses related to the property and a profit. Instead the total return to the owners is the rents plus the capital gains plus the tax advantages, like deductions and depreciation.

We have seen governments gut the tax advantages, and capital gains are now known to be vulnerable, RE does not ALWAYS rise. Though we now have values above the pre GFC peak it is not a guarantee they are going to bet all their capital on.

One thing I noticed when I returned to the US from Ireland was that these days rentals are being expected to make an actual positive cash flow, or a lot closer to it. And I know the town I just left to move to Florida saw a 90% increase in rents between 2013/14 lease period and 2019.

The other relevant aspect of this market is yes some people can move out of their rentals in with Mom and Dad in an emergency, and a few will have to just go homeless, or couch surf till nobody welcomes them in anymore, but the vast majority of the market is one of the least elastic for demand there is. Even food is more elastic because someone will feed you for free before watching you starve, food banks, missions, but nobody will house you if you can’t afford it. If they did we would not now have millions of long-term homeless. Yes a few can qualify for HUD section 8, usually the very (and permanently) disabled poor, and unmarried women with minor kids. And even then the waiting list can be many years.

I say the overall effect here will be rents will either remain stable in most markets or rise. The higher the proportion of renters in a given market the more rents will have to rise to cover expenses of landlords. Basically markets that were already hot and rising/high priced, like LA and Denver, will have to rise more. And just to guarantee that happens some landlords will sell, units will leave the market, that means lower vacancy rates, that means higher rents, it is self reinforcing. Even when real estate values/prices cratered in the GFC rents did not go down. In fact they went up because millions were thrown out of homeownership and the demand rapidly rose for rentals.