April 8, 2009
Effective San Francisco MSA Residential Rents Lead U.S. Decline
Effective residential rents in large apartment buildings in the San Francisco MSA declined 2.8% in the first quarter of 2009, the sharpest recorded decline amongst the top 79 U.S. markets. New York recorded a 2.6% decline to take second place and San Jose a 2.5% drop to take third.
According to San Francisco Apartments Association Executive Director Janan New by way of the Examiner, "rents have dropped most in the Marina, Russian Hill and Telegraph Hill neighborhoods, and least in Mission and Inner Sunset."
As outlined in our 2009 residential real estate outlook in January, we expect to see rents in San Francisco continue to drop throughout 2009.
First Published: April 8, 2009 9:00 AM
Comments from "Plugged In" Readers
I don't see why this is being posted on an RE site. This surely won't effect SF housing prices. SF is immune.
I'm surprised it's only 2.9%. Mine dropped more than that. I must be better than average.
Posted by: smarty at April 8, 2009 9:24 AM
Someone told me the other day that he heard there is a 35% vacancy rate in the Marina District. I found that rather high.
Posted by: anonn at April 8, 2009 9:29 AM
I was talking to Gateway the other day, and they told me to put down deposit to hold the unit because they go fast. Funny, I thought.
It seems more like 10% drop than 2.8% in overall market. Now you see units advertised for less than $3k for 2br in buildings like Palm, Artani, Museum Parc, or Strata. Rincon Residential is offering 2 mo free. (Meanwhile, Argenta is still dreaming on at $3800 to $5150)
Posted by: jj at April 8, 2009 9:30 AM
I can confirm at the gateway.
I checked out a townhouse there because I was thinking of renting out my place, and it was already reserved before I could return with a check.
Rent-controlled + Good location = will rent at some price
Posted by: jessep at April 8, 2009 9:50 AM
Does this mean that the value of multi-unit buildings is falling too?
(Of course, as a sane person, I would never buy any rent-controlled residential property until the Bolsheviks are voted out of power.)
Posted by: Conifer at April 8, 2009 9:52 AM
[sarcasm]Clearly this is an indication of just how strong the SF real estate market is. In other markets, rents are being propped up by owners who have been foreclosed on and now must enter the rental market, but not in SF! In SF there are legions of bitter renters that are leaving the rental market entering the RE market as buyers - hence rents are falling. Buy now or be priced out forever! [/sarcasm]
Posted by: anonm at April 8, 2009 9:56 AM
One would expect the largest drops in complexes built after 1979, and thus exempt from rent control. Landlords in these complexes can raise rents when the economy improves. Owners of rent-controlled apartments who discount now are stuck indefinitely.
Posted by: Dan at April 8, 2009 9:57 AM
Not to diss Gateway, they have one of the most fabulous location, no doubt. But, man, their townhomes are nothing to write home about. If you don't insist on that particular location, you can get much, much better deal for your $3400, imo. All matter of priorities, I suppose.
Posted by: jj at April 8, 2009 10:46 AM
I've been studying anecdotaly the rental market for the past 3-4 months by checking CL and some of the major rental agents in the city. I exclude the fee-based agents from my reviews as I feel they grossly misrepresent things in their benefit and double post the same listing. Ugh.
In any event, inventory is way up and places are taking an incredible amount of time to rent. Owners / landlords are negotiating rents. And places are renting at lower prices. There is still a healthy rental market / appetite from what I'm seeing; but much like we saw the 'mix' impact the numbers on the sell side; I'm seeing the 'mix' on rentals happening too. That is, above average homes that are priced right are renting fast, and sub-par homes are sitting.
Every weekend I see several noticeable trucks packing people up that are moving out. EVERY rental building in PH has a "For Rent" sign hanging outside. One thing is very clear to me -- And that is the negative impact that this is going to have on the selling prices of real estate. I make no real predictions and don't claim to have any crystal ball, but I honestly believe that the worst is not over in all of this mess.
Posted by: eddy at April 8, 2009 10:49 AM
How would you correlate rental prices to home prices, Eddy? Because at this point r.e. price declines are out ahead of rental reductions seemingly.
Posted by: anonn at April 8, 2009 11:08 AM
Does this mean I should ask my landlord for a rent lowering?
Posted by: lolcat_94123 at April 8, 2009 11:30 AM
Let me weigh in.
Any landlord seeking the raise the rent this year should be easily faught, I have a friend who's landlady wants to raise rent on their 3 bedroom from 2700 to 2900, easy to tell her go to hell and find something nicer.
No doubt rents are decreasing, and how this plays with RE prices is a bit complicated. For example, I was close to purchasing a rented multi-unit building a couple months ago. Decided against it because it was going to be prohibitively expensive to kick out the tenants. However, since the rents were "market rate" it would have been nice to own the place and know I have rents paying at or above current markets. So the place in hindsight is more desirable.
The effect of "owners becoming renters" because they are kicked out of their homes is bunk. Former owners and renters who lost their job or are in financial straights are not looking to rent on their own, think moving in with family and friends out in the far east bay. The effect being priced out of the rental market because of high RE prices has far more effect.
Posted by: trotsky at April 8, 2009 11:58 AM
Hey - does anyone know if the City's rent control folks might actually mandate a rent REDUCTION at the end of the yearin the face of this? Or at least mandate a 0.0% increase for once...?
