Interesting Times

What’s Happening With Rents?

It seems like every other day someone I know will complain to me that rents seem to be horribly high for single family homes, and yet they read that foreclosed homes are sitting vacant.

Now part of the reason for this rental price shock may be that the people who are looking at rentals haven’t had to rent a home in a long time, and are simply shocked at the prices.

And people say that it’s the law of supply and demand, and that there’s a lot of demand for these homes.

But I think something else is going on.

First of all, there really isn't a problem with supply.  Homeowner vacancy rates and rental vacancy rates have been climbing sharply over the past few years, and are currently at relatively high rates.

So there appears to be plenty of supply.

I think the problem is that there are a large number of owners of single family homes who have become, whether on purpose or by accident, investor owners, who are holding the homes vacant in hopes of selling at a higher price in a year or two.

The problem is that the holding cost of these homes is a significant negative cash flow, and owners are trying to cover their losses by renting the houses at unreasonably high rates based on their costs rather than market value.

If you bought a fairly typical three bedroom two bath home in Novato (Marin County) in 2004-2007, you probably paid around $800,000. Even if you put $200,000 down – which few people did during these years of easy money – you still have a $600,000 mortgage.

(Things are actually much worse. In 2005, more than 40% of all home purchases in California used 100% financing.)

A $600,000 mortgage at 6% (30 yr. amort.) would have payments of $3,597 per month. Taxes would add another $833 per month, and insurance $125 (approx). So the owner of this 3 BR home is on the hook for about $4,555 per month for PITI (Principal, Interest, Taxes and Insurance), not including expenses for maintenance, repairs, landscaping, etc.

But now he/she/they want (or need) to move – a job transfer, health issue, divorce, etc. When they talk to their friendly local real estate agent, they find out that their $800,000 purchase is now selling for $650,000-$700,000.

So they decide to hold on to the house until the prices go up. (Which I don’t believe is a good move, but I guess time will tell.)

The problem for this investor/homeowner is that the fair market rent for this three bedroom house is probably about $2300 per month, and his cost is $4,555. He can’t bear to eat a $2,255 loss every month, so he puts the house on the market for $3,000 per month, or even $3,500 per month. It may sit vacant for months, until the owner comes to grips with reality.

But in the interim, prospective tenants get sticker shock.