Why Residential Rental Prices are off their Rocker

Why Residential Rental Prices are off their Rocker“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years,” go the sage words of Warren Buffett.  At present, this advice is especially important.  For asset prices are expensive.

Stocks are near record valuations.  Buying even the best companies today could result in holding stocks that are underwater for a decade – or more.  These are the risks when prices have been pushed to their limits.

We’ve gone over the absurdity of current valuations so many times we’ve lost count.  No matter how you slice and dice it – be it the Shiller’s Cyclically Adjusted Price Earnings (CAPE) ratio or the Buffett indicator – overall stock prices are a complete and total rip off.  This simple fact is being largely ignored at the moment.

On top of that, treasury yields – which move inverse to price – are skidding along the bottom of a 30-plus year credit cycle.  When yields finally turn, they could rise for the next 20 years.  Conversely, asset prices will deflate as borrowing costs increase.

This is a trend that’s been a long time in the making.  But it isn’t quite here.  Cheap credit and expensive asset prices still dictate the economy.  The impending shift will not be easy.

Suspect House Prices

One asset that is particularly sensitive to borrowing costs is house prices.  Just a 3 percent rise in 30-year mortgage rates can add $500 to the monthly mortgage payment of a median priced home.  Thus, to bring things back in line with higher borrowing costs, house prices must decline.

Naturally, house prices have significantly benefitted from the Fed’s zero interest rate policy.  Unsurprisingly, their prices have also creeped back up over the last few years.  The Fed’s cheap credit has puffed up their price.

While they aren’t back to the extreme price levels reached during the epic housing bubble of the mid-2000s, since early 2012 the median price of houses nationwide has gone up over 20 percent.  In some regions they’ve increased even more.  However, the price rise has been a little suspect.

Namely, the increase in house prices hasn’t being supported by an increase in growth and a rising standard of living.  In short, per capita incomes are rising at 3.1 percent and wages are rising at 2.2 percent…house prices are rising much faster.  The gap, of course, has been made up with cheap credit.

Nonetheless, median house prices are largely unaffordable for median income earners.  Perhaps this is why the U.S. homeownership rate is at a 20 year low.  Perversely, the reduction in homeowners has resulted in an increase in renters…and an associated increase in rental rates.  What to make of it…

Why Residential Rental Prices are off their Rocker

The economic distortions from the Fed’s money and credit games are rearing their ridiculous heads in the residential rental market.  In fact, things have been pushed so far out of balance that, according to the National Low-Income Housing Coalition, “A worker would need to earn $19.35 per hour – nearly three times the current federal minimum wage of $7.25 – to be able to afford a basic two-bedroom unit.  A one-bedroom unit is only slightly less costly, requiring a wage of at least $15.50 an hour.”

But that’s nothing… “Not surprisingly, some states have it worse than others.  Hawaii, Washington, D.C., California, New York and New Jersey have the highest rents, each requiring workers to earn more than $25 per hour and, in Hawaii’s case, nearly $32 per hour.”

Alas, the proposed solutions to high rents fail to address the problem.  Rather than putting an end to the Fed’s disastrous financial engineering tweaks, high rents are greeted with calls for higher minimum wages.  Somehow higher minimum wages are supposed to bring the economy’s productive value up to distorted rent prices.

Yet higher minimum wages won’t make housing more affordable.  But they will make jobs more scarce.  Similarly, they’ll push the economy closer to the perilous edge.

Fewer jobs plus inflated rent prices will make for a reduction in living standards.  Unlike the 2008 financial crisis, where the Fed’s actions were cheered and celebrated, the next crack up could bring the Fed a hurl of rotten tomatoes.  With a little luck, their technocratic ditherings could be replaced with a renewed focus on sound money and market based pricing for credit.

Only then will house and rent prices equilibrate with economic activity in a way that’s natural, fair and just.

Sincerely,

MN Gordon
for Economic Prism

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