Not sure how that office calculates things. It's always distilled down to a tenth of a percentage point, which implies great precision; but despite that it never seems to be particularly connected to the market (frequently lagging the market to the benefit of us renters, so I'm not complaining or nothin' ... I guess I'm just greedy enough that if the Bolsheviks grant me a reduction next year, I'll be happy!).
Posted by: Grimwood at April 8, 2009 12:02 PM
eddy, I do agree with your anecdotal information. I personally "upgraded" from a dumpy place in Russian Hill to a much nicer place and building in Nob Hill for lower rent. The real kicker was they only required a minimal security deposit to move in. The previous apartment required $3000, plus first and last. Of course, I am sure they will nickel and dime that deposit to give me the least back possible.
I had looked at some investment property last year for some family members, many places barely penciled out then, definitely would not now.
Posted by: theNOB at April 8, 2009 12:11 PM
All I can say is that in the $4k+ range, everything is negotiable. I'm also seeing the corporate rentals and overpriced stuff (jwavro, mazel, etc.) sitting on CL.
Posted by: unearthly at April 8, 2009 12:15 PM
Can any experts weigh in on how this will affect home prices?
I'm not an expert on residential rental markets, but I am wondering: Is this a trailing affect due to housing market foreclosures? For a while rents were stable at 2005-2006 levels, but are now following the housing market downward.
Or, is this due to the employment market?
I would assume with housing prices going down, and rents going down with it, this could turn into a negative feedback cycle (i.e. rents going down pushing housing values down pushing rents down further)?
Posted by: Rincon Hill Billy at April 8, 2009 12:20 PM
This PDF from the Rent Board tells you how the increase is computed:
"NEW! Effective March 1, 2009 through February 28, 2010, the allowable annual increase amount is 2.2%. This amount is based on 60% of the increase in the Consumer Price Index for All Urban Consumers in the Bay Area, which was 3.6% as posted in November 2008 by the Bureau of Labor Statistics."
Posted by: Eric in SF at April 8, 2009 12:23 PM
PS. A *lot* of people are leaving SF when they lose their jobs. My partner and I have already arranged to move in with an old friend in a flyover state should either of us lose our jobs. If we're going to have to get a car and rejoin suburbia, we're going somewhere a LOT cheaper than the Bay Area.
Posted by: Eric in SF at April 8, 2009 12:26 PM
Grimwood, I think that it has simply never come up that there has been a negative CPI since rent control was enacted. However, because the Rent Board pct is simply an "allowable" increase, I'm fairly certain that nobody would or could ever mandate a rent reduction, just as nobody mandates an increase now. The "allowable" increase would simply be zero (but a landlord could still impose banked increases, I believe, unless new legislation prohibits that).
Posted by: Trip at April 8, 2009 12:31 PM
anonn, my long term belief is that there is a definite connection between rental pricing and comparable real estate pricing. SF has in recent years had a significant premium on ownership over rentals. I believe those premiums were stretched to their maximum limits (i.e., renters just wouldn't pay more).
For a while -- say the last 8 months, those premiums were moving back towards more reasonable levels as home prices dropped. Those premiums however are now growing again since rental prices are dropping. If you believe, as I do, that there will continue to be an overall market correction reverting back to more sustainable income to ownership ratios, and you believe that rental and ownership should move in some meaningful correlation, as I do, than the decrease in rental values should have a indirect impact on the related stock of similar homes. Trust me, I do not think that these things move in lock-step, or that this correlation is perfect, but I do believe in these trends. The increased vacancy rates, gamesmanship in goosing rental prices (e.g., theNOB's story of low security deposit), decreased rents certainly suggests that there is more weakness to come in the home value metrics.
This obviously assumes that Rentals are the leading indicator. I suppose you could counter argue (which is pretty much what you suggest above) that homes were the first to drop and rents are trending back to their previously high multiples. Personally, I do not think this is the case. I believe that we are in the process of deleveraging these multiples to longer term sustainable rates. For Prime SF, just as in NYC, there will always be a premium to ownership -- but the premiums in both these markets got way out of hand and I do think they are both coming back to reality. There is lots of press / research indicating that NYC is in for a world of hurt with rents possibly dropping 40%. This will certainly impact the housing market.
Posted by: eddy at April 8, 2009 12:43 PM
Hey Trip -
Thanks for the info & please forgive my cluelessness, but, um.... what's a "banked increase"?
Posted by: Grimwood at April 8, 2009 12:47 PM
I just had my rent raised in my rent controlled apartment. They had not raised the rent since 2003 it was a 7.2% raise when all the years were added together or a whopping $135. I'm gladly paying it, because my landlord is getting screwed by rent control and they still take excellent care of my place by fixing everything right away. I can't complain about paying $2,000 for a 9 room/5 bedroom 2,000 square foot top floor apt overlooking Duboce Park.
Posted by: LongTimeRenter at April 8, 2009 12:50 PM
"There is lots of press / research indicating that NYC is in for a world of hurt with rents possibly dropping 40%. This will certainly impact the housing market"
There is no question about that in my mind. However the 1 to 5 % rent reductions we're seeing now, which let's be honest are by and large following behind September's r.e. price shift, are not that.
NYC might be more exposed than SF, it might not. I wonder what percentage of that city's higher dollar figure renters are in financials or related?
Posted by: anonn at April 8, 2009 12:53 PM
Under the Rent Control Ordinance, a landlord can "bank" an allowed increase -- not impose an allowed increase in one year but then impose that "banked" rent increase in a later year (in addition to the allowed increase for that later year). There has been discussion among the stupervisors of limiting landlords' right to impose these banked increases going forward (as to some tenants -- e.g. those that have lost a job).
Posted by: Trip at April 8, 2009 12:53 PM
Hill Billy, there is no feedback cycle between buy/rent. The rent ("earning") determines the price, in the absence of bubble, and the rent is determined by the economy which effects supply/demand.
That said, here is what I think will happen. There are many properties currently renting hoping to wait out the market. The owners will have harder time with cash flow as it gets more difficult to find tenant at a viable price, and some of them will cry uncle and capitulate, either selling at the market price or walking away. (I've seen at least one in your hood.) And that'll put pressure on the price.
Posted by: jj at April 8, 2009 1:00 PM
My anecdotal take as a 25+ year resident of the Haight Ashbury is that a lot of the young folk in the hood do an immediate bail when the economy goes down.
They moved here for a good time, and when the good times end they have about a 5 second thought process before they drag the futon out onto the sidewalk (where they found it) and call mom.
Posted by: redseca2 at April 8, 2009 1:03 PM
I think the supervisors' meddling is what caused my landlord to finally go ahead and raise the rent after 6 years. She was worried she might not get to raise the banked increases at all if the supervisors had their way. My landlord also said the rent would be raised every year from now on. More unintended consequences brought on by our idiot supervisors.
Posted by: LongTimeRenter at April 8, 2009 1:03 PM
"which let's be honest are by and large following behind September's r.e. price shift "
I'm not so sure. The ratios got so out of hand that I believe we were pinned at maximum rental prices (i.e., renters just wouldn't pay any more for their class of property). As a result, rents held stable through most of the initial home value declines. It's like the correlation to speed and the number on your speedometer. If your speedometer only goes to 100mph and you car is going 150mph -- the needle is going to stick at 100 until it drops below that number. I think the same was happening in SF Rentals. A
I know a dozen friends and families that moved here; and each of them is spending their absolute maximum $ for their absolute minimum housing requirements. And most of them are looking to move into a better / cheaper situation. This just wasn't possible 12 months ago. I'm also friends with a few landlords, and rental agents who are seeing the same trends. The rental agents are less concerned than the landlords, but this is real.
Also, just looking at percentages doesn't tell the full story. Rents are down more than 5% if you factor that only the best places are renting, and for less. You're getting a lot more value for your $ right now; and there are rental tricks out there keeping prices high. Plus if all inventory was priced to rent tomorrow; you'd see a much larger drop that the 1 - 5% reductions you are citing. The good thing about rental units is that they generally tell a more honest story over the short run as landlords realize that a non cash-flow generating asset is bad! As such, the rental market will be an increasingly more interesting asset class to study as an indicator of forward-looking events.
Posted by: eddy at April 8, 2009 1:44 PM
Rents are very very directly tied to employment. Witness the spike in rents during the dot com boom, and the tremendous drop after the bust. It is much more directly about supply and demand than home ownership, which is affected by all sorts of other things like interest rates and the perceived real and intangible benefits of homeownership.
Until very recently, SF was doing OK employment-wise, and rents were actually propped up by the credit crisis in housing which drove (or convinced)people to choose renting for the short term. So any downward rental pressure took awhile, even though economic conditions were very uncertain. But now our unemployment rate is shooting skyward, income is going down, and rental supply is also increasing from all those empty condos.
The anecdotes of people moving are real. I can always tell when times are tough in SF by how many uhauls I see on the street (lots) and how easy it is to find a parking space on my block (easier and easier). When you're not tied to owning a home, and when your immediate job prospects are not bright, the economically rational thing is to move away from San Francisco to somewhere cheaper. It is happening (although in my opinion we have are still not at the dot com bust low)
Posted by: curmudgeon at April 8, 2009 1:46 PM
Or, is this due to the employment market?
i'll echo others, and even myself.
rental prices are directly tied to income.
Housing prices are only indirectly tied to rental rates. housing prices in the Bay Area are more tied to the mortgage market.
this downturn was a credit crisis. by definition, it hit credit first. thus, mortgages were increasingly hard to come buy. thus houses for sale got hit first.
only later as the credit crisis fed through to the "real" economy did we see job losses/lower wages. this is now affecting the rental market.
clearly rental rates do affect purchase prices of homes in an inderect way. (extreme example: who would pay $1M for a condo if you could rent a similar condo for $1). but overall the prime determinant of rental prices is income, and the prime determinant of housing prices is availability of credit (at least the last 10 years or so). some would argue that income is prime determinant for house prices as well... but I think availability of credit is more important.
Posted by: ex SF-er at April 8, 2009 3:09 PM
THe market is being flooded with a glut of condos that cant sell. Some building are being converted to rental. Supply vrs demand: too many units seeking to few people; thus: lower rents. I would love to buy a 3 or 4 unit vacant foreclosed apt complex. Cash will be king when real depression sets in. This is the beginning of a major economic disastor. Hope you saved your money to swoop in on bargains when they really hit the market. Sit back and wait: it is coming.
Posted by: glut at April 8, 2009 3:26 PM
There is a huge contingent of financial stable renters who chose to not buy because it's a bad investment. If I pay 8k in rent for SFH in PH and the house comes on the market for $1.4, I might buy it. At $2.5, no thanks. The premiums on ownership make buying here very risky. Riskier than it has ever been. Buying a home pre-2002, and certainly pre-1997 vis-a-vis renting was extremely more palatable. Why the high rents, and high housing prices are expected to resist long term trends is beyond me. It's clear that the policies in place post 1997 inflated these metrics to out of control levels. At the same time, there was an incredible amount of wealth creation that still exists so there is also real appreciation here, but there is still a lot of retreading IMO.
Posted by: eddy at April 8, 2009 3:30 PM
I made one phone call and got my rent reduced $600 in the Marina. There are a ton of vacancies and people moving out. I can only imagine how far prices are going to fall now that rents and incomes have come down so much. There is no hope on the horizon for the financial and tech sector at this point. Tons of un- and under-employed people out there burning cash every month. Unemployment is just getting worse with an *accelerating* trend which is extremely alarming - I wouldn't take a piece of property unless it was practically given away, and even then maybe not. Who needs any liabilities (debt) at all when there is no bottom in sight? We could all be making $40k a year for the rest of our lives if U.S. incomes move toward parity with the rest of the world (ChIndia).
I think we might be past a secular, multi-decade era where innovation is rewarded to an age of "cheap as possible" mass commoditization. Really, how important are all of our technological "advancements" (Twitter, Facebook, etc.)? It's all about faster/cheaper and both the Valley and the U.S. in general can no longer compete with the incredible low cost labor available overseas. Even Mexico is too expensive now. I'm talking for nuts and bolts industries like comm hardware, semiconductors, etc. All things I view as the "real" underpinning of the tech business. Now we're all about novelty businesses (Twt, FB, again) with poor economics.
Posted by: SF Banker at April 8, 2009 6:36 PM
Now is the time to get rid of wage and environmental controls. Bring down the cost of labor, and allow for mass pollution, then we can compete against the chinese. This will in turn drive values down further (Affordability index). End game will be cheap living for everyone. Lets just get this Earth thing over with. Rise up against the landed gentry (PH & Marina) and take way the means of production. Do it now before values stabilize and the job market comes back.
Posted by: glut at April 8, 2009 8:17 PM
As I've posted here before, there's pretty good evidence that in "average" housing markets, the long-run ratio of price to (annual) rent is about 15:1 (see http://www.cepr.net/index.php/publications/reports/the-changing-prospects-for-building-home-equity/).
I've yet to discover any data on the ownership premium in high-end markets (looking beyond the bubble years of 2002-2007). Perhaps it is higher. I'd appreciate any leads . . .
FWIW, and contrary to some of the posts above, housing prices are not greatly affected by mortgage interest rates. I don't have the study at my fingertips, but I believe it was Glaeser of Harvard who looked into this and found that a one percentage point change in interest rates results in a two-to-three percentage point change in the asset (house) value. So even a huge movement in mortage interest rates of 3-4 percentage points should not be expected to result in more than an approximately 10% change in the asset price.
Posted by: cse at April 8, 2009 9:37 PM
Poor widdle wandwords. boo hoo. so sensitive these days.
Posted by: sf at April 8, 2009 10:35 PM
I suspect that there is an ownership discount, rather than an ownership premium, as all the various discounts -- liquidity, risk, are born by the owner, not the renter. In SF, renting has option value of a highly mobile population living in an earthquake zone. Transaction costs for owners are much higher than for renters, etc. So owners should require a discount for the cash commitment, and demand a premium from renters.
One way of measuring this discount/premium is to look at costs as a percentage of income. I like to think of this as a crude yield curve. For SF, ownership costs didn't start to exceed contract rental costs until the late early 2000s. Currently, ownership costs are running at 31% while contract rental costs are at 27% of income. In 1989, median owner costs were 24%, and median rental costs were 28% of household income.
My prediction is that an inverted "yield curve" indicates over-valuation, and that at some point, it will return to a positive slope, meaning a rental premium. Census data is also available in quartiles, so you can do a finer analysis if necessary. Looking at income ratios and medians should wash out issues with mix/quality.
Posted by: Robert at April 9, 2009 12:41 AM
I like to think of ownership discount/premium in terms of the class of property.
At the low end, where properties are least objectively desirable because of layout (e.g., studio or 1/1), I'd think fair value would imply a discount for ownership. The reasons are simple: all of the liquidity risks mentioned by Robert, plus the idea that because not everyone in the economy has the ability and discipline to acquire and responsibly use capital (e.g., the downpayment, and the capital that is lent by a lending institution), a premium should accrue to the owner who does have this ability and discipline, implying that rental costs would be above ownership costs.
Moving up the scale of desirablity, say modest SFRs or larger condos in most nabes, the rent-buy should come more into line. The capital risks no doubt still exist, but in aggregate the class of owners of these types of properties can reasonably value the stability of the living arrangement and ability to customize the dwelling. These attributes would mitigate the liquidity risks. Additionally, as you go up the income ladder, tax effects would also start to accrue to the owner-occupier, which would have the effect of lowering equilibrium ownership "discounts".
At some point in the scale of desirability, perhaps at the large SFR in a well established nabe where one can see living for a long time (say, at least 10 years+) as a base case, I'd guess that the intangibles of ownership (stability, customization of the living arrangement, etc.) outweigh the identified risks. In addition, neither the class of owner looking to buy one of these nor the class of renter looking to rent one would be expected to be particularly capital constrained. Therefore, there is no need for an "ownership discount", which is another way of saying there is no need for that class of renter to pay a premium (they could just go out and buy the asset b/c of the absence of capital constraint).
Moreover, as we get into these more expensive/desirable properties, owners can objectively and legitimately (from a fair value point of view) begin to assign some value to the rough inflation hedge provided by housing, which would also tend to lower and perhapd eliminate ownership discounts.
At the highest end (mansions, very special properties) there are obviously many non-financial considerations, and the class of potential renters is very small relative even to the class of potential owners for these properties, such that no ownership discount should be expected. In fact, these properties should cost much more to own than to rent b/c of the intangibles benefit (especially customization), and that is exactly what is observed.
Using a rough model of ownership discount/premium by class of property that identifies capital/credit constraint as a key variable imo helps to explain the relative outperformace of the lower end/less desirable properties in this latest credit-fueled orgy, in which capital and credit constraints were effectively removed by insanely loose credit and "no downpayment" policy. The effects of this (temporary) condition included fooling the marginal buyer into paying a premium for property that absent the lax credit condition would have offered a discount, and to otherwise pay well in excess of fair value (base on the credit model) across the desirability spectrum.
Posted by: LMRiM at April 9, 2009 6:48 AM
There is no hope on the horizon for the financial and tech sector at this point.
Did you see the news coming out of WF today?
For tech, I can tell you that my company, a $2billion tech, is guiding Q2 higher in the earnings call in 2 weeks.
Posted by: ester at April 9, 2009 7:03 AM
I think LMRiM's last paragraph explains Robert's observation. There historically has been no -- and logically should be no -- ownership premium for most housing types. But the "premium" was disregarded because (1) it was assumed that housing prices would rise forever and overtake the premium, and (2) there were no barriers to entry with no-doc, no-down mortgages available.
Both those conditions are gone now. Indeed, with so many buyers getting wiped out, I suspect we will overshoot as the premium is assumed to be greater than it would be in a normal market.
Posted by: Trip at April 9, 2009 7:08 AM
A friend came to visit from Phoenix a few weeks ago, and said that they were thinking about moving to SF.
If they were to move, they plan to buy a condo, but find a rent-controlled unit to live themselves. I guess that is a winning strategy. don't know if anyone is really doing that???
Posted by: ester at April 9, 2009 7:24 AM
"Did you see the news coming out of WF today?"
Great news! Did you know that diemos inc. made $1T dollars last quarter? It's true! You see diemos inc. owns a bic pen which I included in the companies level 3 assets at a book value of $1T dollars. Et voila! A $1T dollar profit. Now all I need to do is borrow $1M against that asset so that I can pay the CEO (me) a $1M dollar bonus to reward myself for the companies excellent performance. At some later point when it's revealed that the bic pen isn't actually worth $1T I'm ready to give "the standard press conference". To wit:
"That is very strange. I don't know what could have happened. There must have been something wrong with my bic pen valuation model. Everything was going great and then something must have changed in the market. It's inexplicable! [sadly shakes head] I'm afraid the company is bankrupt and won't be able to pay back the $1M loan. [sighs heavily] All I can do now is take my $1M and retire to my mansion in the Hamptons to try to understand what went wrong. [look of shock] What!? What's that you say? Give back the million? [look of wounded innocence] But that's my pay. You can't just steal someone's pay! That un-american!."
Posted by: diemos at April 9, 2009 7:33 AM
"If they were to move, they plan to buy a condo, but find a rent-controlled unit to live themselves."
Outstanding plan! Encourage them to make a hefty cash downpayment.
Posted by: diemos at April 9, 2009 7:40 AM
I see that a European private equity group bought iShares. I hope they stick around in SF (probably would have been better for SF if Warren Hellman would have gotten the buy).
Bank earning season followed (at some point) by "stress test" results should be quite a roller coaster. Hold on, ester.
Posted by: Trip at April 9, 2009 8:07 AM
Ownership also provides protection against inflation. It is often mocked here as "betting on price gain" but the truth is, home prices and rents have tended to go up. You shouldn't really just do a flat 1:1 calculation of rent vs. home ownership costs (which most people on here do wrong anyway) but the discounted cash flow of all rents vs. all mortgage payments over the life your occupation of the property. You also have some protection against a big uptick in inflation. It is hard to model how much that is worth.
For SF, ownership costs didn't start to exceed contract rental costs until the late early 2000s. Currently, ownership costs are running at 31% while contract rental costs are at 27% of income. In 1989, median owner costs were 24%, and median rental costs were 28% of household income.
Can you show me your calculations here, or point me to the source? This is very interesting data.
Posted by: NoeValleyJim at April 9, 2009 9:16 AM
The effects of this (temporary) condition included fooling the marginal buyer into paying a premium for property that absent the lax credit condition would have offered a discount, and to otherwise pay well in excess of fair value (base on the credit model) across the desirability spectrum.
I tend to agree. I also think its important to note that only the relatively small % of homes transacted in the years between 2001 and 2008 were subjected to this phenomenon; and the later you bought -- the greater premium you paid. Yet, somehow the last sale price of the biggest fool is assumed to create a 'comp' for all other homes in the surrounding area. This is why foreclosures and sales of homes from pre-bubble, or early bubble, will continue to push prices back into some equilibrium.
Posted by: eddy at April 9, 2009 9:38 AM
Ownership also provides protection against inflation.
Just a few counterpoints to this argument, and an observation:
1) Most "owners" are merely renters of capital from a bank. As such, they implicitly enter into a "spread game" (cost of funds versus nominal moves in the leveraged asset) against people who are far more sophisticated than they (namely, the banksters/Fed). As the price of entering this game, many "well-off" purchasers chose to put their own capital in the first loss position. In this regard, the no-down subprime crowd was making a wiser bet: $0 at risk in exchange for some inflation protection on the upside.
2) "Ownership" of the asset requires maintenance costs. These maintenance costs will likely track whatever one is using to project price inflation at the time of purchase decision. Although over the medium- to long-term the asset nominal value will correlate with most measures of price inflation, providing some hedge for the purchaser, on the other hand the purchaser is absorbing inflation risk in the maintenance expense. In normal (non-prop 13 markets, for instance), the owner would also be absorbing the "inflation" risk of the ever-increasing maw of inefficient government that is reflected in higher taxes.
3) Regardless of whatever inflation protection is provided by housing, paying in excess of intrinsic value for the protection is unwise. The difference in effective (after tax) cost between buying and renting is a partial measure of the ongoing cost of this inflation "protection".
4) (Observation) Leveraged assets that are assumed to be correlated with generalized price inflation provide no protection against bouts of deflation (or change in inflation expectation). Just the opposite. The leveraged aspect of the typical home purchase ensures that the equity in the asset is whipped around mercilessly, especially in the early years when it consists mostly of the "first loss" downpayment. Many people in the Bay Area are now discovering this obvious characteristic of assets purchased with high leverage.
Posted by: LMRiM at April 9, 2009 10:13 AM
In some regards, this housing bubble was a bit of, and still remains somewhat of a ponzi scheme of musical chairs. Those stuck with the inflated assets (be it home 'owners' or banks) are watching their equity go poof.
Posted by: eddy at April 9, 2009 11:25 AM
I don't know how to say this but... For me - renting sucks.
Now that I own - I am mentally more invested in my community, invested in my garden, invested in making fung shei modifications to my house that greatly improve my state of mind (think more closets, more built-in's, more skylights). It's not just a rent vs. buy calculation. I never would feel as comfortable making the physical improvements in a rental and I would always wonder if the landlord might want to move back in (I had an OMI about 8 years ago) or sell the building, leaving me potentially displaced on someone else's terms.
My life is super busy - with a job, kids, community, side projects, travel - knowing I can come home to fairly organized and warm surrounding makes a huge difference in my sanity and energy level. It's hard to value.
Posted by: anon at April 9, 2009 11:27 AM
None of these arguments hold water against purchasing a multi-unit building in a good rental area such as the Castro, with good rents past, present, and future, as a longterm hold, a portfolio buy, and a hedge against inflation. Most of the criteria utilized to criticize property purchases in this market has to do with shorter holds. In fact I'd go as far as to say every single one I've ever seen is less than six years.
Posted by: anonn at April 9, 2009 11:37 AM
First, I agree you have to look at DCF, which is why I am comparing monthly costs. The stream of these is the DCF.
For my source, this is census data. Go to factfinder.census.gov, select the american community survey, select the year, then "detailed tables", then select San Francisco county -- all the tables should come up. ACS has data for the period 1996-2007 (although pre-2000 data is in the form of dbdumps via ftp. A bit of reverse engineering is required, but it's not too hard.)
The same graphical interface accesses 1990/2000 census data. 1980 and earlier data requires a visit to the library.
Btw, you can select a specific census tract which is effectively a few blocks, so that you can get data such as median income and tenure on a very micro basis. The factfinder site has an interface to determine which census tract a building is in.
Trawling through census data is fun -- enjoy yourself!
Also, rents are not a function of inflation, but of incomes. If inflation increases, but incomes do not, rents will not increase. It's an accident of history that since 1989, real incomes have basically not increased (I think a CAGR of 0.5%), so rent paid has moved in-line with inflation. In the same way, if inflation stays flat, but incomes increase, rents will go up. Finally, few owners in SF keep their house for more than a decade -- most people, it seems, believe in constant "trading up" -- so the risk is that inflation will drive mortgage rates up, therefore driving prices down. Record low rates is a great time to refinance, but not to buy. Moderate, yet falling rates is when you should buy.
As to your other points, the comparison I advocated is actually a bit subtle -- I'm comparing different buildings and different incomes, but by just looking at the cost ratio, I get a measure of the ownership burden versus the rental burden. It is very unusual for the owners to pay a proportionally higher share than renters, for the reasons cited above. I would like to re-iterate, though, the earthquake risk, which is substantial. It seems ludicrous to me that people are taking into account a point or two of potential inflation gains while they sink a huge proportion of their net-worth into an illiquid, heavily-taxed, deteriorating asset sitting atop an earthquake zone.
I think it boils down to psychology and lifestyle choices. I go to the Safeway once every three months, buy light bulbs, and that is the sum total of my "home improvement". I spend about 5% of my income on rent, and save over 40% of my income. This frees up a lot of cash for me, and gives me much more safety and peace of mind to focus on the things that are more meaningful (to me) than improving a house.
I have a friend who bought in 2005. The house has a brick foundation. He needed to add a retaining wall. He discovered the electrical system was not properly grounded. While doing this, he found rot from a leak in the roof. Then he replaced the bay windows (another leak), the roof, and had the house painted. He loves "improving the house", as it seems you do. Fair enough -- he is also a shade-tree mechanic, but he has sunk much money and many weekends into his hobby.
San Francisco has beautiful 100+ year old victorians that require an enormous amount of maintenance and repair. Most owners don't have the income/time/skill to even maintain their homes, let alone improve them. I'm not talking about covering every square surface area in the kitchen with granite, but replacing the water pipes and fixing rot/mold underneath the porous floor of your bathroom. There was an earthquake recently. How do you know it didn't cause a pipe to spring a leak? That it didn't cause one of your windows to become improperly mounted, or enlarge a crack in the roof?
There is a lot of stuff "under the hood" that needs to be done. Of course, few do this, because at the end of the day, you will end up moving in 7 years anyways. And if you are the type who swears that they will really stay, then you will probably move out in 5. I've seen this happen too many times to believe anyone's predictions about their future desires or satisfactions. Life changes, and it is really a game of musical chairs in which you hope you are not the one owning when the problems become noticeable, when the earthquake hits, the neighborhood changes, or the economy goes sour.
A "home" is the set of social relationships that you have to keep and be responsible for -- I think many americans are confused about this, and try to substitute objects that can be bought and sold for relationships in most aspects of their lives. Hence you hear terms like "partner" instead of "wife", "community" instead of subdivision, or being "invested" in a relationship, or taking a "productive" vacation. It may well be that at this point, the rot is spread so far that incurring a million dollars of debt is required to make some people feel "invested" with their community, but this need not be the case for you or anyone else.
Actually, I think the opposite tends to be true. Neighborhoods with a predominance of detached, single family houses tend to be weaker because there is less shared public space. People grill in their private backyards instead of the public park, or swim in their private pool instead of the public pool, or buy their own book instead of going to the library. From "home theaters" to "home schooling" there is a march away from public spaces, which leads to more isolation and detachment.
For me, buying a house would require turning over a large proportion of my savings and incurring huge debts. It wouldn't improve any of my relationships, or add "meaning" to my life. It would subtract from my peace of mind, and I am willing to pay a premium to not do so. And, if my own satisfactions change, I can always buy a house at the price I am willing to pay, even though I may not be able to sell a house at the price I want to get. This is option value, but in this market, I am the one who is paid a premium, and the owner is the one who pays me. I am the one with the inflation hedge (via rent control), yet the owner is the one taking the inflation risk (via a huge levered bet). That was the point of my earlier post.
Posted by: Robert at April 12, 2009 9:10 AM
Robbert, all great points.
BTW: RC as it stands in SF isn't a price control. It's a requirement that each rental unit include an option to remain indefinitely with below-inflation rent increases. Options cost money, and the burden is born by short-term tenants.
Posted by: jessep at April 12, 2009 10:15 AM
Options cost money, and the burden is born by short-term tenants.
I think you are assuming that incomes only go up. The big picture is that incomes have not been increasing much more than inflation (only about 0.5% real CAGR form 1989-2007).
However, SF is a small city, so there is volatility. Lots of volatility. From 2000-2002, the rental price on my unit fell 20%. It took 8 months of vacancy, for the owners to grudgingly reduce the rent first once, then again, and finally a third time (when I moved in). The building was 50% vacant before that. After they lowered the third time, the building quickly became fully occupied (within 2 weeks). Now, city-wide, incomes did not fall 20%, but rent control exacerbated the situation, just like incomes did not increase by 20% from 1998-2000, but asking rents did.
The effect of rent control is to prevent owners from realizing income spikes and dips on the entire pool of renters -- the short-term renters end up paying much more or much less than they otherwise would -- so it really is like purchasing an option.
For all the complaining about rent control, the actual effects of it are to make the economics more like those of house prices -- which are also set on the margins. And the additional stability provided by rent control -- fixed, predictable payments -- are the same as for mortgage payments. Once you add eviction control and full access to city services, there really is not much more reason to buy except to make renovations.
Posted by: Robert at April 12, 2009 11:42 AM
Standard definitions of inflation include both wage and price increases. I am not going to use some half-baked Austrian definition for the word just because a few people on this blog try to define it that way.
But yes, if prices went up and wages did not, this would be bad for both the rental and housing markets. Conversely, if incomes rose faster than inflation, this would be good for those markets. We are in agreement here.
Looking at the ACS data you pointed me to, I see the following (for 2006):
Median gross rent as a percentage of household income
Median selected monthly owner costs as a percentage of household income in the past 12 month (Universe: Owner Occupied Housing)
Housing units with a mortgage: 30.4
Housing units without a mortgage: 11.1
Total ownership costs are actually lower, as a percentage of income, for home owners than for renters, primarily due to those who have paid off their homes.
That is primarily the point that I am trying to make: rents go up, mortgages do not. Rent-control offers some protection from this, but not in SFHs and the legal protection provided to an occupier of a rent controlled unit is much smaller than a home owner. You can always be Ellis Act evicted, for instance, at least today. The trend politically has been to generally erode rent control, but it is hard to guess where this is going in the future.
There is also the great benefit that you can end up owning your home outright, which 30% of the SF home ownership universe does (according to some simple algebra on the above percentages).
I agree that people who buy and sell all the time pay huge transactional costs and this is a big mistake financially.
And plenty of homeowners are paying pretty small fractions of family income on housing, it was something like 15% for us last year, including maintenance. Now we undoubtedly "underconsume" housing and save too much, just like you, but it is almost as easy to do that holding a mortgage as renting.
Posted by: NoeValleyJim at April 12, 2009 12:57 PM
"Standard definitions of inflation include both wage and price increases."
Which is why they are pretty useless for actually understanding how things work.
"rents go up, mortgages do not."
Yes! In the good old days of endless mild inflation where everyone had a 30 year fixed mortgage. Not in today's world of ARMs and debt deflation.
"There is also the great benefit that you can end up owning your home outright"
Indeed. Pre-paying your housing costs is a wonderful thing. But the only way normal people could "afford" SF house prices recently was by using a loan that would never be paid off.
"it was something like 15% for us last year, including maintenance. Now we undoubtedly "underconsume" housing and save too much, just like you, but it is almost as easy to do that holding a mortgage as renting."
13% of gross income for me renting. Almost as easy to do with a mortgage? Yes, if you use a neg-am where you're not paying any principle or even all the interest. With a 30 year fixed fully amortizing? Please NVJ, don't make me laugh. Even with today's low interest rates I'd still be paying more like 22% for a comparable place in the same area.
Posted by: diemos at April 12, 2009 1:16 PM
The other definitions of inflation I have seen posited on this blog (the total money supply including all credit) are unmeasurable, so worse than useless.
The percentage of income you would be spending on housing would increase from 13% to 22%, both of which I am sure you can afford. Or you could move down a bit on the housing ladder. But yes, purchasing costs more than renting today, no one disputes that. The question is whether it should in the long run or not. I can see arguments either way, but I think that SFHs should cost more.
If you take the extremely pessimistic and admittedly quite common on this blog view that nominal incomes will never rise again, then you are right, you would be making a huge financial mistake to purchase an asset whose primary value is in inflation protection.
I think the people that make this claim are way out on the fringe and overly pessimistic in the extreme. These claims historically are common near the end of a recession, by the way, which looks more and more like where we are today.
Posted by: NoeValleyJim at April 12, 2009 1:44 PM
Standard definitions of inflation include both wage and price increases
Inflation in these discussions is CPI inflation. CPI is what most people mean when they say "inflation". It is not a half-baked Austrian concept. I'm sure you know this, so I'm puzzled by this sentence.
Total ownership costs are actually lower, as a percentage of income, for home owners than for renters, primarily due to those who have paid off their homes.
More puzzlement. By your logic, if house prices doubled, but half the houses were purchased outright with cash, then the "owner costs" would not increase. This should convince you that including houses without a mortgage is not a valid comparison of monthly costs.
I was comparing the amortized cost of those who are "buying" a house month-to-month versus the cost of renting a house month-to-month. This gives a meaningful comparison of the monthly purchase burden vs. rental burden. You cannot include houses that are not being amortized anymore than you can include rental units that are not being rented.
If you pull this data for all the years, you'll see that the norm is for owner costs (with mortgages) to be lower than the owner costs for rent. You will see how anomalous the current situation is, and if you are patient, you will see owner costs decrease to trend levels.
Posted by: Robert at April 12, 2009 2:06 PM
Don't get me wrong though, I don't think it is time to rush out and buy or anything. Housing markets tend to move in slow cycles, so you might as well wait and see a clear bottom if there is little cost in doing so. Or in your case, even a substantial benefit!
Posted by: NoeValleyJim at April 12, 2009 2:07 PM
Inflation in these discussions is CPI inflation. CPI is what most people mean when they say "inflation". It is not a half-baked Austrian concept. I'm sure you know this, so I'm puzzled by this sentence.
I proposed this a few months ago and got shot down in this thread, which you commented in:
Though I forgot that I had agreed to stop using the word inflation, because it causes so much confusion.
You cannot include houses that are not being amortized anymore than you can include rental units that are not being rented.
I think that most of those paid off houses are ones that the owner has paid off a mortgage. As diemos pointed out, pre-paying some of your housing costs is a good idea. You need to examine lifetime housing costs for ownership vs. rent. Alternatively, you could examine ownership costs minus principle payments and compare that to rental costs, but I don't think anyone gathers that info. You can easily do it on an individual basis though and this is a good way to personally do the rent vs. buy calculation.
Posted by: NoeValleyJim at April 12, 2009 3:03 PM
I'm looking to upgrade my rental as well and I'm shocked not only at the large amount of listings on Craigslist, but the delusional nature of some of them. I've lived in several major cities across the US and have never seen rental listings that were so unprofessional. It makes one wonder what color the sky is on these people's planet(s). Maybe a year ago, this kind of slop was acceptable, but not in a competitive market. I mean seriously, who writes these things when they are trying to rent a 1 bedroom for $2400 or more?
- The fact that the apartment has basic kitchen appliances (stove/ oven/ refrigerator), a working bathroom, and that the mini-blinds are "clean", as major selling points for the property.
- Not taking the time post pictures, use spell check, or list the square footage (even if is just approximate).
- Advertising a 1 bedroom that has a separate living room space as a 2 bedroom. I don't care if the living room does have a closet, it's not a 2 bedroom. If there was not a separate living room, the apartment would be a studio, and not a 1 bedroom.
- Advertising a unit as having an “eat-in” kitchen because there’s enough room to stand over the sink and eat a bowl of cereal
- Calling the top floor unit in a 2-story building a “penthouse”
These are just a few of the absurdities I've seen. It occurs in listings for both older and new properties, so I guess I can't completely blame rent control. Even Manhattan in the 90's, when rental competition was fierce, didn't have listings this sloppy. Ok, rant off...
Posted by: pica1986 at April 13, 2009 1:33 PM